Bailout price tag pressures dollar
Broad gains for other major currencies as investors weigh U.S. plan
By William L. Watts, MarketWatch
Last update: 6:26 a.m. EDT Sept. 22, 2008Comments: 4LONDON (MarketWatch) -- Sticker shock weighed on the dollar Monday as financial markets wrestled with the implications of the U.S. government potentially taking on $700 billion in debt to finance a massive bailout and stabilization of the financial sector and money markets.
Washington's ambitious strategy to bail out the troubled U.S. financial system "have been largely dollar negative," said James Hughes, analyst at CMC Markets.
The dollar index (DXY:US Dollar Index Future - Spot Price DXY 77.21, -0.24, -0.3%) , a measure of the greenback against a trade-weighted basket of currencies, fell to 77.432, down from 77.663 late Friday in North American trading.
"Many traders seemingly [are] buying into the core idea that anything that's good for the banks will be bad for taxpayers," Hughes said.
The euro moved well clear of the $1.4500 level, changing hands at $1.4575, up from $1.4488 late Friday. The British pound surged to $1.8442, up from $1.8334.
The dollar also fell against Japan's currency, slipping to 106.19 yen from 107.28 yen.
U.S. lawmakers and Bush administration officials huddled over the weekend to work out details of the plan.
The administration's proposal would allow the government to buy the bad debt of U.S. financial institutions for the next two years. It gives the Treasury secretary authority to buy $700 billion in mortgage-related assets, and would raise the statutory limit on the national debt from $10.6 trillion to $11.3 trillion. See full story.
Separately, the U.S. Treasury last week said it would insure publicly offered mutual funds that pay a fee, while the Federal Reserve will buy agency discount notes from primary dealers, acting as a backstop when and if money-market funds want to sell their assets. See earlier story.
The dollar "will likely come under more pressure out of concern for the envisaged increase in public debt, but we remain of the view that the positive impact on the U.S. [macroeconomic] and financial outlook will dominate, supporting a moderate dollar strengthening over the next 15 months," wrote strategists at UniCredit MIB in Milan.
The dollar came under pressure Friday after initially rallying on news of a Washington-engineered rescue plan.
Sorting out the implications
The sheer scale of the proposed bailout has stirred concerns about the addition of massive levels of debt to the federal budget. More debt will likely weigh on the price of U.S. government bonds, sending yields higher.
"U.S. yields are likely to move higher in the medium term as the U.S. Treasury will be forced to issue bonds to finance its run of bailout packages," noted strategists at BNP Paribas.
Indeed, Treasury prices fell by the most in two decades on Friday, as investors sold in anticipation of lots of new supply coming on the market for U.S. government bonds. See full story.
International investors may respond to the prospect of holding U.S.-denominated paper in the face of expanding supply by turning to assets such as gold and other commodities, strategists at Bank of New York Mellon told clients.
"Such a shift in thinking is also likely to see investors favor currencies where the central banks retain an anti-inflationary stance and where there is a well-developed government bond market where they can leave their capital," they wrote. "The euro would seem the most likely home for such investment flows."
Meanwhile, coordinated efforts by the Federal Reserve and other major central banks unveiled last week to pump billions of additional dollars into money markets should serve to ease a near-term dollar shortage, analysts said. See full story.
"We continue to hold the view that the U.S. dollar liquidity provided outside the U.S. will reduce the liquidity squeeze in the short term and therefore lead to lower dollar demand," wrote Sven Schubert, a currency strategist at Credit Suisse in Zurich.
Japan's yen, meanwhile, continues to gain ground on renewed risk aversion, analysts said.
William L. Watts is a reporter for MarketWatch in London.
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