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Friday February 19, 2010 - 01:04:29 GMT
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Dollar Soars, Euro Plunges as Fed Hikes Discount Rate

The U.S. Dollar is mounting a strong rally late in the trading session following news that the Fed is set to hike the discount rate 25 basis points to 75 basis points. While not actually beginning a tighter monetary policy, a hike in the borrowing rate charged to member banks is a sign that the Fed is getting ready to begin removing stimulus and raising other key interest rates.  The Dollar is rallying because the rate hike tightens the interest rate differential between the U.S. and other foreign nations.


On Thursday, the Dollar had a volatile trading session triggered by economic reports and rumors of intervention. The Greenback opened higher, driven by spillover from Wednesday’s strong U.S. economic data. Early during today’s session the Dollar got a boost from mixed economic news. The Producer Price Index was higher than expected, but weekly jobless claims rose. This was followed by a better than expected Leading Indicators report and Philadelphia Fed Survey.


Initially, these reports supported the Dollar but a recovery in the equity markets encouraged speculators to demand more risk. This slowed down the upside momentum in the Dollar as intra-day profit-takers took over.


The Greenback accelerated to the downside on unconfirmed rumors that China and Russia were buying the Euro. After a sharp break, conditions settled and the Dollar turned positive once again. Later in the session, it was confirmed that Russia was actively buying foreign currencies. The recent weakness in the Forex markets has driven the Ruble to a 14-month high. Both Russia and perhaps China feel the need to protect their export markets by driving up foreign currencies.


News that the Fed is planning to hike the discount rate sent the Euro sharply lower late in the trading session. The heavy selling pressure took out the recent bottom at 1.3531 although it failed to accelerate to the downside once this price was pierced.


The EUR USD had an extremely volatile morning session. Stronger than expected U.S. economic reports put pressure on the Euro early in the session, but speculation that China and Russia were buyers turned the Euro around. Intra-day trailing stops were hit as the market rallied, turning the Euro positive for the day. The rally was short-lived, however, as buyers failed to support the market on the subsequent retracement. Although the Euro weakened at the mid-session, it managed to maintain the low for the day at 1.3539.


The move by Russia and most likely by China could create volatile trading conditions. According to the recent CFTC Commitment of Traders Report, over $8 billion of short positions are being wagered against the Euro. Further interventions by these two countries could create a classic battle between Russia, China and the short hedge funds.


The shorts want to see fresh money coming in so they can initiate new positions. The buyers want to create fear to encourage the weaker shorts cover their positions, thereby driving up the Euro.  It will be interesting to see if China and Russia continue to support the Euro on weakness especially since the current break is being driven by the Fed’s action. Nonetheless, intervention is out there and traders should be aware of the volatility it can create.


The GBP USD finished sharply lower. U.K. economic pressures continued to push the British Pound lower. Although there was a slight short-covering rally mid-morning, the currency was never able to turn positive. Expectations are for the Pound to continue to drift lower as fear that the U.K. recovery is falling far behind the U.S. is encouraging traders to keep up the selling pressure. The weak close has this market in a position to take out the recent bottom at 1.5534.  The action by the Fed to raise the discount rate is helping to put additional pressure on the Cable.


The USD JPY surged to the upside after it was reported the Fed was set to hike the discount rate by 25 basis points. This move by the Fed helped to increase the interest rate differential thereby making the Dollar a more attractive investment. Overnight the Bank of Japan said it would refrain from buying Japanese Bonds. This gave the Yen a slight boost until better than expected U.S. economic reports gave investors strong reasons to sell the currency.


The hike in the U.S. discount rate sent commodities lower, taking with them the Canadian Dollar. A surge in Canadian inflation pressured the USD CAD overnight, but stronger than expected U.S. economic data turned the market around. Lower gold prices and mixed crude oil results also encouraged traders to sell the Canadian Dollar. The U.S. Dollar could rally further if the hike in the discount rate causes stocks, gold and crude oil to fall sharply.


The USD CHF rallied after the Fed hiked the discount rate late in the trading session. This pair traded higher earlier in the session after talk circulated that the Swiss National Bank had intervened once again. The mid-morning short-covering rally in the Euro gave the Swiss Franc a boost, but these gains were erased once the Euro turned lower for the session. The move by the Fed tightened the interest rate differential between the two countries, forcing investors to adjust their positions.


The commodity-linked AUD USD and NZD USD had a volatile, two-sided trade this morning. Early strength in the Dollar pressured both the Aussie and Kiwi, but mid-morning demand for higher risk assets turned these pairs positive. A failure to follow-through to the upside and a strengthening Dollar drove both pairs lower after the mid-session. 


News that the Fed hiked the discount rate sent commodities sharply lower, dragging with them the commodity-linked Australian Dollar and New Zealand Dollar.  Wednesday’s closing price reversal in both of these markets signaled a top which was confirmed today. The charts indicate the Aussie can break to .8806 and the Kiwi to .6942 to .6910.


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