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US Dollar: Hits 2 Month Low After FED Cuts Rates to 0.25%

Last updated 12/16/2008 5:36 PM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• US DOLLAR: HITS 2 MONTH LOW AFTER FED CUTS RATES TO 0.25%
• EUR/USD: INTEREST RATE SPREAD WIDENS TO 225BP
• GBP/USD: BREAKS 1.55, BUT BE CAUTIOUS OF THE RALLY
• AUD/USD: RALLIES AFTER RBA MINUTES SUGGEST HOLD
• CAD: HITS 1 MONTH HIGH AGAINST USD
• NZD: RALLIES 4.40 PERCENT
• USD/JPY: TANKS BUT OTHER YEN PAIRS RALLY AFTER FOMC

EXPECTATIONS FOR UPCOMING FED MEETINGS

US DOLLAR: HITS 2 MONTH LOW AFTER FED CUTS RATES TO 0.25%

The US dollar fell to a 2 month low against the Euro following the Federal Reserve’s decision to cut interest rates by 75bp to 0.25 percent.  The greenback is now the lowest yielding G10 currency and for that reason, we should see foreign selling of US dollars exacerbate.  At 0.25 percent or more specifically, a target range of zero to 0.25bp, foreigners may not find the yield attractive enough to warrant the risk.  Despite the selling that we have already seen in the dollar today, this could just be the beginning of a longer phase of dollar weakness that may last into the first quarter of 2009. 

Federal Reserve Outlines Plan for Quantitative Easing

In our FOMC preview, we talked about how the Fed may consider adopting a BoJ style rate cut that takes interest rates somewhere between 0.25 and 0 percent. Although that was exactly what we saw today, we expected it to happen in March and not December. The Fed has taken another page out of the Bank of Japan’s book and will continue to follow in the footsteps of the Japanese central bank as they adopt Quantitative Easing even though they refuse to use those words explicitly.

This was the right move for a central bank that wants to be proactive and no longer just reactive. The Federal Reserve did not want to continue denying what is already being priced into the markets. Cutting interest rates to 0.25 percent was inevitable and it is better that they deliver this stimulus now rather than later. The Federal Reserve expects to keep interest rates at “exceptionally low levels for some time,” and to employ all available tools going forward including the purchase of long term Treasuries. In other words, they are telling us that they are formally moving to Plan B, which is Quantitative Easing. In the statement, they even outlined their plans for QE which includes possibly purchasing long term Treasuries.

There is no question now that the Federal Reserve is the most aggressive central bank. Since 2007, they have cut interest rates by 500bp and since the beginning of year, they have cut by 325bp. With the economic outlook weakening and the financial markets remaining quite restrained, the Fed wanted to over deliver. This morning’s consumer price numbers also raises the risk of deflation, which may have pushed the Federal Reserve to make the larger move. The Fed did not indicate in the FOMC statement whether zero interest rates are still on the table, but an interest rate of 0.25 percent is just as bad.

Risks for the US Dollar in 2009

In addition to having the lowest interest rate of the G10 currencies, the US dollar faces many risks in 2009.  Weak retail sales and the widening of the trade deficit could trigger a major decline in fourth quarter GDP.  On top of that, we expect Q4 corporate earnings to reflect the consequences of the dollar’s strength in second half of 2008.  The US dollar rally is over and today’s interest rate decision only confirms that.  Even though the Q3 current account balance is due for release tomorrow, we do not expect it to put much of a dent on the currency market.

EUR/USD: INTEREST RATE SPREAD WIDENS TO 225BP

The interest rate cut in the US drove the EUR/USD to a 2 month high above 1.40.  Although the Eurozone service and manufacturing PMI numbers beat expectations, the trigger for the EUR/USD rally was the widening interest rate differential between the 2 currencies.  In the beginning of the year, the gap between Eurozone and US interest rates was 0.25 percent in the US dollar’s favor and now it is 2.25 percent in the Euro’s favor.  Although the shift in the interest rate differential has been underway for most of the year, the EUR/USD really took off this month when it became increasingly clear that the Euro would remain a significantly higher yielding currency than the US dollar for some time.  We still believe that the strength of the Euro will have a negative impact on the Eurozone economy in 2009, but we may see a further adjustment in dollar positioning first.  The Euro’s rally over the past 5 trading days has been strongest since the launch of the currency.  Looking ahead, Eurozone consumer prices are due for release tomorrow.  If you recall, ECB officials have been telling us that a January rate cut is contingent upon inflation pressures. The CPI numbers will shed some light on how much inflation has eased in the month of November. 

GBP/USD: BREAKS 1.55, BUT BE CAUTIOUS OF THE RALLY

The British pound soared against the US dollar today but weakened against every other major currency.  Despite the 359 point rally in the Dow, GBP/JPY and GBP/CHF failed to end the day in positive territory.  This goes to show that the market is still bearish the British pound and that the rally in the GBP/USD currency pair has been driven entirely by dollar weakness.  EUR/GBP hit a new record high of 0.9050.  Consumer prices fell less than the market expected last month.  Given the mixed PPI numbers and higher shop prices, we were not completely surprised to see the smaller decline.  Employment numbers as well as the Bank of England minutes are due for release tomorrow.  These are very market moving reports for the British pound and could stifle the currency’s rally against the US dollar.  The BoE cut interest rates by 100bp at their last meeting and it will be interesting to see if the decision was unanimous as well as how much further they plan on cutting interest rates going forward.  

AUD/USD: RALLIES AFTER RBA MINUTES SUGGEST HOLD

Commodity currencies rose across the board today, largely reflecting the historic interest rate cut in the US and the not so dovish minutes from the most recent RBA meeting. The Reserve Bank of Australia stated in its minutes that aggressive rate cuts, weakness in the currency, and government support should amount to a proficient stimulus for the time being.  They explicitly said that the latest rate cut of 100bp in December, “should be large enough to reflect in the lending and borrowing within the country.” This suggests that like the ECB, the RBA may want to take a break from cutting interest rates at their next monetary policy meeting. Fiscal stimulus is on the way with government handouts expected to near 8.9B Australian Dollars.  Even if the RBA pauses at their next meeting, this does not mean that they are done cutting interest rates. Dwelling starts decreased, reflecting the weakness of the housing market.  New home sales are due for release tomorrow.  There was no data from New Zealand but the Canadian dollar benefited from possible production cuts from OPEC.  Wholesale sales are also due for release tomorrow and it tends to be a good leading indicator for retail sales.

USD/JPY: TANKS BUT OTHER YEN PAIRS RALLY AFTER FOMC

Although the Federal Reserve’s interest rate cut was bearish for USD/JPY, the currency had already sold off significantly going into the rate decision.  Therefore the dollar’s weakness was more pronounced against the Euro, British pound, Australian and New Zealand dollars, driving EUR/JPY, CAD/JPY, AUD/JPY and NZD/JPY higher.  The Tertiary activity index also beat expectations but that only had limited impact on the yen crosses.  The Bank of Japan has an interest rate decision this week but no changes are expected.  Instead, they will contemplate at the upcoming meeting whether or not to invest in commercial paper, invest liquidity directly into the banks, or to accept of other collateral for long-term bonds that are purchased by the government.

GBP/USD: Currency in Play for Next 24 Hours

The currency in play for the next 24 hours will be the GBP/USD. Tomorrow, Bank of England is set to release its minutes from previous meeting along with Jobless Claims at 4:30AM EST or 9:30GMT. Further in the day, U.S. will announce its Current Account Balance for the third quarter at 8:30AM EST or 13:30GMT.

The British pound has had an impressive rally since hitting a 7 year low earlier in the month, forming what appears to be a rounding bottom. Currently, the pair is trading in the Buy Zone which was we determine using the Bollinger Bands. Current Resistance is placed between the 1.5750 which is 50-EMA and 1.5800 which is a 23.6% retracement from July high and December low. The support is placed at the 1.5300 which is the open for the day as well as 1st Standard Deviation of the Bollinger Bands. With an increase of volatility and a major economic day for the Pound, the levels could be tested relatively easy. 

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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.