How Far Does This Go?

By NewstraderFX

This is shaping up to be one of the more interesting weeks, as the question of how far this all goes has to be uppermost in everyone's thoughts. My own opinion is that this has a lot more downside and that 12,600 on the DJIA is the next stop. As with all trends-things won't move in a straight line, but the overall trend is down and looks likely to stay that way for the immediate future.

If you are of the belief that the two main drivers of the long bull market were global growth and global liquidity, you have to believe that one of the legs has been kicked out. The asset-backed global liquidity market is no longer functioning anywhere near the degree that it has been and does not look to make a recovery in the near future. As a matter of fact, to a large degree it's not functioning at all at this time as an estimated $200B worth of deals in the pipeline may be delayed or prevented from happening at all by a lack of funding. J.P. Morgan Chase, Citigroup and Goldman Sachs, lead bankers for the buyout of Chrysler, Wednesday shelved plans to sell $12 billion of loans to fund the purchase of the automaker by private-equity firm Cerberus from DaimlerChrysler. Future financing of deals will be hampered because the banks and investment banks who are now left on the hook for billions in loses due to previous LBO loan commitments will be unwilling or unable to take on new commitments. Meanwhile, credit-default swaps, the "insurance" against coporate bond failure, have seen prices rise to levels not seen since thier creation several years ago and spreads of corporate debt to government notes have widened to levels not seen since October 2001.

Another question lies with current debt holders. Their paper is now not returning fair rates of interest and even worse, they may be stuck holding notes who's prices have fallen in a very illiquid market. All those present holders of CDO's, CLO's etc are facing the daunting task of having to make new investments in an attempt to somewhat cover their loss. The pension funds, insurance companies and municipalities will likely be driven to the safety of government debt. We're already in a bull market for bonds that is being driven by a frantic flight from risk. What are the chances that these former buyers of collaterialized debt will be willing to buy more under the present circumstances-in other words-is good money likely to now chase after the bad? If you think that it will, then for you the bottom of this market is close. For me, it's not even within sight.

What does this all mean for currency prices? More of the same that occured this week. Unwinding of carry trades will be the order of the day. The dollar will appreciate vs the high yielders and lose vs the Yen. The BoJ is rumored to have intervened when the Yen hit 118 on the dollar last Friday-so that's the level to watch because if it's breeched, it could indicate that the BoJ may be unable or unwilling to stop the Yen from gaining further. In that case, the GBP/JPY pair could be driven to the lower 230's by week's end.