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Forex Research - Fed Cuts 50bp, Opening the Door to ZIRP

Fed Cuts 50bp, Opening the Door to ZIRP Last Updated 10/29/2008 5:18:54 PM EST (GMT +5)

TODAY’S BIGGEST PERCENTAGE MOVERS

USD/CAD ( -477 pips or -3.79%)

GBP/USD ( +382 pips or +2.38%)

AUD/USD ( +163 pips or +2.50%)

THE STORIES IN THE CURRENCY MARKET

  • USD: FED CUTS 50BP, OPENING THE DOOR TO ZIRP
  • EUR: EURO SUSTAINS RALLY AGAINST DOLLAR
  • GBP: BRITISH POUND CONTINUES RALLY AFTER YESTERDAY’S 500 PIP GAIN
  • CAD: OIL UP MORE THAN 7.0%
  • AUD: HAS RBA INTERVENTION PRODUCED INTENDED RESULTS?
  • NZD: AWAITING BUSINESS CONFIDENCE REPORT
  • JPY: WILL BOJ CUT INTEREST RATES?

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

FED CUTS 50BP, OPENING THE DOOR TO ZIRP

The Fed decided to yield to popular opinion today by cutting rates by 50bp. This widely expected decision has brought rates down to the historically low levels of 1.0%. This strikes as an interesting correlation between Fed cuts from 2000-2003, which eventually led to the 1% interest rate. In its statement on the interest rate decision, the FOMC draws concerns that, “The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures”. The Dow ends the day down by .80%, after teetering above and below positive territory for much of the trading session.

Bringing rates down to these levels has many implications on further monetary policies. We must keep in mind that many believe that bringing rates down to such levels opened the doors for cheap credit, and inevitably the housing bubble. In the wake of the bursting of the tech-stock bubble and the recession that followed, Alan Greenspan’s Fed took more than three years to cut rates to 1%. Bernanke’s Fed managed to do the same in only two years time.

Zero Interest Rates Become a Serious Possibility

In yesterday’s FOMC preview, we warned of the implications of zero interest rates. With an economic crisis that may continue into the foreseeable future, the Fed will have less and less ammunition as rate cuts begin to draw down to the zero figure. The amount of slack left may be insufficient as it is because recent rate cuts have only been met with tightening credit conditions. It seems that newly created Fed initiatives, like making purchases in commercial paper and buying equity in banks, will have to be relied upon more as lower interest rates begin losing their effectiveness. We continue to believe that the market will call upon the Fed to cut rates further, as economic conditions persistently weaken. In particular, recent complications in the auto industry may set up an accelerated series of layoffs, which could have a large negative effect on next week’s employment situation.

GDP May Steal Highlight from Rate Cut

The Fed cut will not be the only influential report released this week. To further complicate matters, we will have GDP and accompanying Personal Consumption Expenditures and the GDP Price Index. Negative growth is largely expected as consumers, who were responsible for any level of growth in previous quarters, have cut spending substantially. This fact can be judged by disappointing Retail Sales. In addition recent trade weakness will also take its toll on growth. Tomorrow’s report may very well be the first step toward a technical recession, defined as two periods of negative quarterly GDP growth. The probability for deteriorating growth in the fourth quarter is a real possibility, as the credit crisis has hit consumers and businesses in strides.

EURO SUSTAINS RALLY

The German Consumer Price Index comes in softer than last month’s indication, with prices stabilizing at 2.7%. This is compared to 2.9% on a year-over-year basis. EUR/USD gains more than 150 pips in trading today, as dollar pullbacks continue. Tomorrow we are expecting more influential German reports in Retail Sales and Unemployment figures. These reports are important clues into the chances the Euro-Zone will slip into a recession. In addition, Producer Prices will be released by the French along with EZ Business Climate and Consumer Confidence. Even though Hungary is not part of the EZ, it is worth mentioning that the nation has secured a loan/bail-out package totaling $25 billion from the International Monetary Fund and European Union. Officials are worried that the failure of Hungary may speed up the appearance of a continent-wide recession

WILL BOJ CUT INTEREST RATES?

The Nikkei rallies today reversing some of the losses recorded earlier this week. This follows newly revised sentiment which has seen rallies in most world-equity indices. Relief in equity markets has largely contributed to the yen losing some considerable strength against the dollar in yesterday’s trading. However, today shows USD/JPY slipping more than 200 pips, Japanese Industrial Production showed some signs of strength last night, as the index comes in at 1.2% compared to -3.5% reported last month. Such indication shows that Japan’s manufacturing sector may be able to operate efficiently in the face of declining world demand. The domestic sector may be stronger than previous expectations. Yet such positive news pales in comparison to the BoJ rate decision expected tomorrow. As of late, traders have tossed around the idea that Japan will be forced to cut rates from their already low levels. The rationale behind this is recent reports have shown weakness across the most important Japanese sectors. These rumors may fail to come to fruition as the country has learned that interest rates near the zero level are not a prosperous monetary policy. Nevertheless, a surprise decision will see substantial weakening in the yen. In addition to the rate decision, we are also awaiting CPI and Household Spending.

BRITISH POUND CONTINUES RALLY AFTER YESTERDAY’S 500 PIP GAIN

UK Mortgage Approvals and M4 Money Supply come in slightly stronger than expected. The thing to take away from the potential optimism following an increase in approved mortgages should be met with the fact that these figures refer to economic conditions reported in September. The credit markets, and UK prospects as a whole, have worsened dramatically since, making the forecasting implication of the number doubtful. Hotter than expected M4 may concern some as to the likelihood of another rate cut, but consensus has shown that inflation will take a back-seat as the primary target in UK monetary policy. GBP/USD is able to stage a significant rally, with most gains occurring before the Fed announced its cut. We will not be met with any truly market moving reports for the rest of the week.

OIL IS SEEN UP MORE THAN 7.0%

Commodities stage a strong rally today, sending Crude Oil up more than 7.00%, its largest percentage gain in five months. The impact of RBA intervention seems to have shown more of its intended reaction, as AUD was sent higher against USD and JPY for the past couple of days. Its true implications are still not clear, as much of the rally is attributable to broad rebounds in global equity markets, relieving some market fear and anxiety. All commodity currencies are seeing some of the most substantial rallies for months. USD/CAD serves as the most poignant example, losing nearly 500 pips. Aussie DEWR Skilled Vacancies were down more than expected to -3.7%. Australian Conference Board Leading Index is expected tomorrow, with NZD Business Confidence and CAD M3 expected tomorrow. The major event risk for CAD trading will be in the form of CAD GDP expected for Friday. We have yet to see if CAD weakness is merely the result of risk aversion, or for more deeply rooted fundamental reasons.

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

EUR/USD will be our currency in play as important news releases are expected from both the US and EZ. First, we expect US GDP to give us some recessionary implications at 8:30 am ET or 12:30 GMT. In addition, the German ILO Unemployment rate is expected at 2:00 am ET or 6:00 GMT.

EUR/USD has taken the first steps at a meaningful rally, as the pair manages to break out of our Bollinger band selling zone. Price action has remained relatively constricted between the one and two standard deviation Bollinger bands for more than a week. The most immediate resistance to the rally is being experienced at the 10-period SMA. Today’s price action immediately retreated after touching the level. The 1.3000 level becomes more significant as a psychological level and a previous high placed on October 23rd. We are placing our support at the previous low at the 1.2328 level. A break of the moving average must precede a viable run up in EUR/USD.

 

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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