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Forex Research - Is the Fed Trying to Avoid a 75bp Rate Cut in March?

Tuesday, 11 March 2008 21:37:05 GMT

Written by Kathy Lien, Chief Strategist

• Euro: Big Reversal
• Stocks Rally 400 Points Triggering Sharp Recovery in Carry Trades

Is the Fed Trying to Avoid a 75bp Rate Cut in March?
The Federal Reserve is getting desperate and they are pulling out all of the stops. Minutes after the US trade balance numbers were released this morning, the Fed announced auctions to lend as much as $200 billion in US Treasuries. Yesterday, we indicated  that the dollar could rally this week and even though this wasn’t the trigger that we had expected, it achieved the outcome. Whether the dollar will continue to rally is dependent upon tomorrow’s retail sales report, Friday’s consumer price index and the amount of easing that the Federal Reserve delivers next week. In response to today’s announcement, Fed fund futures are now pricing in only a 62 percent chance of a 75bp rate cut, down from 86 percent yesterday and 98 percent on Monday. Today’s plan helps to reduce the Federal Reserve’s urgency to lower interest rates, but is that the main reason for their move? Yes and no. Over the past few months, the Fed has been growing increasingly frustrated with banks and their resistance to lend or to offer more flexibility to struggling homeowners. Not only has this hindered the central bank’s efforts, but it has also exacerbated the liquidity strains in the financial markets. In response, the Fed is allowing primary dealers to swap their mortgage banked securities for Treasuries to raise cash. If the banks take the bait, the Federal Reserve may be able to avoid stepping up the degree of their rate cuts once again. In late January, the Fed slowed down by cutting interest rates 50bp. If they have to step up the pace, it would immediately send a message to the markets that things are getting worse and the Fed is quickly losing control. (Will the Fed Cut by 50 or 75bp?) For currency traders, the announcement has been dollar and carry trade positive, but if tomorrow’s retail sales report is weak, the dollar could easily give back a significant portion of today’s gains. We expect the volume of retail sales to decline, but with food and gasoline prices on the rise, the value of goods sold could increase which makes forecasting the retail sales report a particularly tough call. Nonetheless, consumer spending is the backbone of the US economy and if it is weak, even the generous move by the Fed today may not stop the dollar from falling.

Euro: Big Reversal
The Euro hit a new record high of 1.5496 against the US dollar following a sharp improvement in the German ZEW survey. Despite a strong currency and high interest rates, better than expected economic data has helped to reduce the degree of analyst pessimism. Wholesale prices were surprisingly weak but the market paid little attention to the release as ECB member Weber warned that price pressure gives the ECB no room to cut interest rates. For the past few weeks, there has been rampant speculation on whether the ECB will intervene to suppress the value of the Euro. For the first time since last year, Trichet said that he was concerned about the excessive moves in the currency market. However today the ECB intervened without real intervention. They let the Federal Reserve provide as much as $200 billion of liquidity into the financial system and they offered to lend up to $15 billion in a joint action with the Fed. This has triggered a strong reversal in the EUR/USD, which is achieving the desired results of ECB intervention without the ECB actually selling Euros.

Visit the Euro Currency Room for resources dedicated specifically to the Euro.

Stocks Rally 400 Points Triggering Sharp Recovery in Carry Trades
Yesterday, we wrote about the risk of Bank of Japan intervention and even though the BoJ did not intervene, the rally in USD/JPY today is certainly reminiscent of intervention. At 8:30am Eastern Time this morning, USD/JPY rallied 90 points in a matter of minutes which is the type of move that we typically see when the BoJ intervenes. Of course, this rally was directly related to the Federal Reserve’s $200 billion liquidity boost and not any announcements from the Bank of Japan. However if risk aversion continues to subside and USD/JPY extends its rally, the Bank of Japan will not need to intervene any time soon. Furthermore, MoF member Shinohara said last night that the current circumstances are different from when they intervened in 2003 and 2004, which is why the USD/JPY move may not be worth looking at. We remain suspicious of a broad recovery in carry trades because stock markets around world remain extremely volatile. Japan has a lot of numbers due for release this evening including CGPI, the current account balance, consumer confidence and final Q4 GDP.

Visit the Japanese Yen Currency Room for resources dedicated specifically to the Euro.

Australian, New Zealand and Canadian Dollars Recover
The Australian, New Zealand and Canadian dollars all rose strongly against the greenback today as risk appetite slowly returns to the markets. Economic data was mixed with Australian job advertisements declining, but home loans and NAB business confidence improving. The New Zealand terms of trade also slowed in the fourth quarter but that has failed to dent the New Zealand dollar’s rise. The Canadian dollar on the other hand had good reasons to rally. Not only did oil prices rise to another record high, but the Canadian trade surplus increased more than expected as record oil prices offset a 9.9 percent drop in automobile shipments last month. New Zealand has food prices due for release this evening; we expect them to be firm given the recent surge in wheat, corn and rice prices.

Tell us what you think on the Canadian dollar Forum.

British Pound Continues to Struggle
The British pound continued to struggle in the face of mixed economic data. The RICS house price balance was lower than expected but the DGLG house price report was stronger. The BRC sales monitor on the other hand was firm, but the divergence between the best and worst performing retail sectors continued to grow. The trade balance is due tomorrow; we expect the number to be pound bullish.

Visit the British Pound Currency Room for resources dedicated specifically to the Euro.

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By Kathy Lien, Chief Strategist of DailyFX.com
Contact Kathy Lien about this article at klien@dailyfx.com






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