Euro strong on ECB comments ... ECB to turn the tap to Spanish banks off ... Gustav feels like Katrina ... when does wheat smell of fish?

As is typical the $ hasn't stop falling since I proclaimed its correction to be fully in play yesterday morning. Axel Werber (sounds like a heavy metal drummer but is in fact president of the Bundesbank) said that ECB would be likely to raise, not lower, interest rates at the end of the year if the economy recovered.

Well maybe ... data has been stronger, not weaker these last few days, including yesterday's US durable goods report. But I can't help remembering Bernanke speaking in a similar tone and with like confidence back in May post the very decent Bear Stearns rally in the market, only for the GSEs to subsequently blow up into the July meltdown. The US has a second wave of housing pain upon it. The GSEs, who represent 80% of all mortgage activity no longer have the capital to continue their support operation and are reigning in activity as we speak. The housing market remains vulnerable on various metrics (such as affordability) and I reckon another 10-20% fall from here is likely. The whole financial system is leveraged against a depreciationg asset and you get the impression they're out of options on the recapitalisation front. So I suspect the GSEs won't be the last blow up. Who's next? Who the hell knows, but I note that Goldmans were weak on further earnings downgrads, amid general strengthening in the BKX too yesterday ... I keep saying it, but if you see someone walking on water, they're not. They're doing something very clever, but they're not walking on water. How the hell are GS making money? Does anyone actually know? And JPMorgan are on the hook for how many trillions of derivatives? Anyway, the end game will be a nationalisation of the financial system or, more likely, its debt and we're still some way from that.

Interesting piece in yesterday's WSJ saying that the solvency of the GSEs didn't matter so long as they were government guaranteed, which is a cute way of looking at it. But if they are tightening standards and reigning in lending (debt issuance down 40% in July, conforming mortgage rates 50bp higher now compared to June) then the GSEs are failing in their role as a policy vehicle. Surely this matters a great deal to the government - what's the point of guaranteeing their operations if you can't make them an effective policy lever?

And speaking of policy levers ... the ECB look set to change the rules on collateralised lending to financial institutions. One of the reasons the liquidity crunch has been less sever in Europe is that the ECB accepts a wider range of ABS collateral for its govvies. The Spanish and UK banks have been the biggest beneficiaries. But the ECB want to make sure the rules aren't "abused"with some issues being originated by banks with the express intention that they can be shifted straight onto the ECBs books. Careful what you wish for ...

The glimmer of hope is that the Chinese slowdown has been exaggerated by the Olympic shut down. It's not plausible to see China escaping a sharp slowdown in its biggest export market. But those power plants, railways, dams need to be built regardless of how bust the US financial system is. And Chinese retail sales are now growing stronger than its exports. The authorities hit the pause button on an economy the size of Mexico before the Olympics (in the way only the Chinese can) and are now set to let it run again. Time will tell. Commodity bulls certainly hope so.

Commods are quiet this morning, rising about as much as the $ has fallen. Gustav has been sapped of some of its intensity after making land south of Cuba. It is expected to regain that intensity, possibly to a cat 3, over the Caribbean and enter the GOM by Aug 30th, which is Saturday. Louisiana have declared a state of emergency. Sadly, it all feels a bit Katrina like. Incidentally, Katrina hit on the Labour Day weekend in 2005. Nat Gas gapped by 20% when the mkts opened on the Tuesday, falling 10% from that opening in the same session. As things stand at the moment, the time to sell Nat Gas/Oil/Gold will be on Monday which will be possible even though the US will be closed using the European traded ETFs.

The Baltic Dry Index fell again yesteday, reportedly on a lack of grain shipments. The problem is't that there is no grain, but that farmers are witholdling their grain in elevators in anticipation of higher prices. Wheat for sale directly from grain elevators in the Mississippi sell at $5.95 a bushel compared to the Chicago exchange price of $8.24 ... hmm ... doesn't that smell fishy?

I've probably been reading up too much on market corners, but if I was trying to corner the wheat mkt, I'd need several billion dollars (value of US crop last year was roughly $15bn) to buy lots of futures, take delivery and stick it the elevator. That would make the elevator price trade substantially below the exchange price. But who has that sort of money? The Saudis? Rich with oil money ... living in a dry desert ... looking to buy farmland ... hmmm, the Saudis ... who tried to corner the silver market in the 70s ... yes, the Saudis ... or the Russians? Record harvest for them ... but why corner a grain mkt though? It'd be political suicide being blamed for world hunger. Surely its just too bad an idea, cornering wheat? Then again, aren't market corners always bad ideas? Am I becoming one of those loony conspiracy theorists? Yeah, probably ...

Earnings at Sinofert, China's largest fertiliser importer doubled as their chief exec said the export price controls were having little effect. He expected prices to continue rising at the next round of contract talks to be held sometime in Q4 ...