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Forex Research - Coordinated Interest Rate Cuts - Too Little Too Late

Coordinated Interest Rate Cuts - Too Little Too Late Last Updated 10/8/2008 5:24:42 PM EST (GMT +5)

TODAY’S BIGGEST PERCENTAGE MOVERS

AUD/JPY ( -635 pips or -8.80%)

EUR/AUD ( +150 pips or +7.64%)

AUD/USD ( -480 pips or -6.74%)

THE STORIES IN THE CURRENCY MARKET

 

  • USD: COORDINATED INTEREST RATE CUTS – TOO LITTLE TOO LATE
  • EUR: ECB CUTS RATES, EURO RECOVERS
  • GBP: HITS FRESH 2 YEAR LOWS ON BAILOUT PACKAGE AND RATE CUTS
  • JPY: THE ONLY WINNER
  • CAD: OIL PRICES AT $88.48
  • AUD: FALLS MORE THAN 6 PERCENT TO 5 YAR LOW
  • NZD: HITS FRESH 2 YEAR LOW

EXPECTATIONS FOR UPCOMING FED MEETINGS

** PERCENTAGES MAY NOT ADD UP TO 100% BECAUSE OF THE PROBABILITY OF LARGER OR SMALLER MOVES BEYOND THOSE SHOWN ON THIS TABLE

COORDINATED INTEREST RATE CUTS – TOO LITTLE TOO LATE

We have been literally begging the Federal Reserve, the European Central Bank and the Bank of England to work together to stem the bleed in equities and they have finally done it (What is the Fed Waiting For? And Panic Selling in FX Begs Coordinated Easing). For the first time since Sept 2001, central banks around the world have delivered a coordinated interest rate cut. Coming 2 days before the G7 meeting and 1 day before the official BoE interest rate decision, their move sends a strong message that central banks are holding nothing back in their attempt to unlock the credit markets, stabilize the stock market and stimulate growth.

Given that the Bank of Japan stood aside, the move was bearish for USD/JPY. However the impact on the Euro was limited because the interest rate differentials between the dollar and the Euro remained unchanged. Unprecedented is the buzz word in the financial markets these days and today’s rate cuts were nothing short of that.

Unfortunately despite an initial rally in stocks, equities ended the US trading session down 189 points as investors believe that the actions by the central banks were too little too late. This is undoubtedly the right move for the central banks, but not the right timing. They should have made the rate cuts last Friday after the TARP approval if not earlier because each move that the central banks are making is getting bigger and more extravagant but each market reaction is getting smaller and less consequential. Stocks continued to sell off because the rate cuts have not solved the funding issue. The LIBOR - OIS (Overnight Index Swap) rate hit a record high indicating that credit is still tight. The Reserve Bank of Australia’s full percentage point rate cut earlier this week raised the bar for everyone and so far, no one has met it.

Time for Halloween Treats - Next Stop Could be 1% for the Fed?

Given the market’s lack of a reaction to the rate cuts, the Federal Reserve may still give investors a Halloween treat by cutting interest rates 25bp at the end of the month and the beyond that we could see a move to 1 percent. The outlook for the US economy is certainly bad enough to warrant bringing interest rates back down to the levels that we saw during Greenspan’s tenure. The financial crisis that we are facing now is far more damaging than the burst of the technology bubble. When Greenspan cut interest rates from 6.5 percent down to 1 percent, USD/JPY fell from a high of 135 to a low of 103.40. This 25 percent move represented the dollar’s shift to a funding currency. Since the Fed started cutting interest rates last August, USD/JPY has fallen 18 percent. If 1.00 percent interest rates becomes a reality in the US, USD/JPY could hit 95.

Pending home sales and mortgage applications were stronger than expected, but with 1 in 6 homeowners struggling with negative equity, the housing market is still in trouble.

Another Announcement Post G7?

It is important to know that the G7 Meeting is still being held on Friday, so we do not rule out the possibility of major changes to the communique. The Bush Administration has already announced that Treasury Secretary Paulson will be discussing further coordination options at the meeting and a press conference will be held at 6:45pm on Friday. Bernanke hinted about today’s rate cut before it happened and perhaps the Bush Administration is suggesting that another coordinated act could be around the corner. In the past, G7 meetings have led to major turns in the US dollar. This time around, the finance ministers may be mulling over another round of rate cuts or even FX intervention.

ECB CUTS RATES, EURO RECOVERS

The European Central Bank joined the Federal Reserve in cutting interest rates by 50bp today. Although the actual amount of easing was the same for all of the central banks involved, the rate cut by the ECB was the most surprising. Last week, ECB President Trichet only hinted that he was open to cutting interest rates and he certainly did not suggest that he was willing to cut by a whopping 50bp well before their November monetary policy meeting. Despite the rate cut, the Euro actually rallied against the US dollar and amidst all of the market volatility, was the only currency to see a less than 100 pip move. The reason for the lack of volatility is the interest rate differential. With the ECB and the Fed both cutting interest rates, the rate differential between the Euro and the US dollar remained unchanged. We expect more interest rate cuts from Europe – the ECB could take rates as low as 3.25 percent over the next 12 months. The German trade balance is due for release tomorrow and given the drop in the new orders and export component of manufacturing PMI, the trade data should be negative for the Euro.

BRITISH POUND HITS FRESH 2 YEAR LOWS ON BAILOUT PACKAGE AND RATE CUTS

In an attempt to stabilize the banking system, the UK government announced a groundbreaking rescue package as well as a 50bp intermeeting rate cut. The rate cut today superseded the planned BoE rate decision scheduled for tomorrow, which has now been cancelled. The big question that remains is, given recent developments, why is GBP still extremely weak? The answer is rooted in the fact that the market is skeptical about whether the bailout plan will work, especially following the US’ program which has failed to unlock the credit markets. It is also largely expected that the BoE will continue cutting rates, perhaps even more aggressively. The market is pricing in an additional 125bp of easing within the next 12 months. Today’s rate cut was announced in a market that was largely expecting such action. It seems that no matter how drastically rates would be cut, traders will still be disappointed by the fact that the BoE have waited this long to take action. While facing similar economic decay, the UK has lagged behind the US government in cutting interest rates, passing a financial bail-out plan, and announcing changes to deposit insurance amounts. Thursday’s most important development includes the release of the Total Trade Balance expected at 4:30 am ET or 8:30 GMT. It is expected that the trade deficit will narrow to -£4450, perhaps as a result of the weakening pound.

JAPANESE YEN: THE ONLY WINNER

The only winner in today’s coordinated action is the Japanese Yen because Japan was the only major central bank that did not cut interest rates. With 1 percent interest rates becoming a growing reality, there is a strong chance that we may see USD/JPY head towards 95. Although currency intervention by the G7 has been floated around as a possibility, the direction of the actions by the central banks remains unclear. We know that the Euro and British pound would probably be supported but the only thing that the Japanese may agree to is buying USD/JPY rather than selling it. Ultimately the move in the USD/JPY and the other Japanese Yen crosses will be determined by the market’s risk appetite. For the central banks, this was the best trick in their bag and since it hasn’t worked, we are interested in seeing what comes next.

AUSTRALIAN, NEW ZEALAND AND CANADIAN DOLLARS HIT NEW LOWS

The currencies that have been affected the most by the central bank rate announcements and the volatility in the equity markets have been the commodity currencies. The Australian dollar was the day’s biggest mover, shedding 6.8% against the US dollar and 8.8% against the Japanese Yen. The AUD/USD hit a new 5 year low while the New Zealand dollar fell to a 2 year low. Although the RBA did not partake in the rate cut, they cut rates 100bp earlier this week and more is expected to come. The Australian employment report is due for release this evening. Given the improvement in the employment component of service and construction sector PMI, we are not expecting any major job losses. The New Zealand dollar also dropped 4.20% against the greenback to a 2 year low. Of the 3 commodity producing countries, Canada was the only one that cut interest rates, driving the Canadian dollar fell to a new 1 year low against the greenback.

EUR/USD: Currency in Play Over the Next 24 Hours

EUR/USD will be our currency pair in play for the next 24-hours. Tomorrow German Trade numbers will be released which includes the Trade Balance and Current Account at 2:00 am ET or 6:00 GMT. Any perceived weakness can send the pair falling further.

 

EUR/USD is firmly placed in the sell zone, which we determine using Bollinger Bands. The support level is in place as the most recent low at 1.3446. We believe that the small retracement today represents an opportunity to sell on a bounce. Any continued retracement will be limited by the 23.6% (1.3778) retracement which is drawn from September 29th high. A break of this level sees potential upside reaching the 38.2% retracement which lies at 1.3986 followed by the 50.0% retracement at 1.4154.

 

About The Author

Lien has extensive knowledge within the interbank market, particularly in trading spot FX and options. She has written for numerous publications, is frequently quoted on financial media outlets, and is the author of several books, including Millionaire Traders. Read more >>

DISCLAIMER: This forum and the information provided here should not be relied upon as a substitute for extensive independent research before making your investment decisions. Global Forex Trading is merely providing this column for your general information. This forum and its information does not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision based upon this forum or any information contained within. In addition, any projections or views of the market provided by the author may not prove to be accurate. Global Forex Trading and Kathy Lien will not be responsible for any losses incurred on investments made by readers and clients as a result of any information contained in this column. Global Forex Trading and Kathy Lien do not render investment, legal, accounting, tax or other professional advice. If such advice is sought, or other expert assistance is required, the services of a competent professional should be sought.





 

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