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Cautious optimism is the perfect catch phrase for today’s events. Things are getting better but it is unclear whether or not this is just a break in the storm, or the very beginnings of stabilization. The Federal Reserve seems to believe that we are a long ways off, while recent economic data and earnings reports are pointing toward stabilization. The Dow spent much of the day trying to find the answer to this unanswerable question. In the end, the bulls were barely able to maintain control. The euro and pounds got hammered in today’s session, losing more than 150 and 120 pips respectively. Surprisingly, dollar strength was not enough to keep USD/JPY from sinking further. Commodity currencies were mixed on the day.
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The Philly Fed factory index survey printed far better than expected in April, coming in at -24.4 versus -35 anticipated. Every major sub component showed improvement with future index rising to 36.2 vs. 14.5 new orders climbing to -24.3 from -40.7 and employment at -44.9 versus 52.0.
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US stock markets finished the day strongly. For most of today’s trading, markets expressed uncertainty about the latest flood of economic reports, most of which did not improve as much as anticipated. By the end of the day, the Fed was able to step in and console investors as to the current stage of stabilization in the US economy. The Fed’s Beige Book, a tabulation of conditions reported within each Federal Reserve District opened with the usual words of concern but then introduced the notion of stabilization. The markets took this news and decided to rally with it by more than 100 points. Currency markets reflected stern euro weakness in turn for broad based pound strength. The dollar was higher against the yen but lost more than 100 pips against the Canadian dollar.
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FOMC's stunning announcement yesterday that it will buy up to $300 Billion in Treasury bonds took the currency market by surprise and rallied the EUR/USD by more than 500 points in less than 24 hours. As we wrote earlier the FOMC announcement ,” represents an 'all-in' bet on massive monetary stimulus in order to stem the worst contraction in the US economy since World War II. The move is of course wildly dilutive to the currency with nearly $1 Trillion created out of thin air. Little wonder then why the dollar collapsed across the board even as other asset classes rallied. It also indicates that the Fed may have come to the conclusion that the two biggest customers for US debt – China and Japan – may be unable or unwilling to provide additional capital to finance the gargantuan expansion of US fiscal spending this year and next.”
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The reverberations from yesterday’s surprise announcement by the Fed continued in the currency market with EUR/USD remaining bid in early European trade but the 1.3500 handle remained serious resistance as the pair had trouble penetrating that level. Yesterday’s announcement by the FOMC that it will purchase up to $300 Billion in US Treasury securities, spurred a massive dollar sell off as few traders expected the Fed to initiate quantitative easing quite so soon and on such a large scale.
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In an interview to 60 Minutes Fed Chairman Ben Bernanke forecast that US economy will begin to stabilize by the end of the year and stated that the greatest risk to the recovery was lack of political will. “The lesson of history, “ he noted, “ is that you do not get a sustained economic recovery as long as the financial system is in crisis.”
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The Federal Reserve has officially run out of room to cut interest rates. For the first time since August 2007, they left interest rates unchanged at a target range of 0 to 0.25 percent. The dollar rallied because the Fed did the minimum of what was needed to pacify the market, which was to say that they could purchases Treasuries but are not going to do so right now. Currency traders were looking for something more radical such as inflation targeting or a bold announcement that they start buying long term Treasuries in size - which would have been dollar bearish. Interest rates could remain at current levels for the next six months as the central bank focuses on credit easing. The Federal Reserve was pessimistic about the outlook for the US economy and said that inflation could continue to remain weak in the coming quarters.
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The US dollar continues to rise, but the rally is tempering. After sharp losses this past week, the Euro, Japanese Yen and Australian dollar are beginning to stabilize against the greenback. US equities have been in the red throughout the day, which is why most currencies remained negative despite sharp intraday reversals. Over the next week, the US dollar faces 3 big threats that all traders and investors should be aware of – a bad bank plan, central bank intervention and economic data:
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For the most part, markets today expressed a tone of relief and satisfaction for global economic events. We have seen the classic pattern of dollar and yen weakness across the board that is quite the mainstay in markets that think the worst is over. However, we are cautioning that this brief level of renewed sentiment may be short lived. In the US the euphoria that was left over from European trading seemed to dwindle in the latter part of the trading day. The Dow finished one of its typical whipsawed trading sessions, falling off of highs of more than 100 to dip in to negative territory. The index did finish in positive ground. This level of uncertainty definitely casts some doubt on the continuation of this renewed confidence in the financial markets.
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Trading in equities very closely mirrored yesterday’s volatile session. It is clear that investors are still uncertain, as direction in the Dow has been largely range-bound. Equities have swerved between two extremes, at one time positive by more than a hundred points. Even though the excitement and enthusiasm behind the newly proposed relief program has managed to give equities a new leg, we are still undeniable seeing the levels of concern that have pervaded the markets for most of last year. This level of fear was a big factor that led to the original implosion of the equities market. Trading in the dollar has been likewise mixed, with strength against the euro and yen, but weakness against the pound and commodity currencies.
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Tuesday’s FOMC meeting will be remembered for decades to come as the Federal Reserve brings interest rates down to the lowest level this generation has ever seen. With 2 realistic options on the table and economist and traders divided on how much the Fed will cut interest rates, the only certain outcome is significant volatility for the currency market. The US dollar is selling off aggressively going into the rate decision as traders realize that after tomorrow, the dollar will either be the lowest or second lowest yielding G10 currency. No matter how you look at it, an interest rate of 0.50 percent is just as bad as an interest rate of 0.25 percent.