Bank earnings, oil prices and diversification are driving the dollar this morning. The big question is whether the problems with Fannie Mae, Freddie Mac and IndyMac have extended to JPMorgan, Merrill Lynch and Citigroup.

Although JP Morgan reported a 53 percent drop in profit, their decline was less than the market expected. Merrill Lynch however may not fare as well. Yesterday, they announced that they will sell their $4.5 billion stake in Bloomberg. With $6 billion in expected writedowns, this is definitely a desperate measure to avert massive selling of their stock in case writedowns or losses are unusually large. They wouldn’t sell such a valuable investment if they didn’t need cash.

Housing starts, building permits and jobless claims were dollar bullish, helping the US dollar recover against the Japanese Yen. But the dollar is still struggling against many of the other G10 currencies such as the Euro, British pound and Australian dollars. A further recovery could be possible given the extreme levels of EUR/USD risk reversals, but traders should do as the Sovereign Wealth Funds do by looking for opportunities to sell rather than buy the dollar. The Financial Times reports that one SWF in the Gulf has cut its dollar denominated holdings from 80 to 60 percent while China’s State Administration of Foreign Exchange is also looking to do the same, but of course by a smaller degree.

This is one of the reasons why the Bernanke wants the dollar to rise. A stronger dollar restores investor confidence and brings down oil prices, giving the relief to the stock market and US consumers.