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US Dollar: Another Failed Attempt at Stabilization

Tue, Oct 28 2008, 08:09 GMT
by Kathy Lien

GFT

After the sharp volatility in the currency and equity markets during the Asian and European trading sessions, the US session was relatively quiet up until the last 10 minutes of trading. For most of the US session, stocks oscillated between positive and negative territory, giving traders hope that we may be finally seeing some stabilization. The last hour of trading has been wrought with surprises and today was no different. The Dow tumbled more than 200 points 10 minutes before the market closed, driving all of the major currency pairs down with it. As we have seen throughout the past week, the US dollar and the Japanese Yen have been the biggest beneficiaries of equity market weakness. In this nervous market environment, investors do not need a reason to sell. With no buyers in the market, we have seen a low volume late day liquidation. Going into the Asian trading session, this should lead to more weakness for the EUR/USD and USD/JPY.

Pressure on the Fed to Cut Interest Rates

As the dollar continues to strengthen, the pressure on the Federal Reserve to make a larger interest rate cut has grown. Since the last interest rate cut by the central bank on October 8th, the dollar has rallied more than 8 percent and the Dow Jones Industrial Average has fallen by more than 10 percent. Going into the FOMC meeting, economists can’t seem to agree on how much the Federal Reserve will cut interest rates. Of the 64 economists surveyed by Bloomberg, 53 percent expect a 50bp rate cut, 26.5 percent expect a 25bp cut. Fed Funds traders appear to be more optimistic as they have already priced in 50bp of easing for Wednesday with a 32 percent chance of a 75bp rate cut. The only problem is that the next interest rate cut by the Fed will not be their last. The economy is expected to get worse before it gets better and the Federal Reserve will not want to back themselves into a corner quite yet; a larger rate cut on Wednesday would give them less room to cut interest rates in December.

Dollar Rally May Not End After Presidential Elections

If history can be a guide, the dollar rally may not end after the November 4th elections. In 6 out of the last 7 elections, regardless of whether Democrats or Republicans win, the US dollar has rallied in the 6 months following the election. With this in mind, central banks will have to take more aggressive monetary measures if they want to combat this historical trend.

Housing: Have We Hit a Bottom?

Both new and existing home sales bounced in the month of September, suggesting that the housing market may have bottomed. Although the data is certainly encouraging, it is important to realize that the increase is coming off of very low levels. The sale of inventory has also been driven by price cuts as home owners and developers become more desperate. The median price of a new home saw negative annualized price growth for the 5th month in a row. It will be interesting to see how the numbers fare in October because credit has been almost unattainable this month. Tomorrow we will receive the S&P/Case-Shiller Home Price Index, which can shed more light on the housing market. However it is important to realize that the data will be for the month of August and a lot has changed since then to make these numbers of little value in indicating a bottoming housing market. Consumer Confidence and the Richmond Fed Manufacturing Index are also due for release. The turmoil in the financial markets and the erosion of retirement accounts should weigh heavily on consumer sentiment.

ECB LOOKING TO CUT INTEREST RATES AGAIN

European Central Bank President Trichet has always been one to hate surprises. In the past, he has frequently forewarned the market before a rate hike and has even openly admitted that the words strong vigilance is synonymous with a rate hike projection for the following month. However in a complete U turn from the central bank’s prior monetary policy biases, Trichet is now projecting a rate cut. In his most candor comment this new rate cutting cycle, Trichet said this morning that he is looking to cut interest rates at their monetary policy meeting next week. With interest rates at 3.75 percent, the ECB has plenty of room to ease monetary policy. We believe that the best option by the ECB would be to cut interest rates alongside the US on Wednesday. Since they already have the intention to cut interest rates next week, there is no reason to delay it if a coordinated rate cut would send a more powerful message and have a better chance of stabilizing the financial markets. Eurozone M3 money supply came in slightly above expectations, while the German IFO business sentiment index reaffirmed recessionary concerns. While the IFO Current Assessment was slightly stronger than expected, Expectations and Business Climate were seen to the down-side. Tomorrow’s schedule is packed with German and French Consumer Confidence numbers.

G7 STATEMENT IS ALL TALK AND NO ACTION

The Japanese are becoming increasingly frustrated with the appreciation of the Japanese Yen and their G7 counterparts are doing the minimum needed to appease them. The G7 released a statement on the Japanese Yen this morning, but it was all talk and no action which suggests that the Japanese are having a very hard time convincing their US and European counterparts to join in on any physical intervention to sell the Yen. It is certainly not in the US’ best interest to engineer further strength in the dollar and for the ECB to intervene and buy Euros would completely contradict the dovish comments made by Trichet this morning. The Japanese will have to act alone if they plan on engaging in any physical intervention because the ECB and the US know that a weak USD/JPY and EUR/JPY is good for exports. The strength of the Yen has become a major hindrance for the export-driven economy and part of the reason why the Nikkei has fallen to 2 decade lows. Japanese Corporate Service Prices were seen down by 0.1% compared to a report of 1.4% reported last September. Retail Trade figures will be released later today. Tomorrow, we will see Vehicle Production and Industrial Production figures. YoY vehicle production will gives us some insight into the strength of Japan’s two strongest automakers (Toyota and Honda) and how they have been able to cope with faltering international economies.

Published on  Tue, Oct 28 2008, 08:10 GMT