Nevertheless, it is significant that central banks are prepared to act together, suggesting that they now share a more common purpose, rather than being engrossed in their own circumstances. The euro’s initial response was positive, as was the reaction of battered bank shares. Traders are conscious that being short euros ahead of today’s Ecofin meeting might not be a good idea, as it is just possible something more substantive may result, especially if America’s Tiny Tim convinces Europe’s elite to implement his TARP template. That said, this action on dollar funding will be more effective in putting a cap on funding costs rather than bringing them down from the currently elevated levels. The premium for borrowing in dollars via euros has fallen to around 80bp, which takes it back to levels last seen five weeks ago. In other words, the major central banks have merely treated the symptom, rather than the cause. Should the Ecofin meeting produce yet more dithering, it is likely that euro-selling will resume next week.

But before we get carried away we must not forget that August will go down as the month in which serious talk of a return to recession emerged and stocks globally are still some 8% lower vs. the start of the month.  Furthermore, there is a chance that US jobs data could reveal a fall in overall non-farm employment when released on Friday, something which will re-ignite recessionary fears.  In FX, the Swissie remains the stand-out, weakening further yesterday on fears that the government may introduce further measures to soften the currency, but the limited options available don’t look very appealing.

The situation has moved from tragedy to farce in the US as the Republicans are fighting among themselves and the vote that was due last night on their package was delayed once again.   It’s now pretty obvious that any deal that eventually emerges is going to be primarily driven by political compromise, rather than be structured to tackle the longer-term issues on the US budget.  

This makes a downgrade by one of the major ratings agencies pretty certain.  Markets are moving to accept this view, which is not proving to be as negative for the dollar and also US bond markets as many had feared.  The dollar index has risen for the past two sessions and also overnight, in part thanks to the weaker tone to the euro.  Meanwhile, 5Y CDS on the US has risen by more than 10bp over the past week, up to 64bp by yesterday.

David Rodriguez is a quantitative analyst for DailyFX.com, specializing in statistical studies in currency trading markets and algorithmic trading systems for the Managed Accounts Programs offered by parent company, FXCM. He holds a degree in Economics from Williams College with heavy emphasis on quantitative methods and began trading financial markets in the tech boom and bust of 1999-2001. Since then, David’s primary focus has shifted from equities to currency markets, but he continues to trade futures and futures options on a broad range of asset classes as well as currencies.

1. The US debt ceiling issue is gaining traction. How do you think this will unfold, and how will this affect the greenback?

Markets are showing relatively little hope of short-term resolution for the ongoing US debt ceiling issues, and such uncertainty is currently weighing on financial markets. The direct effect on the US Dollar is slightly less clear. Despite S&P 500 weakness, the typically correlated Greenback has fallen against the euro and currently trades near record-lows against the Swiss Franc and Japanese Yen. All in all such uncertainty seems to favor US Dollar weakness, and indeed we have little choice but to favor further short-term declines.

The Greek rescue package is substantial and may represent a real breakthrough in ongoing fiscal crises. The package seems large enough and is quite comprehensive in dealing with lack of confidence in the Greek government bond market. Yet the devil is always in the details. Will individual European parliaments approve the aid package, and how exactly will private investors react to the voluntary debt restructuring? The latter seems a particularly important sticking point given that some private bondholders have resisted restructuring. The crisis is far from over, but the EU summit conclusion was certainly a step in the right direction for Greece and other periphery nations.

John Kicklighter from DailyFX discusses this option, the upcoming ECB rate decision, the meaning of the end of QE2 and other fundamental questions:

The Swiss National Bank (SNB) left the Libor Rate unchanged at 0.25% and while they said they would do “everything” to keep price stability, they said that the economic growth and the demand for Swiss exports – hinting that another intervention in the forex markets is unlikely soon.

In Switzerland, SNB Governing Board Chairman Philipp Hildebrand will speak about the central bank’s monetary policy during the crisis. Referring to interest rates and possibly currency interventions will probably move the Swiss Franc.

The Swiss National Bank intervened again in the currency markets to weaken the national currency. Like in previous cases, USD/CHF jumped in minutes by about 150 pips, from 1.03 to 1.0450. Like in previous cases, this jump was short lived. USD/CHF is now back down to 1.0370. Looking at the near past once again, USD/CHF is going down.

Although the dollar weakens, it doesn’t affect all currencies. Mervyn King sent the Pound down yesterday. On the other side of the channel, EUR/USD is continuing upwards. Casey Stubbs wrote a fresh technical analysis for EUR/USD.