Finally, Dollar Smile Theory In Play?

It’s been a long time coming, but we finally have a countertrend dollar rally underway. It would appear that we are now entering the early phase of the Dollar Smile Theory.

“In anticipation of the world finally starting to catch on that this mess isn’t just a U.S. problem, I’ve spent the week selling the EUR:USD cross and selling the CAD against the JPY.” –TheFinancialNinja, 04/03/08

I sold EUR:USD all the way up to $1.60… and then damn near got stopped out. I’m not gonna lie, I really didn’t want to see anything much above $1.60. I have since taken out 25% of my position around $1.55. I intend to drop another 25% of my position fairly soon depending on how the markets react to this -20k non-farm print. So far so good.

I will add again to my position on bounces into the $1.57 - $1.58 area.

This move in the USD appears to be fairly robust and sustainable for weeks or months. I say appears to be, because the entire world was dollar short and long any and every other currency, especially the Euro. Commodities are behaving as they should. Oil has come off hard and quickly, confirming the dollar strength.

"The US dollar has perked up some on continued weak economic developments out of Europe. Consequently some of the fast money pulled out of commodities such as Gold and Oil.

The $120 area would appear to be 'arbitrary' resistance do to its status as a 'round number'. This makes for an interesting short opportunity around these levels.

Commodity price strength will ANNIHILATE the already MORTALLY wounded U.S. economy..." -TheFinancialNinja, 04/25/08

Since then crude was aggressively rejected just shy of $120 and is now sitting near support.

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Commodities Unravel, Confidence Collapses

Maybe not yet, but soon it will be that time again...

The Yen (XJY) has come off and consolidated as the Carry Trade Unwind has run its course. As risky assets the world over rallied, the hedgies have even re-entered their Yen carry trades. Keep an eye on the Yen for the first signs of any stress returning to the system. The Yen would probably be a good leading indicator as it has been throughout the entire credit crisis.

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Fed Raises Cash-Loan Auctions by 50% to $75 Billion (Update1): “The Federal Reserve expanded its cash- loan auctions for banks by 50 percent to $75 billion each after higher borrowing costs blunted the impact of the four-month-old program.

The Fed also increased its currency-swap arrangement with the European Central Bank by two-thirds to $50 billion and doubled the amount with the Swiss National Bank to $12 billion, extending their terms through January. In a third move, the Fed will accept other AAA/Aaa-rated asset-backed securities as collateral for Treasury loans through another program.

Fed Chairman Ben S. Bernanke created the TAF and two other programs to reverse a decline in liquidity that began last year with the collapse in the market for subprime mortgages. Today's move may reduce loan payments for some companies and homeowners with variable-rate mortgages.

The actions were taken “in view of the persistent liquidity pressures in some term funding markets,” the Fed said in a statement.

The Term Auction Facility, which provides 28-day loans to commercial banks, will sell $75 billion per biweekly auction, starting with a sale on May 5, the Fed said in a statement. The decision will increase the amount outstanding under the auctions to $150 billion from $100 billion.

It's the third increase since the program started in December at $40 billion per month.”

Raising the auction amounts by 50% at a time is nothing at all to worry about?
Hmmmmmmmmmm. Everything is fine though eh? Just get long. To the moon Alice!

“The expanded collateral under the Term Securities Lending Facility will take effect with the sale to be announced May 7 and settle on May 9, the Fed said. The Fed announced the program in March, auctioning as much as $200 billion in Treasuries. In several of the sales, the Fed has failed to attract enough bids to cover the securities at auction.

The Fed already accepts residential and commercial mortgage- backed securities and agency collateralized mortgage obligations through the TSLF.”

Dropping the quality of collateral is also a good thing right? Could it be that there isn’t enough ‘good’ collateral to go around? Nah… That would be crazy talk. Its not like commercial mortgage backed securities could possibly go the way of residential backed securities right?

Bank of America (BAC) appears to have begun with the back pedaling…

Bank of America May Not Guarantee Countrywide's Debt (Update1): “Bank of America Corp., the second- biggest U.S. bank, said it may not guarantee $38.1 billion of Countrywide Financial Corp.'s debt after taking over the mortgage lender, fueling speculation that Countrywide's bondholders face renewed risk of default.

“There is no assurance that any such debt would be redeemed, assumed or guaranteed,” the Charlotte, North Carolina-based bank said in an April 30 regulatory filing, adding that no decision has been reached. Investors have grown more optimistic the bank would back Countrywide debt, and Standard & Poor's said this week it may raise Countrywide's rating to match Bank of America's.”

BAC has started to realize that their acquisition of Countrywide (CFC) was early and on far too generous terms.

“Bank of America agreed to buy Countrywide, the largest U.S. mortgage lender, for about $4 billion amid speculation that the worst housing market since the Great Depression would bankrupt Countrywide. Bondholders have been counting on the merger to put Bank of America's AA credit rating behind Calabasas, California- based Countrywide's $97.2 billion of debt.”

If BAC doesn’t back the debt, then the some $38 billion is at risk.

“Investors have been asking Bank of America about plans to back Countrywide's debt since January, when the issue was raised in a conference call to discuss the merger. The bank has demurred ever since. Bank of America spokesman Scott Silvestri declined to comment further beyond the filing.”

It is becoming more and more likely that BAC will attempt to find a creative way out of the entire situation.

“The purchase of Countrywide is scheduled to close in the third quarter. Investors have speculated Bank of America may seek a lower price or cancel the deal because U.S. home prices and sales have deteriorated.

“This confirms how tenuous this transaction is,” said Christopher Whalen, managing director at Institutional Risk Analytics, a banking research firm in Torrance, California.

Whalen expects Bank of America to absorb the best assets, including Countrywide Bank, while the debt remains with a new company created by the merger, Red Oak Merger Corp. Red Oak may then file for bankruptcy, shielding Bank of America from liability, Whalen said.”

In all honesty, it is not in the interest of BAC to back the CFC debt. If it can at all be done, BAC will pillage CFC for its best assets and dump the rest. Unsuspecting bagholders beware…

“Countrywide’s finances have worsened since the merger announcement because of falling house prices in California, which accounts for about 40 percent of its lending. The company reported a first-quarter loss of $893 million as late payments and foreclosures soared. Lewis has reiterated Bank of America's commitment to the deal, citing long-term benefits of becoming the largest U.S. mortgage lender.”

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