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Tuesday March 18, 2008 - 23:01:54 GMT
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Forex Research - Dollar Rallies, But be Wary of an Intermeeting Rate Cut

 

Tuesday, 18 March 2008 22:10:24 GMT

Written by Kathy Lien, Chief Strategist

• British Pound Gains Strength Ahead of BoE Minutes and Employment Data
• Stocks Rise 400 Points, Is Risk Appetite Here to Stay?

Dollar Rallies, But be Wary of an Intermeeting Rate Cut
The Federal Reserve cut interest rates by 75bp, turning the US dollar into the second lowest yielding currency in the developed world. For currency traders the rally in the US dollar was expected because the Fed under delivered while the 400 point rise in equities suggests that stock traders are simply relieved that they got a big rate cut. In the FOMC statement, the Federal Reserve was downbeat about growth but they reminded everyone that inflation is not off their radar. Producer prices indicate that even though headline inflation growth is slowing, prices on a core level are rising. We have not seen the last of rate cuts, but the FOMC statement did contain a tinge of hawkishness as two members of the FOMC voted in favor of a smaller move. However we believe that the Federal Reserve is giving themselves the flexibility to cut between meetings if needed. Over the past month, they have made historic moves by opening up the discount window to banks and accepting investment grade debt securities as collateral. They know that the market needs time to absorb the recent moves and want to save some ammo for later if another bank sees the same fate as Bear Stearns. This is not to say that a 75bp cut is not a big move. It is only the second time in the past decade that interest rates had been eased this aggressively. Meanwhile the futures curve is still pricing in a strong probability that interest rates will fall to 1.75 percent in June. With the fear of counterparty risk potentially triggering liquidity problems for other banks on Wall Street, the Federal Reserve is still on high alert. Despite the slightly hawkish statement, they will not be able to sit back and relax just because they have stepped up monetary easing. Creativity is vital if the central bank wants the US to avoid turning into Japan. In the 1990s, Japan fell into 10 years of stagnation after a similar banking crisis. Furthermore if traders considered the Swiss Franc a carry trade currency, then the US dollar has officially become one as well. The dollar could rebound further, but we still expect weakness to resume over the next few weeks because the band-aids are just not big enough.

British Pound Gains Strength Ahead of BoE Minutes and Employment Data

The British pound will be a big market mover tomorrow with the Bank of England minutes and employment reports due for release. Although the central bank meeting was held before the latest liquidity crunch, we believe that the minutes should be dovish as the outlook for UK growth and credit conditions deteriorate. This morning, the Bank of England also pumped GBP5 billion into the money markets which is the first time that they have made emergency liquidity provisions since September. Like the US, they have recognized the severity of recent problems and are scrambling to find solutions. Consumer prices continue to rise with the annualized pace of CPI growth hitting 2.5 percent. Core prices are slightly weaker, which may also give the BoE a reason to be more dovish. As for the labor market, declines in the employment component of construction and service sector PMI suggest that the labor market may be deteriorating.

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

Stocks Rise 400 Points, Is Risk Appetite Here to Stay?

US stocks saw their fourth largest point gain ever after the Federal Reserve cut interest rates by 75bp. Carry trades including USD/JPY skyrocketed with pairs like AUD/JPY and NZD/JPY rising close to 4 percent. These are big moves for the currency market which is why even though we believe that carry trades could see further gains, they should be limited because volatility and risk aversion remains high. Until the threat of another bank failure moves to the back of the minds of Wall Street traders, the risk appetite that we have seen today is not expected to stay. Meanwhile Japan faces a leadership vacuum beginning tomorrow. As of Wednesday, Bank of Japan Governor Fukui’s five year term officially comes to an end. This could not come at a worse time for Japan. They rapidly need to find a replacement. Thankfully, the impact on the Japanese Yen should be limited because risk appetite dominates for the time being.

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

Euro Weakens After Fed Rate Decision, but Rally May Not be Over

The Euro sold off after the FOMC rate decision and even though we could see further Euro weakness over the next 24 hours, the rally is not over. The move today reflects nothing more traders adjusting positioning after the Federal Reserve cut interest rates less than expected. However it is important to remember that not only does the ECB expect to keep interest rates unchanged, but they remind us everyday that price stability is their top priority. They have remained calm throughout the past week with no European banks at the brink of collapse and for these reasons, we believe that the outlook for the Eurozone is still more promising than the outlook for the US. There is no significant Eurozone economic data due for release tomorrow other than the Eurozone trade balance. Meanwhile Switzerland released its fourth quarter industrial production numbers and like the Eurozone, their data beat expectations.

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

Return of Risk Appetite Drives Australian, Canadian and New Zealand Dollars Higher

The 400 point rally in US stocks has driven the Australian, New Zealand and Canadian dollars higher. Even though the RBA felt that inflation could rise further and the economy remains strong, the minutes from the last monetary policy meeting was less hawkish than the February meeting. New Zealand Finance Minister Cullen on the other hand warned that the country could not rule out a recession, but there was no impact on the New Zealand dollar. Canada reported stronger than expected consumer prices and although the annualized pace of headline inflation slowed, the pace of core price growth accelerated. Only minor data are expected from the commodity producing countries tomorrow including Australian leading indicators, New Zealand credit card spending and Canadian wholesale sales.

Tell us what you think on the Canadian dollar Forum.

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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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