• Home ::
• Fundamental ::
• Market View ::
• Daily Fx Strategy

• Send
• Print
• Add To
• Rss

Daily Fx Strategy

Dollar Gets Bernanke Lifeline

Tue, Jul 8 2008, 13:25 GMT
by Ashraf Laidi

CMC Markets

Dollar lifts off its lows as Fed Chairman Bernanke throws a quick a lifeline to the when he said earlier this morning the Fed is considering the extension of lending facility to Primary into next year. This may be what the markets wanted to hear after credit woes pertaining to U.S. financials resurfaced sharply yesterday. Although yesterday’s trading volumes in Wall Street were typically lethargic of post July 4 weekend activity, the 1.2% turnaround in stocks from their session highs was behind the 1.1 cent and 1.5 yen decline in the dollar against the euro and the yen.

Are Fed Funds Futures Traders Wrong?

Whether we’re referring to bond vigilantes trading treasuries or fed funds futures, these traders were prominently correct a year ago when the bottoming in the 10-2 year yield spread helped signal increased pressure by the Fed to act. But could they be wrong this time? Indeed, they were wrong in their longer term expectations such as in spring 2007 in pricing expectations for rates to remain steady 6 months out. Although futures have scaled down odds of a rate cut, they continue pricing nearly 50% odds of 25-bp hike by the September 16 meeting and as much as 75% odds of similar tightening by year-end. Such pricing is in our opinion flawed considering the history that the Fed had never raised rates before a considerable decline in the unemployment rate. And unemployment is far from being the only obstacle to a rate hike. Recall that the Fed continues to pump extra liquidity in the system through its Primary Dealer Credit Facility just to keep some form of normalcy in the financial system.

San Francisco Fed president Janet Yellen said yesterday she is forecasting the unemployment rate to peak below 6.0% in the present cycle from the current 5.5%, while describing credit conditions as tighter than the in last August. Her optimism for lower inflation expectations ahead may dampen expectations of a rate hike this fall. Although her remarks aren’t widely shared by the rest of the FOMC, the more likely course of preference by the Fed is that of holding rates steady into the rest of the year. The relentlessly hawkish speeches emerging from the Fed over the past 3 months (since oil surged past $120) were largely meant to dampen inflation expectations as opposed to signal an actually rate hike. Central bank officials around the world are aware that inflation expectations are vital to controlling actual inflation. And that is exactly what Fed funds futures are reacting to as the Fed manages its rhetorical targeting of inflationary expectations. By shaping these expectations ahead, the Fed hopes to support bond yields and stabilize the dollar, which will cap oil prices. The main risk to this strategy is that oil prices are influenced by their own set of supply and demand forces, while the capital situation for US financials and the macroeconomic figures will play against the Fed’s plan. Thus, while price stability is part of the Fed’s objectives, so is “maximum employment”. Ensuring stability in the financial system may not be an objective but is a major responsibility of the Fed. And although the Fed is continues to provide liquidity through its term loan facilities, these efforts are now regarded as a bear minimum in light of the latest developments with UBS, FNMAE and Wachovia. Expectations of a losing quarter in Merrill Lynch will surely not help. We continue to expect the next move interest rates will be a reduction of 25 bps to in October, followed by an additional cut in December to bring down rates to 1.50%.

At 10 am EST, pending home sales seen falling 3.0% in May after a 6.3% jump in April.

At 12.30 pm, Richmond Fed Pres Lacker to speak on the economy.

Euro Remains Consolidated

Consolidation to continue being part of the game plan in EURUSD as both currencies are increasingly torn by the opposing forces of inflation and central bank hawkishness on one end, and increased downside risks on the other. Setting oil dynamics aside, the euro remains bolstered at the expense of the dollar’s woes vis-à-vis the deteriorating capital structures of U.S. banks and onset of further write downs. But it is not all about financials and markets. Last Thursday’s jump in weekly jobless claims above the 400K figure was widely overshadowed by the June payrolls number, which was in line with official expectations but half than what was feared. The run up in claims means that the jump in the unemployment rate to 5.5% was no aberration. Thus, the euro has more than US financials to feed off from.

Interim support holds at $1.5640, backed by the 200-day MA of 1.5610. From a longer-term perspective, EURUSD is seen extending its consolidation into the $1.5350-$1.5900 range. Thus, 1.5620 and 1.550 remain viable short term targets. Upside capped at 1.5750.Key resistance stands at 1.5780.

Another Failed USDJPY Recovery

Failed rallies in USDJPY are becoming increasingly interrupted by sharp 100-point declines occurring in 2-hour intervals. This highlights the ease at which the reduction in risk appetite is disrupting financial markets. Bernanke’s speech did lift the dollar from 106.80 to 107.20 after the Chairman said the central bank will extend the liquidity lifeline to banks. USDJPY faces resistance at 107.30, followed by the 200-day MA of 107.55. Subsequent run-up remains capped at the trend line resistance of 107.90. Support stands at 106.55.

Sterling Extends Declines After Bernanke

The impact positive dollar impact from Bernanke’s speech is expected to be especially punishing for GBP as the deteriorating UK fundamentals remove resistance facing the offers. Much speculation will emerge on whether the Bank of England will cut rates this Thursday, which will dictate fresh volatility in the currency. We expect the decision to be a close call in favor of no rate cut at which point the reaction is likely to be of further GBP losses. Support stands at $1.9705, followed by 1.9660.

Published on  Tue, Jul 8 2008, 13:28 GMT

Archive

• Pre- EU CPI, US GDP FX Strategy
  Published On Thu, Jul 31 2008, 07:35 GMT
• GSEs' Impact on Foreign Inflows & Risk Appetite
  Published On Mon, Jul 14 2008, 13:35 GMT
• Dollar Gets Bernanke Lifeline
  Published On Tue, Jul 8 2008, 13:25 GMT
• Dollar Faces Dual Threat from Trichet, Payrolls
  Published On Mon, Jun 30 2008, 13:11 GMT
• Dissecting H1 FX & Gold Performance
  Published On Fri, Jun 27 2008, 15:14 GMT

[ View All ]

• More Reports from this Author
• More Reports from this Contributor

CMC Markets Plc  | 66 Prescot Street, London, E1 8HG, United Kingdom
http://www.cmcmarkets.com/ | info@CMCforex.com