The Yen continues to rally as risk aversion dominates the markets on the heels of the Lehman Brothers Bankruptcy and Merrill Lynch Purchase. A historic day in the financial markets that will change the landscape of the U.S. banking industry forever had sunk the dollar against most major currencies.

Talking Points

·          Japanese Yen: Rallied As Risk Aversion Reins

·          Pound: Back Below 1.800 As BoE Infuses Liquidity

·          Euro: Falls Back Below 1.43 On ECB Actions

·          US Dollar: Industrial Production on Tap

Euro, Pound Give Back Gains, Yen Rallies Over 300 Points On Lehman, Merrill Lynch News

The Yen continues to rally as risk aversion dominates the markets on the heels of the Lehman Brothers Bankruptcy and Merrill Lynch Purchase. A historic day in the financial markets that will change the landscape of the U.S. banking industry forever had sunk the dollar against most major currencies. However, the Euro and Pound have given back some of their earlier gains as the BoE and ECB have taken measures to infuse liquidity into their economies. The Euro has fallen back below 1.4280 after reaching as high as 1.4479.

The news that two more broker dealers have fallen by the wayside sent the financial markets in turmoil and sent the USDJPY dropping over 300 points to below 104.60 as risk aversion reined. The failure of Lehman Brothers to find a buyer has left the beleaguered banker to file for bankruptcy ending nearly a century and a half of existence. In response the Fed has expanded the collateral it will accept for emergency loans to include equity as it attempts to minimize potential disruptions to the financial system.

In response to the events in the U.S. the ECB and BoE took measures to add liquidity. The BoE is to offer GBP 5.0B in 3-day repo in order to provide short-term liquidity. The ECB added to what will most likely be a worldwide effort of central banks to bring stability to markets with their no intended volume 1-Day tender. These measures have weakened these currencies against the dollar as supply demand factors offset bearish dollar sentiment. The Pound has gained over 600 points against the dollar since testing the 1.7450 price level as oversold conditions and the U.S. banking events have led to the rebound. Yet, the U.K. economy is still believed to have entered a recession by CBI, which has reduces its growth outlook for the country to 1.1% in 2008 and 0.s% in 2009 from 1.7% and 1.3% respectively. Therefore, we could see the Sterling give back its gains after stability returns to the markets.



The dollar was stung but has remained relatively strong given the nature of the events that have transpired, which could see the greenback look to erase some of its losses. However there still looms the issue of AIG, which has asked the Fed for a $40 billion bridge loan in an attempt to raise capital and prevent credit downgrades that would cripple the company. The overall impact of the events of Lehman Brothers and Merrill Lynch could lead to U.S. investors adding to the dollar weakness. An expected decline in Augusts’ industrial production of 0.3% will add to the dour economic picture for the U.S. following the unexpected drop in retail sales. Speculation has grown that that the Fed may cut rates by as much as 50 bps at tomorrow’s rate decision. Although we don’t expect the central bank to take the benchmark rate below %2.00, fed fund futures are pricing in a 12% chance of a 25bps cut and a 22.6% chance of a cut at their next meeting, which has increased from 0% just a week ago. If the outlook for a rate reduction continues we could see continued dollar weakness.

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