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Good Day Currency Traders!

You may remember that Bear Stearns was the firm which brought the whole sub-prime mess to light last July. This debacle all started with the collapse of two of its hedge funds which invested in securities linked to sub-prime mortgages.

Over the weekend, Bear Stearns was sold to JP Morgan Chase & Co. for just US$2 per share, well below the US$84 book value of the company. In fact, the total sale price is only one quarter of the value of the securities firm's headquarters building in midtown Manhattan.

Can you say fire sale? This sale illustrates once again just how bad things are on Wall Street, and how afraid everyone is of all of the 'nasty stuff' hidden in these firms' balance sheets.

The Fed to the Rescue, Fashionably Late Once Again
Before they announced the sale, the Fed stepped in and provided emergency funding to Bear Stearns through JP Morgan to avoid a collapse. But the Fed didn't stop there. Minutes after the sale was announced, the Fed cut the so-called discount rate by a quarter of a percentage point to 3.25%.

In my opinion, this is what the Fed should have done months ago. The discount rate cut will have a much greater impact on the credit markets than the big Fed Funds cuts has made over the last few meetings.

In its first weekend emergency action in almost three decades, the Fed also said it will lend to the 20 firms that buy Treasury securities directly from it. Bernanke is trying to force feed funds into the banking system to help loosen up the credit markets.

These unprecedented moves are further proof the Fed is still reactive instead of proactive. There is little doubt the Fed will announce a further cut of the Fed Funds rate later today. The markets are expecting a 50 bps cut, but some still feel 75 bps are possible.

I think it's obvious the Federal Reserve is running scared, and 'Helicopter Ben' is doing just what many predicted he would do - he's throwing as much money into the system as possible.

These Inflation Numbers Are Pure Fantasy
But all of these rate cuts and cash infusions have got to be inflationary right? Not according to the 'official numbers' which were released on Friday.

The government reported U.S. Consumer Price Inflation actually fell during the month of February! Does anyone really believe prices for consumers are falling? I won't even justify these numbers by reprinting them here. They are absolute fantasy!

But these numbers did give the Fed the green light to continue to cut rates, which they immediately did over the weekend.

These aggressive moves by the Fed have all but sealed the fate of the U.S. dollar. Currency traders have continued their assault on the greenback, and there is currently no rescue in sight. I don't think even Treasury Secretary Hank Paulson can seriously talk about a strong dollar policy anymore.

They have obviously thrown concerns about inflation and our weakening currency out the window. Instead, they're just trying to keep the U.S. economy from falling off the precipice. Unfortunately I think we have already fallen off, and the currency traders look like they agree.

Meanwhile, on the Other Side of the World
The Europeans also announced consumer price inflation, and their report showed price increases accelerated to 3.3% in February. That's the highest in 14 years, according to the European Union's statistics office. That's faster than expected, and a much more realistic assessment of current conditions. Labor cost growth quickened in the fourth quarter to the highest since 2006.

European Central Bank (ECB) President Jean-Claude Trichet last week quashed speculation of a rate reduction by stressing the bank's commitment to price stability even as economic growth cools. The ECB has not wavered from their primary focus, and the euro will continue to benefit from their strong guidance. The euro will continue to be seen as the world's 'new' reserve currency, and investors and countries will likely continue to diversify out of their dollar holdings into the euro.

But two other currencies were the biggest movers in Asian and European trading. The Swiss franc rose beyond parity against the dollar and the Japanese yen traded all the way to 96 overnight.

The credit crisis in the U.S. led investors to sell the higher yielding emerging market assets. All former carry traders are repaying loans in both Japan and Switzerland. The Swiss franc is still seen as a safe haven for currency investors and will likely continue to strengthen as market volatility picks up. The franc was also supported by speculation the Swiss National Bank will hold rates steady in an effort to combat rising inflation.

With the U.S. hell bent on lowering interest rates, even the low yields on Swiss francs and Japanese yen are beginning to look attractive to investors. The rise of the Japanese yen has largely been a story of the reversal of carry trades, as the economic fundamentals and political stalemate don't really justify the recent moves.

The political stalemate has allowed the yen to move up unchecked, with the Bank of Japan unable to intervene in the markets to slow the yen's quick rise. Without intervention, the reversal of all of the short positions will likely continue to push the yen higher.

Chris Gaffney, CFA
Vice President
EverBank World Markets

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Making 'Cents' of the Headlines
One Long, Unprecedented Weekend of Fed Meddling and Market Mayhem

From Currency Director: Sean Hyman

What Happened:

Wow, on a night like Sunday night, where do you start? Let's see, first the Fed surprisingly cut the discount rate on a Sunday. The Fed hasn't cut rates over the weekend since before my time - nearly three decades ago.

Then the markets opened up in Asia and they quickly dropped 4%-5%. At one point, the Hang Seng index in Hong Kong was down over 1150 point which is down over 5%. The Nikkei followed its lead.

The Fed had to "save" Bear Stearns on Friday. Then it got even worse. Bear was still about to go under so J.P. Morgan started talking to Bear Stearns about buying Bear out. Since Bear Stearns formerly had a market capitalization of over US$4 billion, many thought that they might get bought for say...US$2 billion. But it was much worse than that. JP bought Bear for US$236 million or a measly US$2 a share, as you read above.

How the Markets Reacted :

So that was what was happening in the stock world. In the currency world, traders were bailing out of the buck and running for shelter in the yen and Swiss franc. They also ran straight for the euro, appropriately nicknamed "the anti-dollar."

The dollar opened up for trading and dropped like a rock. The EUR/USD skyrocketed over 250 pips and hit 1.59. The USD/JPY pair fell about 400 pips to hit the 95's. The Swiss franc is valued at more than a dollar now with the USD/CHF rate around .9800.

Then we move on to the carry trades. They unwound with a fury. The EUR/JPY pair fell about 350 pips at one point. But wait until you hear about British pound. The GBP/JPY pair plummeted almost 800 pips overnight. That would be a 70% gain on your investment with just the overnight move alone.

What I Say:

So the Fed really helped put a scare into the market. The market obviously said: “If the Fed feels the need to cut rates on the weekend before the actual Fed meeting, things must really be bad.”

Most traders (aka the overall market sentiment) probably think the Fed is panicking. They’re selling everything because they’re scared that we could have a real “stock market collapse” on our hands.

So the market expected the worst and investors started bailing out of their shares as quickly as possible.

Where does all of this leave us? It tells us not to be “risk seekers” until all of this finally blows over. The yen and Swiss franc will still be your best friends for a while because both are “risk aversion” plays. Traders are running to these beaten down assets like they are a “safety zone” away from all of the fall out.

This means that the carry trades (especially EUR/JPY, EUR/CHF, GBP/JPY and GBP/CHF) will be susceptible to large swings to the downside until all of this shakes out. So those of you who have taken our suggestions and shorted these carry trades should be cleaning up right now. This “nightmare” for stock traders has become your best trading day of the year likely.

At some point, the major central banks from around the world will probably have to collectively join forces and support the dollar during this time.

In the meantime, don’t hunt for bargain stocks. Instead, add to your gold holdings when it pulls back a bit. (By the way, gold hit US$1.023 an ounce overnight). I’d still short carry trades after rallies upward. Personally, I think the euro looks more risky at 1.59. I think the safer bet at this point is to stick with the shorting of the carry trades because the EUR/USD may not have much “juice” left in it unless more of this “market madness” continues on in the short-term.

I would NOT buy the British pound at all because even the buck rallied against it overnight as it came down from the 2.04 level down to the 2.00 level.

Remember in trading in environments like this, place unusually wide stop losses, to allow for volatility. Also, if you’re trading in the forex market, make sure you cut the number of your lots way down, possibly in half of what you normally trade.