The U.S. dollar fell to two-month lows against the euro and a basket of currencies on Monday, pressured by uncertainty over the fate of U.S. automakers and reduced safe-haven flows.

The dollar was starting to respond negatively to concerns about further weakness in the U.S. economy, analysts said, after a run of weak data caused an exodus from risky positions and increased flight-to-quality buying in the currency.

Investors shunned the greenback amid fears a failure of one or more of the automakers could exacerbate a year-long recession and drag down other companies.

“The uncertain outlook for the U.S. automakers continues to keep investors wary of over exposure to the dollar at this point,” said Omer Esiner, senior market analyst at Ruesch International in Washington.

“We’re starting to see a shift in the market where negative data is starting to actually impact the dollar negatively, which is contrary to what we’ve seen for the better part of the last couple of months,” he added. “We’re seeing a naturally weaker dollar as we get into the year end, so bad news is only exacerbating the need for investors to just exit their long dollar positions.”

In early New York trading, the euro was up 1.5 percent at $1.3570 , after climbing as high as $1.3584, the highest level since Oct. 15, according to Reuters data.

The ICE Futures U.S. dollar index, which tracks the value of the greenback against a basket of six currencies, hit a low of 82.517, the weakest level since Oct. 20. It last traded down 1.3 percent at 82.606.

A more upbeat tone in the global equities market also helped ease extreme risk aversion, reducing the greenback’s safe-haven appeal and boosting demand for higher-yielding currencies.

The Australian dollar rose 1.1 percent and the New Zealand dollar was up 1.5 percent .

Against the yen, the dollar fell 0.9 percent to 90.31 , after hitting a more than 13-year high of 88.10 yen on Friday. But yen gains were capped on speculation that Japanese authorities could intervene to stem further currency strength.

BAILOUT IN FOCUS

The White House said on Friday it was considering tapping a $700 billion financial industry bailout fund to prevent a collapse of ailing U.S. automakers. That came after the U.S. Senate on Thursday rejected a bailout plan to avert a possible bankruptcy by one or more of the nation’s three automakers.

But U.S. President George W. Bush said on Monday an announcement on a car industry rescue was not imminent, leaving the industry’s fate clouded.

Investors also awaited the outcome of a policy meeting by the Federal Reserve on Tuesday to see how close to zero the U.S. central bank will cut interest rates and what alternative measures it will take to boost the economy. The Fed is widely expected to cut rates by at least 50 basis points from the current 1 percent.

“What the Fed says will likely overshadow its rate move,” currency strategists at Brown Brothers Harriman, wrote in a research note. “Many investors are looking for insight into where the Fed anticipates ending the rate cuts and what other non-traditional steps will the Fed adopt.”

Wanfeng Zhou
NEW YORK, Dec 15 (Reuters)

The Fed’s decision was unanimous. Cited was the fact that the pace of growth has slowed “markedly” and concern that financial market strains could put the economy at greater risk. “The intensification of financial market turmoil is likely to exert additional restrain on spending, partly by further reducing the ability of households and businesses to obtain credit,” the statement said.

In addition, “In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate in coming quarters to levels consistent with price stability,” meaning that inflation is no longer even on the radar screen.

The Committee also said it “will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.” That leaves open the tantalizing possibility of yet another cut in the future.

How low can they go? Lower, thinks Ian Shepherdson, chief U.S. economist at High Frequency Economics, who said the “downbeat” statement from the Fed caused him to pencil in another half-point cut at the Fed’s December 16 meet.

Source: Dollar sinks against euro -  Fed rate cut fails to support buck

At the New York close, all three major U.S. indices had sizeable gains:

* The blue-chip Dow Jones Industrial Average Index soared 889.35 points, an increase of over 10%, to close at 9,065.12.
* The tech-laden Nasdaq Composite Index jumped 143.57 points, an increase of 9.5%, to reach 1,649.47.
* And the broader Standard & Poor’s 500 Index shot up 91.59 points, an increase of over 10%, to settle at 940.51.

“The valuations are extremely compelling right now,” Dan Veru, who helps manage about $2 billion at Palisade Capital Management in Fort Lee, New Jersey, told Bloomberg News. “When you’re in extreme oversold conditions, the market is prone to these types of wild swings. The key thing is, can we hold these gains?”

It was the second-biggest daily point gain for the blue-chip Dow, which had a record-setting 936-point one-day gain earlier this month.
With a “lack of selling pressure” late in the afternoon, “the buyers began to ride in on their horses, and that brought in some additional buyers and short-covering,” Robert Pavlik, chief investment officer at Oaktree Asset Management, told MarketWatch.

All sectors posted gains across the board with energy, up 11.76%, and basic materials, up 11.74%, marking the largest gains.

The Fed’s Federal Open Market Committee (FOMC) is expected to release its statement on monetary policy tomorrow (Wednesday) afternoon.

The Fed is widely expected to reduce its benchmark Federal Funds target rate as the likelihood of a U.S. recession continues to increase and inflation pressures have abated.

The Fed Funds rate currently stands at 1.50% and a cut of 25-50 basis points is expected.

“The cut is already in the market,” John Ryding, economist at RDQ Economics told AFP.

“The question is whether it’s 25 or 50 basis points.”

Source: Dow Zooms Above 9,000 on Eve of Expected Fed Rate Cut

Martin Hutchinson says the Fed has finally starting doing its job: putting price stability over Wall Street’s demands. Real interest rates are negative. This is feeding inflation. It also means Treasury bond yields – also currently below the rate of inflation – are too low and should begin to rise again.

Martin says investors can profit from this situation with the Rydex Juno Inverse Government Long Bond Strategy (MUTF:RYJUX).

More from Martin in Money Morning:

The statement that was issued after the policymaking meeting was somewhat “hawkish,” suggesting that the U.S. Federal Reserve is awakening to the dangers of persistent and gently rising inflation.

Wall Street was initially spooked: it had hoped for the usual bounce that follows a Fed rate cut. However, investors subsequently decided the Fed’s inaction meant things weren’t so bad after all. Actually, the inaction was the first example in several years of the Fed doing its job – standing up to the easy-money politicians and Wall Street in the pursuit of lower inflation.

The Consumer Price Index (CPI) for August registered a decline in prices of 0.1%, which observers hailed as an indication that inflation worries are at an end. But don’t you believe a word of it; the decline was entirely due to the recent fall in oil prices, which we here at Money Morning expect will one day reverse course and resume their upward march. The only question is when that will happen and what the catalyst will be to make it so.

In terms of the CPI, the “real” consumer price inflation was actually 5.4% over the past 12 months, which makes the 2.0% Federal Funds rate look pretty silly.

The same is true all over the world: Inflation rates are either well above the local bank base rates (2.3% vs. 0.5% in Japan, 12.1% vs. 9.0% in India), or are only just below them (3.8% vs. 4.25% in the Eurozone, 4.8% vs. 5.0% in Britain). Only China has inflation of 4.8% to go against a bank rate of 7.2% – just reduced from 7.47% – but China had been holding prices down with direct controls for the Summer Olympic Games, so its current inflation number is pretty dodgy.

If interest rates are at or below the inflation rate in most of the world, then it follows that global monetary policy is expansionary and inflation can be expected to increase generally.

You can’t entirely blame the world’s central banks; we have been in a credit crunch for more than a year now, and investment banks the size of Lehman Brothers (NYSE:LEH) and Merrill Lynch (NYSE:MER) getting in trouble is a pretty good indication that all is not well. However, there’s also no denying that low or negative real interest rates will tend to produce an acceleration of inflation.

The two objectives – saving the world banking system, and keeping inflation under control – are in conflict.

The market demonstrates the solution to the conflict.

On Monday the Federal Funds rate traded for much of the day at 6.0%, versus the Fed’s target of 2.0%. To get the market Federal Funds rate down towards the target, the Fed needed to inject lots of liquidity, which it did – to the tune of about $70 billion.

That liquidity increased the money supply, but only to make up for the decrease caused by bank failures and market fear, thus restoring the market’s balance and lowering the Federal Funds rate to about 3.0% by the end of the day’s trading. An interest rate cut Tuesday would simply have moved the “target” Federal Funds rate, rather than the actual rate, and would have led to more inflationary pressures without materially helping the banking system.

Indeed, one can wish that the Fed had confined itself to injecting liquidity throughout this prolonged credit crunch, keeping the Federal Funds rate level at its September 2007 level of 5.25%. In that case oil prices would probably never have soared to $147 a barrel, and U.S. inflation might have remained safely around 3.0%.

Going forward, it seems clear that next time the FOMC meets without having had about half of Wall Street disappear in the preceding week (the next scheduled meeting is Oct. 28-29), it will be tempted to announce a modest interest-rate rise, unless the U.S. economy is truly in the tank by then. Of course, the Fed would remain ready to lower rates again if a deep recession appeared, or to inject liquidity if more banks got in trouble.

That would suggest that the current sharp drop in yields on long Treasury bonds has been overdone (from 4.25% in June to 3.25% yesterday (Tuesday) morning, before rebounding to 3.49% at yesterday’s close). Thus, a rebound in Treasury bond yield – taking them significantly above the level of inflation – is called for as money is tightened and the Federal Funds rate rises.

To take advantage of such a yield rebound, you should consider the Rydex Juno Inverse Government Long Bond Strategy (MUTF:RYJUX). This invests in short futures contracts on long-term Treasuries. It can be expected to gain as Treasury yields rise.

Source: Federal Reserve Policymakers Stand Up to Wall Street’s Easy-Money Crowd

At this point, Ben Bernanke has to feel like Barney Fife. Remember how on the Andy Griffith Show, Andy only gave Barney one bullet and he had to keep it in his pocket? Mr. Bernanke has to feel like he is running out of bullets and needs to keep them in his pocket.

The economy isn’t improving the way he had hoped. With the cuts being done in 25 basis point increments, the most the Fed has left is nine. Of course, they could go the same route as the Bank of Japan and start cutting by 10 basis points.

It won’t be long until the Fed has to make inflation the main concern and at that point, they will have to make moves to strengthen the dollar. This would help counter act the tremendous rise in oil prices.

Earlier today the Federal Reserve said it would lower interest rates by a quarter percentage point.

CNN reports: “US light crude for June delivery fell $2.17 cents to settle at $113.46 a barrel on the New York Mercantile Exchange. Just before the central bank’s announcement, oil was 93 cents lower at $114.70 a barrel.

The Fed rate cut is expected to the last for a the moment after the Fed suggested it will watch inflation.

“This seems a good time to mention that you should be selling your house and buying gold with all your money,” says the Mogambo Guru, “and if the kids have to miss a few meals or if they have to sleep in the car because I cannot afford an apartment big enough for all of us but it is perfectly cozy enough for me, that is the price you are willing to pay.”

At the time, Wall Street was offering a variety of half-baked explanations as to why the market had moved beyond the cause and effect stimuli that had ruled for generations. My advice to investors was simply to sell into the rally and ask questions later. Since then, bonds have reversed course, with ten year treasury yields hitting 4.9% (a five-month high). Just as Wall Street’s explanation for falling rates was way off base then, so too is their explanation for rising rates now.

The consensus asserts that yields have turned around because new “evidence” of a bottom in the housing markets will keep the economy from tipping into recession, which in turn will diminish the likelihood of a Fed rate cut. The problem with this explanation is that there is no evidence of a bottom in the housing market. Despite the self-serving rhetoric of biased real estate industry spokesmen, a bottom is nowhere in sight, both in terms of price and time.

Although 2006 saw existing home sales decline by 8.4% (the biggest drop in 17 years) and new homes sales fall by a stunning 17.3% (the largest in 16 years), Wall Street Pollyannas stressed that opinion and sentiment trumped data. For example, based solely on a 7.9% decline in existing home inventory, perennial real estate shill David Lereah (chief “economist” for the National Association of Realtors) claimed “It appears that we have established a bottom.” (Mr. Lereah has seen more bottoms than a diaper attendant in a hospital nursery.)

However, the drop in inventory in existing homes is most likely the result of discouraged sellers taking their homes off the market with the intention of re-listing them in the spring. This is a common tactic among realtors as spring is traditionally the strongest home buying season and stale listings are a turnoff to potential buyers. Also, my guess is that lots of other potential home sellers are planning on listing their homes for sale for the first time come spring, and many more would list their homes now if they thought they could actually get their “appraised values.”

New home sales figures are even more misleading. Although the headlines trumpet that inventories dropped in December, the figures ignore cancellations which are running at record highs. So while cancelled contracts are excluded from the “official” inventories, they are definitely part of the real inventory that will ultimately exert additional downward pressure on prices. Also, while new home prices “officially” fell by a modest 1.8% in 2006, the real decline is likely far more substantial. That is because the sales incentives now typically offered by developers, such as paying closing costs, free upgraded floors and countertops, free appliances, free swimming pools, free plasma TVs, free landscaping, decorating allowances, health club memberships, vacations, etc., are not reflected at all in sale prices. However, they are reflected in recent home builders’ earnings reports, which have been universally dismal.

The elephant inhe living room is that the recent jump in bond rates suggests that things are about to get much worse for the housing market. Since January 5th, interest rates have risen by over 30 basis points and gold has risen by over $40 per ounce. When rates and gold prices rise together the most likely explanation is escalating inflation fears. Indeed, my guess is that rather then sensing a bottom in the housing market, bond investors around the world are beginning to appreciate the inflationary implications of a real estate crisis.

A substantial decline in real estate prices will either produce a severe recession on its own or exacerbate one that arises from other factors. In either case, the result will likely be the Fed coming to the “rescue” with inflationary monetary policy. Inflation will push long-term rates even higher, causing more loans to default. With credit destroyed and home equity and jobs lost, foreign creditors will rush for the exits sending the dollar into a tailspin. The Fed will be forced to buy all of the paper foreign lenders no longer want and that savings-short Americans cannot afford. Domestic money supply will explode sending consumer prices soaring.

As is so often forgotten, interest rates are merely the price of money, which like any price is determined by supply and demand. In the United States, where hardly anyone saves and almost everyone borrows, that price should be very high. Our low interest rates are a temporary fluke, once made possible by naïve foreign savers but now mainly a function of misguided foreign central banks.

Instead of trying to fabricate benign explanations for why interest rates are rising, Wall Street should instead prepare investors for the unpleasant consequences to their portfolios should rates continue doing so. The true mystery is why long-term rates have remained this low for so long. Unfortunately by the time Wall Street solves the riddle many of their clients will be broke.

Source: Higher Interest Rates Mean Trouble Ahead