Tuesday March 22, 2005 - 23:25:42 GMT
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Dollar Collapses As Statement Suggests Fed May Remove Measured In May
DailyFX Fundamentals 03-22-05
By Kathy Lien, Chief Strategist of www.dailyfx.com
· Dollar Collapses As Statement Suggests Fed May Remove Measured In May
· US Producer Prices Confirm Rising Inflation Pressure
· Pound Sells Off On Muted UK Inflation Data
The dollar soared against the euro as the Fed did everything that dollar bulls could have hoped for aside from removing the phrase measured from their statement. The Fed raised rates by a quarter of a point to 2.75%, which is the seventh consecutive rate hike for the central bank since they first began tightening last June. The actual tightening was not what the market was focusing on. Instead, traders were specifically eyeing the phrase "measured" within the statement for potential changes. To the disappointment of dollar bulls the Fed opted to retain the phrase for at least another month. Yet many of our traders were confused as to why the dollar rallied if the Fed did exactly what the market expected – which was increase by a quarter point and keep “measured.” The explanation is that even though they left this pivotal phrase in, everything else in the statement was bullish and upgraded a notch, which implies that "measured" could be taken out of the statement as early as May (more on rate decision in dollar section). As we stand right now, the US has higher rates than both Europe and Canada. This gave euro bears a great reason to dump the single currency and they did so aggressively, sending the pair sliding to a low of 1.3060. Weaker French consumer spending also did not help the euro. The latest release indicates that a high unemployment rate and rising oil prices has hurt the appetite of French consumers.
Inflation is becoming an increasing concern, as the Fed acknowledges that "inflation has picked up in recent months and pricing power is more evident." The key point that we observed aside from the upgraded inflation comments and output growth is that the Fed believes that "with appropriate monetary policy action," the balance of risks to sustainable growth and price stability can be kept roughly equal. This suggests that they will be keeping a tight rein on monetary policy and if inflation spirals out of control, they may elect to tighten by more than quarter point clips to make sure that these risks remain roughly equal. With the market hinging upon the statement, the Fed took a baby step towards more hawkish policy. The dollar has reacted just the way the central bank probably anticipated - initially selling off at the inclusion of the "measured" phrase at first glance and then rallying in anticipation of the removal of the phrase the next time around. More interest rate hikes are still in store here in the US, especially since the Fed said that monetary policy is still accommodative. The dollar continues to rally, as the US will be the only major central bank to aggressively raise rates this year. Greenspan has full intention of bringing rates back to neutral, which is the rate that does not spur growth or inflation. This is estimated to be between 3-4.50% - so hang tight for at least another 75-150bp of rate hikes.
Tracking the losses in the euro, the British pound also broke down against the US dollar. Consumer and retail price growth held steady during the month of February. The rebound after January’s dip provides little pressure for the Bank of England to make a preemptive move. Airfare and utility costs were higher as a direct result of the rise in oil prices last month. However, some of this upward pressure was offset by lower costs for furniture, household equipment and consumer electronics. Total business investment also experienced the weakest increase in four quarters as the spending growth by distribution services contracted in Q4. Tomorrow is a big day for the UK. The market is expecting the minutes from the Bank of England’s meeting earlier this month, GDP and Current Account data for the fourth quarter. With all eyes on data that could signal the Bank of England’s next move, the minutes will be closely watched to see how many members voted in favor of a rate hike this month.
The dollar is stronger against the Japanese Yen following the Fed’s rate hike. Yet in the land of the rising sun, we learned that the central bank discussed the possibility of reducing the current account balance at their February BoJ monetary policy meeting. Such action would be interpreted, as a tightening of monetary policy that the group agreed later on is not immediately necessary. Only one member brought up this discussion, which may not be a very accurate reflection of what the monetary policy committee as a whole may be considering at this juncture. Moving over to China once again, the head of China’s central bank said yesterday that the government may speed up its development of the foreign exchange market. This follows the recent article in the Beijing Daily about possible revaluation announcements and China’s previous announcement of developing an “internal” inter-bank system. A former Hong Kong monetary authority official added that China would probably need to revalue by 10% to please the international community.
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