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Compared to yesterday’s sharp moves in the currency and equity markets, trading has been relatively quiet. U.S. stocks meandered in and out of negative territory while the U.S. dollar traded higher against nearly all of the major currencies. Profit taking has hit the financial markets dragging equities and currencies lower. This consolidation gives investors the time to think about whether Monday’s rally is the beginning of a new bull market or just a strong bear market rally. Since March 6th, the S&P 500 has increased 23 percent, which is marginally less than some of the rebounds that we saw during the Great Depression. The point is that equities could still extend its gains while remaining in an overall downtrend.
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Federal Reserve monetary policy decisions have become increasingly less important after the central bank took rates interest down to a record low of 0.25 percent. With no further room to ease, tomorrow’s rate announcement could be anti-climatic, which is a big departure from the currency market’s previous obsession with the FOMC rate decisions because of the volatility that it can have on the U.S. dollar.
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The U.S. dollar gained strength against the Japanese Yen following the better than expected retail sales report. This could be a good day for risk if the momentum continues.
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Currencies and equities have strengthened across the board suggesting that risk appetite may be improving. The dollar, which has been a refuge for safe haven flows, fell against all of the major currencies except for the Japanese Yen. In fact, the rally in USD/JPY has been voracious with the currency pair rising 2.5 percent to an 11 week high. The move today has been driven by a variety of factors, none of which in our opinion are meaningful enough to sustain the rally.
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The much anticipated announcements from Washington have triggered a dramatic turn in the currency and equity markets. With investors flocking back into the safety of US dollars and the Dow Jones Industrial Average falling 381 points, it is clear that investors are not satisfied with the Obama Administration’s new programs to unlock the credit the market and rescue the financial sector. If today’s announcements were to be measured by their ability to restore confidence in the financial markets, then the new President has failed miserably. Fortunately we are more optimistic and believe that economic stability will be restored under Obama’s leadership, but patience may be needed.
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Treasury Secretary Tim Geithner laid out the Obama Administration's game plan for restoring stability in the financial markets. Unfortunately the price action in the currency markets suggests that investors are disappointed by the lack of details and are skeptical about the effectiveness of getting the private sector involved.
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US growth fell by 3.8 percent in the fourth quarter, the largest drop since the first quarter of 1982. The GDP report was not nearly as bad as the market had expected which should not be a surprise for readers of the Daily Currency Focus.
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The US dollar is stronger across the board today as risk aversion returns to the market. Like Florida weather, where it can be hot one day and cold the next but warm most of the time, we can occasionally see an improvement in the market’s risk appetite but the bias is still towards risk aversion. Traders have quickly realized that nothing new came out of the Fed’s monetary policy meeting yesterday and until we have another major announcement from the US government, currencies will be vulnerable to negative US economic data, earnings report and developments abroad.
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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?
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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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Investor confidence has improved this morning and that is helping to drive currencies higher. Traders are quietly moving out of US dollars and back into higher yielding currencies thanks to news that President Obama is considering creating a bank that would absorb toxic assets.
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For the first time since August 2007, the Federal Reserve is not expected to change interest rates. With the fed funds rate now set to a target range of 0 to 0.25 percent, the Federal Reserve has maxed out on their most conventional monetary policy tool. Although they still have different ways of adding liquidity to the financial system and stimulating the economy, what was once the second most market moving event risk for the foreign exchange market could become a non-event. Going forward, traders may have the same disregard for FOMC rate decisions as they do for Bank of Japan meetings. The only way for Wednesday’s FOMC rate decision to hurt the dollar would be if the central bank announces that they will be purchasing long term US Treasuries in size or if they add more ingredients to their alphabet soup of new programs. There is nothing to support the dollar on the upside as the Fed is not expected to start talking about raising interest rates.
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In his confirmation hearing with the Senate Finance Committee, Treasury Secretary Nominee Tim Geithner said that a "strong dollar is in America's National Interest."
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It is not often that we can see the US dollar hit a 23 year high against one currency and a 13 year low against another on the very same day. However that was exactly what happened this morning when the greenback surged against the British pound and collapsed against the Japanese Yen. Volatility ripped through the foreign exchange market as central bank and other US officials comment on their economies and currencies. The milestones were not limited to the GBP/USD and USD/JPY as the NZD/USD and EUR/JPY also fell to a 6 year low intraday. However what was most impressive is the fact that none of the staggering losses were sustained.
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The US dollar is selling off aggressively ahead of Friday’s non-farm payrolls report on the fear that for the second month in a row, job losses may have topped 500k. The recent moves in the currency and equity markets suggest that everyone expects a very weak labor market report. Although the consensus forecast is -520k, the whisper number is closer to -650k to -700k. Sentiment is strongly skewed in one direction which can be dangerous considering the fact that some of the leading indicators for non-farm payrolls call for a rebound.