U.S. Shock and Awe ... Or Not

Obama's presidential campaign was regarded as near flawless, but over the last few weeks, it has been underwhelming, and today's delayed Treasury presentation is more of the same. The details were largely leaked which essentially sacrifices any element of surprise. There seems to be little that is bold or new that will break the negative psychology. On top of that, while the Senate has voted to pass their version of the stimulus plan 61 to 37, there is concern that negotiations between the House and Senate, may be delayed for another week or so. If there is a new element to the Obama Treasury's Plan it seems to be the public/private scheme--to start at $500 bln and may grow to $1 trillion. There will be $50 bln for home foreclosure relief.

Meanwhile, the Fed has announced it will expand the Term Asset-Backed Securities Loan Facility (TALF) and could broaden TALF to include other types of newly issued AAA-rated ABS, e.g. commercial mortgage backed securities, and private label residential mortgage backed securities. This would be funded by TARP funds. A web site, www.financialstability.gov, is a web site that will be established to prove more details of how tax payers’ money will be used. However, Fed Chairman Bernanke has not outlined any new initiatives that could counter the recent pickup in mortgage rates in the text of his testimony to Congress. The option to purchase longer dated Treasuries is still open but the Chairman seemed comfortable with the impact of the newly introduced MBS program on mortgage rates.

One notable aspect of today’s announcements is that in contrast to euro zone plans, the new Obama Administration programs do not appear to have ideological limits on how big funding for the programs should be. Instead, the Administration appears willing to throw a lot more money at the problem. The initial size of the capital injection plan is probably not adequate but the Administration is likely to move to increase the program’s size if necessary. The private/public program already has an option to expand from $500 bln to $1 tln. By contrast, some euro zone countries are already limited by fiscal constraints (Ireland is one example) and the ECB is unwilling to reduce rates too far. Secondly, the US Administration is making progress on its financial and economic packages. By contrast, euro zone finance ministers are in the process of holding discussions on a possible financial package. That package could involve a combination of a bank for distressed assets and guarantees on distressed assets but, as the Czech FM noted, there is unlikely to be an agreement on a single methodology amongst the euro zone members.

We had already cautioned about taking the markets initial reaction to sell US dollars as anything but an exaggeration. We suspect the equity market was already poised for a buy the rumor sell the fact type of activity almost regardless of what today's announcements contained. The bond market rally in front of this week's supply and in light of today's announcements is encouraging. Indeed, today’s 3-year Treasury auction was well received with a bid to cover ratio of 2.67%. In the FX market, sterling's price action may be telling. It is poised to close below its 5-day moving average for the first time in a little more than a week. The break of $1.4600 could see $1.4350.

As we have noted previously, sterling often seems to lead the euro directionally against the dollar. The breakdown of equities, dollar-bloc currencies, and emerging market currencies, while the yen and gold (up almost 3%), are all signs of short-term players putting back on the so-called risk aversion trades.