With the exception of the Japanese Yen, the US dollar has rallied against every major currency. The settlement of the Lehman CDS auction, the new Money Market Investor Funding Facility, the drop in oil prices and the sell-off in equities have all contributed to the impressive strength in the greenback. However the dollar’s rally may be short-lived as the credit market continues to thaw. Although the VIX and individual currency volatilities have increased over the past 24 hours, the 3 month LIBOR and TED spreads have fallen. This suggests that lending conditions are continuing to improve, which should help to stabilize the financial markets. Since the US dollar and the Japanese Yen have benefitted significantly from market instability, calmer times should help higher yielding currency pairs recover.

Fed Introduces New $600B Money Market Investor Funding Facility

The Federal Reserve also announced a new facility aimed at relieving pressure on money market mutual funds. Over the past few months, redemptions by individual investors and hedge funds have skyrocketed. Despite prior steps to restore stability, money market investors continue to head for exits. Through JPMorgan Chase, the Fed has announced a new backstop for these funds whereby they will be buying up to $540B of certificates of deposits, bank notes and commercial papers with a remaining maturity of 90 days or less. The remaining $60B in this facility will be coming from commercial paper issued by the special purpose vehicles set up by JPMorgan. They have called this their Money Market Investor Funding Facility. Although there has been no immediate market reaction, this should help free up credit in the financial markets and restore stability in the long run.

EURO FALLS TO THE LOWEST LEVEL SINCE FEB 2007

The Euro dropped to the lowest level against the US dollar since February 2007. The combination of weaker oil prices and dollar repatriation has weighed heavily on the currency pair. It is becoming increasingly apparent that the Eurozone financial sector is in just as bad shape as the US. According to the Financial Times’ economic forecasts for all European countries, neither Germany, France, Spain or Italy are expected to grow by more than 0.5 percent in 2009. Perhaps they are lucky not to suffer from the negative 2009 GDP growth that is forecasted for the UK. Tough times are ahead for the Eurozone which should lead to a test of the 1.30 level in the EUR/USD. There was no meaningful Eurozone data released over the past 24 hours and nothing of consequence is expected on Wednesday. Switzerland on the other hand reported a stable trade balance as exports and imports decline.

BRITISH POUND CLOSES IN ON 5 YEAR LOW ON RECESSIONARY COMMENTS FROM KING

The British pound fell to the lowest level against the US dollar since November 2003 as Bank of England Governor King suggests that the UK is in a recession. The prospect of a prolonged slowdown in consumer demand and further housing market weakness should thrust the country into its first recession in 16 years. He also added that a larger, faster trade and FX adjustment may be necessary. With such a dour economic outlook, the UK needs a weak currency to attract whatever export demand that may still be remaining. Prime Minister Gordon Brown also said this morning that more borrowing will be needed. Public finances are in horrible shape and is likely to get worse with the expected drop in tax revenue. The Bank of England minutes are due for release on Wednesday. The data will shed light on how close the UK is to another interest rate cut.