The scorching volatility ripping through financial markets is not likely to let up while details of the government's rescue plan are being worked out.
On Tuesday, investors will be looking for further developments in the financial markets bailout and also closely watching the 9:30 a.m. Senate Banking Committee hearing, where Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke will testify.
As Congress wrangles with Treasury over elements of the plan, traders say the markets need a swift resolution. On Monday, stocks sold off sharply after big gains Thursday and Friday. The dollar had one of its worst days in years, and commodities moved higher across the board.
"I think there's a sense of distress with the Democrats," said Cowen's John O'Donoghue, adding there's concern Congress will "hang ornaments" on the legislation. Stocks reacted negatively Monday when Sen. Christopher Dodd said the bailout plan could include government ownership of some financial firm's stocks.
"I think Paulson will stand his ground and get it done," he said.
The Dow finished Monday down 372 points or 3.3 percent at 11,015.69. The S&P 500 lost 3.8 percent to 1207, and Nasdaq fell 4.2 percent to 2178. The dollar was trading at $1.4839 per euro, a 2.5 percent decline.Forex.com said the dollar's decline was its biggest one-day fall since January, 2001.
"1175 on the S&P was my kind of downside look," said O'Donoghue. "We may retest the lows here and bounce around for a while. There's no impetus for stocks to go up."
"How weak does the dollar get? That is the question. The dollar's going to be weak because there's a perception this economic house is in turmoil," he said "The Fed can't raise rates. They're going to have to print money like lunatics here to get all this bailed out. I think the alternative to what Paulson did would have been a crushing, crushing recession if not depression. Now I think we have to go through a recessionary environment, but the cataclysmic shutdown of financial markets has been put off."
The financial sector was the worst performing, down 8.5 percent. Goldman Sachs and Morgan Stanley , the last two major investment banks, were the latest financial companies to make headlines with news that they will come under the Fed's regulatory wing and operate as bank holding companies. Morgan Stanley also said Mitsubishi UFJ Financial planned to make an investment of up to 20 percent in the firm. The idea that Morgan would merge with Wachovia has been put aside for now.
PIMCO's Mohammed El-Erain, guest host on "Squawk Box," Monday explained the firms are being what he calls "de-risked."
"What is happening with Goldman is simple. You have to de-risk them and take them under the umbrella of the Federal Reserve. How do you do that? By changing their structure and giving them more access to more funding and by saying they are now going to be run as a 'derisked,' 'deleveraged' entity that is less profitable. That's true, but that's how they are going to navigate forward," he said.
Oil bubbled sky high Monday in unusual trading. The October crude contract on NYMEX was set to expire Monday, and as it closed, oil shot up to more than $120 per barrel, up 16 percent in its biggest one-day move ever. Traders said there appeared to be a short squeeze in the thinly traded contract, and that there was an effort by some investors to take physical delivery. The CFTC said it was investigating the move.
M.F. Global senior vice president John Kilduff said the November contract could trade starting at around $108 per barrel early Tuesday, which is where it traded Monday. He said there was a short squeeze in the October contract as it expired due to extraordinarily low inventories after hurricanes Ike and Gustav.
"I was looking for $110 equilibrium. as long the dollar keeps getting hammered here, it's going to be supportive," he said.
The dollar's big move down came as currency traders worried there would be a big increase in the national debt and stress on the federal balance sheet from the government plan to buy $700 billion in toxic mortgages and other moves to guarantee money market funds and increase liquidity. J.P. Morgan economists, in a note, said the risk to U.S. public sector finances are being substantially increased. "The total net issuance of public sector debt in the coming fiscal year -- to fund a large deficit and the purchase of distressed assets -- is likely to approach $1.5 trillion, about 10 percent of U.S. GDP."
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"How much of this borrowing is ultimately funded by asset sales will depend in part on how quickly the housing market stabilizes and how well the economy performs," they wrote.
Treasurys were mixed in Monday trading. The 10-year dropped 16/32, raising its yield to 3.829 percent while the two-year saw its yield fall to 2.127 percent.
"It seems like a fait accomplis that interest rates are going to go higher, but many traders on the floor say it's not going to be quite so easy. A lot of the initial supply before November's refunding are going to be in short maturities, anywhere from bills to short-term notes, and the sponsorship by the likes of China should continue," said CNBC's Rick Santelli, from the Chicago pits.
John Sprow, senior portfolio manager with Smith Breeden, said while the stock market was getting thrashed, some corners of the credit markets showed signs of life. "The fixed income markets are still taking the positive momentum forward ... Commercial mortgages, subprime mortgages, corporates - they're all up sharply today," he said Monday afternoon.
"The real question is does (the Treasury plan) free up capital to flow through the system. We don't know if that's going to happen yet. What we saw last week was a complete failure of that. I hope I never see a week like last week again. Nobody trusted anyone. Nobody trusted anyone on trades. The whole ability to move money from point A to point B was ineffective," said Sprow.
Sprow believes the Treasury's plan to buy tainted mortgage debt from financial firms has a chance of ultimately returning the Treasury's investment because the government has the ability to wait it out. "I am optimistic it can be done net of their cost," he said. "Assuming my estimates of defaults, it can be done where they make money. The issue is whether people sell at those prices. It kind of sets a floor on prices."
He said the government also has Fannie Mae and Freddie Mac at its disposal and could use them to provide loans for some subprime borrowers.
Peter Delahunt, senior vice president and national sales manager at Raymond Jamesm, though tells us the municipal bond market, where states and local governments raise money, still has problems. About $6 billion in new issues are waiting to come to market. There's only been one deal of more than $100 million since the week of Sept. 9. The average weekly issue is usually about $8 billion.
As far as secondaries, "Our market is slightly better than last week, only because the large overhang of new product everyday keeps getting postponed," he said. Delahunt said one factor impacting the market is the absence of insurer AIG, which was rescued by the government last week. "The only real institutional buyer in the municipal supply space is property and casualty, and they've been getting hit by claims from Katrina all the way through to Ike," he said.
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