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US Dollar: FOMC Over, Now What?

Thu, Jan 29 2009, 02:42 GMT
by Kathy Lien

GFT

US Dollar: FOMC Over, Now What?

Although the Federal Reserve did not change interest rates this afternoon, the FOMC announcement led to a significant amount of volatility in the currency market. In our FOMC Instant Insight, we talked about how the dollar rallied because the Fed said that they “may” and not “will” start buying US Treasuries. The market was looking for something more radical such as inflation targeting or a bold announcement that they will immediately start buying long term Treasuries in size, which would have been dollar bearish.  In the grand scheme of things, the Federal Reserve delivered nothing new today. So with that in mind, what should we expect now that the FOMC meeting is behind us?

No Action from the Fed Until Spring

In the Federal Reserve’s eyes, their previous rate cuts and programs such as the Term Asset-Backed Securities Loan Facility (TALF) has not really had the chance to impact the US economy. This is why they want to continue to focus on extending credit to households and small businesses rather than jumping in and buying massive amounts of US Treasuries to drive down bond yields. The next monetary policy meeting is not until March which means that we may not see anything new from the Fed until the spring. This leaves the US dollar vulnerable to the developments in the US economy as well as announcements from the Treasury. In other words, the Treasury is stepping up to plate and the Fed is taking the backseat. Treasury Secretary Geithner said today that a Bank Rescue plan is on its way driving stocks higher.  If the plan hits any stumbling blocks, risk aversion could return quickly. However if President Obama is as effective in bolstering investor confidence as he has been in boosting public confidence, currency investors may no longer need to hide in the safety of the low yielding US dollar. The only clear consequence of the Fed’s statement is that yields will rise as traders who banked on the Fed’s purchases of US Treasuries reverse their positions – and higher yields are dollar bullish.

Still Watching the Economy

We are still watching the US economy.  Durable goods, jobless claims and new home sales are due for release on Thursday. The deterioration in manufacturing PMI suggests that durable goods orders could suffer. Boeing aircraft orders are a big component of durable goods and the company announced this morning that they plan on laying off 10,000 workers. If orders were strong, they would probably not be reducing their workforce. Existing home sales were stronger than expected which suggests that we could see a similar rebound in new home sales. However any inventory that is moving on the housing market has been driven entirely by lower prices. Finally jobless claims were 589k the last time that we saw the report. If claims crack the 600k mark, January non-farm payrolls could be as weak as the November and December numbers. 

EUR/USD: TRICHET COMMENTS ON INTEREST RATES

Having rallied as high as 1.3328, the Euro staged a dramatic reversal following the Federal Reserve’s interest rate decision. The earlier strength of the Euro was supported by the rally in equities, the return of risk appetite, stronger economic data and comments from ECB President Trichet. Despite the recession in the Eurozone, consumer confidence held steady in Germany and improved in France. This follows yesterday rebound in German business confidence which suggests that the largest nation in the Eurozone is doing something right. Inflation however continues to fall with German consumer prices easing in the month of January. The annualized pace of CPI growth of0.9 percent is well below the ECB’s target. Meanwhile in an interview with Reuters, central bank President Trichet reminded traders that the next important ECB meeting for rates is in March not February. In other words, he is telling everyone that interest rates will probably remain unchanged at their next monetary policy meeting. Although Trichet believes that economic growth will be negative this year, he feels that very, very low rates are inconvenient. At 2 percent, the Eurozone has the third highest interest rate in the developed world. Looking ahead, German unemployment, retail PMI and Eurozone confidence numbers are due for release. Given the sharp drop in the employment components of PMI, we expect the German unemployment rate to tick higher. 

GBP/USD: BRITISH POUND PRESSES HIGHER

For the third consecutive trading day, the British pound pressed higher against the US dollar.   There was no UK economic data released this morning, but the government announced a GBP2.3 billion package for the auto industry. They were quick to say that this was not a bailout package but instead one to revitalize the troubled industry by helping them invest in green, low carbon vehicles. The UK government has been hitting the economy from all angles with tax cuts and different stimulus plans and that is why when risk appetite improves, the British pound is one of the first currencies to benefit. In fact, the pound is one of the few currencies that to strengthen against the greenback today. Of course, the UK economy still has its own problems and we may be far away from a recovery, but no one can say that the government isn’t doing all that they can. Nationwide house prices are due for release on Thursday. The housing market has been the Achilles Heel of the UK economy and unfortunately that is not likely to change anytime soon. 

NZD/USD: RBNZ CUTS INTEREST RATES BY 150BP

The Reserve Bank of New Zealand cut interest rates by 150bp to 3.5 percent, the lowest level ever.   Over the past 2 months, the RBNZ has cut interest rates by 3 percent. The New Zealand government was late to the game and they are making up for it now. Interest rates are still expected to come down as RBNZ Governor Bollard points out that there is plenty of room to move. However future rate cuts will not be as large. The central bank expects the recession to last for the first half of the year as the global slowdown takes a bite out of New Zealand exports.  This concern was not confirmed by the December trade numbers. The deficit shrunk to -346M from -588M as imports slowed and exports rebound.  For the first time since December 2003, New Zealand now has a lower interest rate than Australia.  The Australian dollar rebounded as data was mixed. Leading indicators were weaker than expected but consumer prices beat expectations. Treasurer Swan believes that there are underlying strengths in the Australian economy and promised to act swiftly and decisively. He pointed out there is room to move on interest rates and a rate cut is exactly what the market expects from Australia at their monetary policy meeting next week. 

USD/JPY: YEN CROSSES REBOUND

The rebound in the US equities drove all of the Japanese Yen crosses higher. Risk appetite is playing a key role in the day to day performance of all of these pairs and there is no reason for that to change any time soon. The biggest market mover was CAD/JPY as the Canadian dollar soared on merger and acquisition related flow. Small business confidence in Japan hit a record low in the month of January as the rising Yen hurts exports. More economic data is expected from Japan this evening and they are may not be pretty. Large retail sales are forecasted to drop by 5.2 percent in the month of December which would be the largest drop in 3 years. Japan and the world economy are also very sensitive to the developments of China. Prime Minister Wen tried to offer some encouraging words at Davos this morning by saying that even though severe challenges lie ahead, the Chinese economy is in good shape on the whole and will definitely maintain strong economic growth. 

EUR/USD: Currency in Play for Next 24 Hours

The currency in play for the upcoming 24 hours will be EUR/USD. German unemployment numbers are due for release at 3:55am ET or 8:55 GMT followed by Eurozone retail PMI numbers at 4:00am ET or 9:00 GMT. US durable goods and jobless claim are due for release at 8:30am ET or 13:30 GMT.

The EUR/USD is trading within the range trading zone but stiff resistance lies above. There is a confluence of moving averages (20, 50 and 100-day SMA) as well as the 61.8 percent Fibonacci retracement of the October to December rally. The levels to watch are 1.3395 on the top side and 1.3020 on the downside. If the currency pair rallies above 1.3395, there is a chance that we could see a move above 1.35. If it breaks below 1.3020, the EUR/USD would have reentered the sell zone, signaling more losses ahead. 

Published on  Thu, Jan 29 2009, 02:44 GMT