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USD steady as Federal Reserve keeps rates on hold

Wed, Aug 8 2007, 02:26 GMT
by Westpac Institutional Bank Team

Westpac Institutional Bank

New Zealand dollar

Dow Jones continues to bully NZD. The NZD traded a tight range between 0.7632 and 0.7665 yesterday as global equity markets received some much needed stability and investors looked towards US and Australian Central Banks for direction. As was widely expected overnight, the Federal Reserve kept interest rates on hold at 5.25%. The market interpreted the Fed’s acknowledgement of the recent financial market instability and credit concerns as less of a tightening bias, resulting in the Dow Jones initially falling. As has been the case recently the NZD followed suit falling to an intra-day low of 0.7555, however a late surge in the US Share Market on the back of stronger than expected US consumer credit data saw the NZD bounce back to close the overnight session around 0.7600.

Australian dollar

Market looks to RBA for direction. The AUD lacked any real direction in yesterday’s local session with market participants happy to take a breather and look ahead to the RBA’s announcement today. Overnight the AUD peaked at an intra-day high of 0.8593 before being gradually sold ahead of the Fed Reserve announcement. After falling to an intra-day low of 0.8514 on the back of the Fed’s statement, the AUD rallied with other high yielding currencies on strong US credit data to close around 0.8545. Attention will now turn to the RBA’s interest rate decision today with interest rates expected to rise to 6.50%.

Major currencies

USD steady as Federal Reserve keeps rates on hold. The USD was steady overnight albeit with a slight upward bias after the Federal Reserve kept interest rates unchanged as expected. Citing economic growth as ‘moderate’ and inflation pressures ‘yet to be convincingly demonstrated’, investors viewed the Fed’s statement as an indication that it will hold off cutting interest rates for some time. The statement also acknowledged recent volatility in the US credit sector and weakness in the housing market. Elsewhere, the GBP fell on the release of July retail sales data which showed growth fell to its lowest level this year.

Economic data and events

The US Fed left rates unchanged at 5.25% following last night’s FOMC meeting. They issued a clever statement, which in essence described a less tight tightening bias than in June. The Fed’s base case is that the economy is likely to continue to grow at a moderate pace over coming quarters. But given financial market turmoil and resulting tighter credit conditions, the Fed now acknowledges that downside risks to that growth scenario have increased somewhat. However, their predominant policy concern is still one of higher inflation, as it has been for the past year. That is the most that we could have expected from a responsible Fed. There is little evidence yet of a real economic impact from recent financial market turmoil, so to have abandoned their inflation policy bias would have been seen as an attempt to shore up markets rather than a response to changing economic conditions. The Fed’s twin mandate is to support growth and constrain inflation; the Fed does not have a responsibility to ease the pain of financial market players who took risky decisions they now regret.

US productivity growth 1.8% annualised in Q2. Productivity growth picked up in Q2, but annual productivity growth through the year to June was just 0.6% yr, down from 1.5% a year ago, and unit labour costs accelerated from 2.2% yr in Q2 06 to 4.5% yr in Q2 07. So one credible way to explain the slowdown in GDP growth over the past year is that not only did growth in hours worked slow, but so did productivity. That means that compared to last year, the economy will generate inflationary pressure at a slower trend growth rate. That goes some way to explaining the Fed’s ongoing concern that inflation is still the predominant risk confronting policy.

US consumer credit growth $13.2bn in June, stronger than expected given weak retailing that month.

German industrial output fell 0.4% in June for a 5.1% yr annual rate. Production is yet to respond to orders growth now running at 15.9% yr, although we expect to see stronger IP outcomes later this year.

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Published on  Wed, Aug 8 2007, 02:30 GMT