FOMC Instant Insight: Dollar Rallies on Lack of Exit Strategy Talk

Last updated 6/24/2009 2:47 PM ET (GMT -5) 8 Comments

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Kathy Lien

Director of Currency Research, GFT

The U.S. dollar has rallied sharply on the heels of the FOMC announcement despite the fact that the Federal Reserve made no major changes to their monetary policy statement. They kept interest rates unchanged and did not alter the size and scope of their asset purchase program. As we said in our FOMC Preview, the recent improvements in economic data and the stabilization of equity and bond markets, give the U.S. central bank no reason to rock the boat at this point in time. Rather than use up more public funds, it is smarter for the Fed to wait and see how the market responds to the massive amount of stimulus that they pumped into the financial system. However with that in mind, traders were disappointed that the central bank did not mention an exit strategy which implies that they the U.S. economy is not recovering strongly enough for them to even consider how and when to remove monetary stimulus. They also reiterated that interest rates will remain exceptionally low for some time and unfortunately, their failure to ease concern about the economy has led to a flight safety back into U.S. dollars.  Risk aversion has driven stocks and the major currency pairs lower.

The next monetary policy decision is not until August 12 ^th which is a long time from now and a lot can happen between now and then.   The Fed is clearly in wait and see mode and need the extra few weeks to assess the health of the U.S. economy. The rally in the dollar may not have significant follow through because at the crux of it, the statement remains virtually unchanged. 

The central bank has acknowledged that the pace of contraction is slowing and financial market conditions are improving but they are worried that about ongoing job losses and further cuts in business spending. The economy will remain weak for some time which confirms our belief that it will be a while until the average American feels the recovery. Despite the rise in oil prices, the Fed does not believe that inflation will be a problem because demand remains weak. 

Federal Reserve Chairman Bernanke will be testifying tomorrow on his involvement in Bank of America’s acquisition of Merrill Lynch and we do not expect him to make any market moving comments. The only fear is that if it appears that if any illegal action has occurred, it could threaten his role as Fed Chairman and political uncertainty will be bearish for the U.S. dollar. 

Comparing the FOMC Statements:

FOMC Statement June 24, 2009

Information received since the Federal Open Market Committee met in April suggests that the pace of economic contraction is slowing. Conditions in financial markets have generally improved in recent months . Household s

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.

FOMC Statement April 29, 2009

Information received since the Federal Open Market Committee met in March indicates that the economy has continued to contract, though the pace of contraction appears to be somewhat slower. Household spending has shown signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth, and tight credit. Weak sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories, fixed investment, and staffing. Although the economic outlook has improved modestly since the March meeting, partly reflecting some easing of financial market conditions, economic activity is likely to remain weak for a time. Nonetheless, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.

In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is facilitating the extension of credit to households and businesses and supporting the functioning of financial markets through a range of liquidity programs. The Committee will continue to carefully monitor the size and composition of the Federal Reserve's balance sheet in light of financial and economic developments.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.

Comments (8)

Ala

June 25, 2009 at 09:50 AM ET

Hello Kathy,

What I understand from your reports on the last 2 days about the Greenback and the Euro that since the broader picture of the US ecomomy is not yet very clear which was implied in the FOMC Statement not metioning the exit strategy from the current easy monetary policy, the Euro will keep struggling against this stimulus for the next 2 months or so. But still you said above that the rally in the dollar may not have significant follow through.

It sounds like if the information is not quite in sync. Can you elucidate a bit more?

Ala

klien

June 25, 2009 at 09:53 AM ET

Yesterday I said that the dollar's rally may not have much follow through and so far today, the flat price action in the EUR/USD and many of the other major currencies validates my view. However for the rest of the week, the lack of economic data and uncertainty in the markets may not help the EUR/USD either (so any recovery could be limited). Bottom line is we could have some range trading over the next 48 hours but the rally the EUR/USD may pick up once again in the coming week, which is chock full of economic data

PLAYJT

June 25, 2009 at 02:03 PM ET

Kathy,

If the CAP and Trade bill is passed which looks like it will tomorrow..

How will the bill impact the currency market?

What will the impact be on Aussie and CAD crosses...

Winner or losers on this bill?

If one takes the Warren Buffet position this a a Tax, wouldn't this be dollar negative? Could this bill be inflationary?



Jonathan

klien

June 25, 2009 at 02:18 PM ET

Good question. For the people who do not know what the cap and trade bill are, under cap-and-trade the amount of carbon that U.S. companies can produce is “capped.” If they exceed that cap, they can purchase (“trade”) carbon allowances or permits to cover the excess emissions. The money generated from the purchase of those allowances would potentially be re-invested in more environmentally friendly companies and possibly also re-distributed to low-income families.

So with that in mind, from a broad market perspective, this bill is bearish for electric utilities because payments for excess emissions hurts earnings. It is also negative for oil and oil companies. The EPA has previously estimated that the bill would reduce U.S. manufacturing capacity 0.3 percent by 2020 and by nearly 1.5 percent by 2050. It could also force a 22 percent increase in electricity prices by 2030, pushing the price of gasoline above $4 per gallon by 2030 and to approximately $5.50 per gallon by 2050. Without the climate bill, the EPA projects gas prices to rise to $4.50 by 2050 and expects electricity prices to increase by only four cents between now and then.

This would probably not take into effect until 2012, but we'll still see the knee jerk reaction in the financial markets before that.

Back to your Q, since this would be negative for certain sectors, it would probably drive their stocks down. If this leads to selling of the indices in general, that would be bearish for the currency market and particularly for the Canadian dollar.

PLAYJT

June 25, 2009 at 03:35 PM ET

Kathy,

Thanks.. If it is passed, where would see CAD head too.. and if it doesn't pass, where would you see CAD move to..

looks like there won't be a vote tomorrow, not enough votes..

Thanks,

Jonathan

klien

June 25, 2009 at 03:37 PM ET

We never know how the currency market will react to the CAP and trade bill, if at all, but if we assume that passing of the bill is negative for the oil industry, then it be logical to assume that it would be negative for the CAD as well. Hope that helps

PLAYJT

June 25, 2009 at 04:19 PM ET

yes, that helps..

Thanks!

koolraul

June 25, 2009 at 05:44 PM ET

Very informative... tnx.

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.