US Fed Knows Housing Bubble Collapse Will Threaten Global Economy

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What news from London? Outstanding Investments’ Al Robinson says Rio Tinto (ASX:RIO) has asked BHP (ASX:BHP) to put up or shut up. “In applying to the UK takeovers panel, Rio wants to force an offer deadline on BHP. They’ll have eight weeks to formalise an official offer.” If nothing materialises in that time, it’s back to the drawing board.

American investors threw a temper tantrum overnight. The Dow fell nearly three hundred points after the US Federal Reserve announced it was lowering the price of money to 4.25%. The market’s fully expected a 50 point cut. The Fed, like a parent who has badly miscalculated what their child wanted for Christmas, disappointed.

But hang on a second. Maybe there will another rate cut in Santa’s bag, sooner rather than later. In its statement released with the decision, the Fed said, “Economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending. Moreover, strains in financial markets have increased in recent weeks.”

Duh.

It’s been the habit of nearly everyone on Wall Street to underestimate the impact of the bursting credit bubble. First they said it was contained to subprime and wasn’t a problem for the economy. Then they said it was just a few band lenders. Then they admitted in might affect corporate borrowing, leveraged buy outs, and maybe even interest rates in the real economy.

Our guess is that the Fed knows full well that the collapsing housing bubble is a massive threat. With the collapse in the value of collateral, leverage in the financial system is being unwound. But really, in simpler terms, investors are beginning to realise all that borrowed money went down the drain. Gurgle.

We asked our new currency strategist Gabriel Andre what to make of all this. We’re expanding our editorial team at the Old Hat Factory. Al “Smokey” Robinson is on the resource beat. And frankly, we’re tired of quoting institutional economists. Free thinkers without an agenda are much better. So we’ve hired a Frenchman who moved to Melbourne last year but has traded forex for the last few years in Europe and Australia.

Gabriel says, “The Fed Reserve cut interest rates by only 25 basis points, that’s why the EURUSD fell and the Yen climbed against the other major currencies. Indeed, a cut by 50 basis points was already priced and expected by many traders and investors. It would have been a strong signal to sell the USD, as the main driver of the FX rates is the interest rate differential between the different economic areas. “

The strongest reason to sell the dollar is that America’s central bank has already told investors it will do anything to prevent a housing-led recession, even if it means more weakness for the dollar overseas. But there are other, more technical reasons too.

Gabriel says that, “The big players in the market, especially the trend followers hedge funds, which have been short USD for a long time and which already made a lot of money this year, want to test the psychological resistance zone around 1.50 (EURUSD) again before the end of the year…also…the liquidity will decrease in the next few weeks, and the market makers could also try to clear the numerous stop-loss just above 1.50.”

The dollar got a bit of reprieve because the Fed cut was smaller than expected. But look for the dollar to test its lows one more time before the end of the year. And after that? We don’t know, but if further rate cuts from the Fed are on the horizon, the dollar had better get used to exploring lower lows.

Dan Denning
The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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2 Comments on "US Fed Knows Housing Bubble Collapse Will Threaten Global Economy"

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Tony Stephens
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The world wide marketing of US subprime mortgages to unsuspecting non american investors has created a fatal and permanent lack of confidence in the integrity of the US dollar
There will be a move away from this currency as the preferred medium of future international trade.
Couple this sentiment with the USA trade deficit and more importantly the US government budget deficit the dollar’S fall has yet to bottom out.

christina
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Winston Churchill once said that: “Occasionally people will stumble accross the thruth, but they quickly pick themselves up and hurry along, as if nothing happened” That’s what i think is happening now, everyone knows that the masses need to stop spending more than they earn, but try telling the masses that! Anyway, everyone is so worried about the subprime mess that they seem to be forgetting one very importanet fact that will also wipe out the economy- next month the first of the baby boomers will retire, and will have to take their money out of the stock market whether… Read more »
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