The bazooka has sounded ... Ike to hit GOM Wednesday

Today Hank Paulson nationalised the GSEs. Capital is being injecting with what looks to be a new issue of highly dilutive prefs. Ord holders will be wiped out. What happens now?

Equity markets will rally, reaching the conclusion that the housing market has been stabilised. This is probably true. Although the intent to wind down the GSE books by 10% pa by what looks to be a cessation of new origination after 2009 will have far reaching consequences indeed for the long-run dynamics of the residential construction industry, this is of no immediate concern. I'd expect banks to rally too. Although although there are a few banks which are large holders of the prefs those banks appear to be off the hook, with help promised. What happens to the FDIC is a problem for later.

The dollar should strengthen, but its not as clear cut as the equity call. On one hand, the major causes of financial concern has now been removed. On balance I expect this this effect to dominate the others. But what makes it a difficult call is the dollar's recent behaviour where financial weakness and associated risk aversion has been accompanied by dollar strength, not weakness. If the pattern of recent weeks has been for the dollar to rally into risk aversion, shouldn't it now fall as that aversion recedes? That the GSEs were going to be nationalised was obvious to anyone who'd spent more than five minutes thinking about it and FX markets are usually more switched on to macro than equity markets. So is it possible that the dollar had been rallying in expectation of the bail out, only now to fall on the news? I doubt it, but its possible.

Also, the GSE nationalisation adds $4.5tr to the national debt - about 35% of GDP. That takes the total (on balance sheet) US debt to GDP ratio to around 75%. The gold bugs and extreme anti-govt libertarians will make much of such recklessness by the custodians of the dollar's value. Jim Rogers will call it a national disaster and Bill Bonner will highlight the inevitability of the inflationary pressure being stored up for later, and about the ultimate and inevitable devaluation it implies for the dollar. I actually have much sympathy with all of these arguments but I don't think the FX market will, not for a while anyway.

Gold will fall. If the dollar also falls if will fall sharply. Its relative strength in the beleagured commodity sector was attributable to flight to saftey concerns. As those concerns will have abated, so to will buying appetite for bullion.

Ike is over Cuba now as a Cat 4. It will weaken as it hits land only to regain strength as it hits the warm waters of the GoM, currently expected on Wednesday which is when we'll have a better idea on how close it will come to the oil installations later in the week (central projections right now look like it will score a bulls eye).