The Euro has surged to 1.3157, a six week high against the U.S. dollar. The currency pair’s strength is a big departure from the price action of the other majors currencies this morning, which have weakened across the board. The break of the old highs opens the door for a move above the January highs of 1.33. The FOMC rate decision will determine the next 1 percent move in the EUR/USD.
Remember, if the FOMC fails to make any new announcements, the dollar should rally, equities should sell off and bond prices should rise.
If they make the nuclear announcement of buying long term U.S. Treasuries, the dollar should sell off, equities should rally and bond yields should rise. For a more in depth outlook on the FOMC rate decision, read my FOMC Preview.
USD/JPY is on a tear this morning. US equities is also trading higher which is completely mind boggling given the fact that US economic data was very weak and Fed Chairman Ben Bernanke warned that we may not be looking at a recovery in the US economy until 2011 or 2012.
There could still be more surprises in Bernanke’s testimony, which is only beginning as he will be facing questioning by the members of the Senate. Although the Q&A session could set the tone for trading this afternoon, the USD/JPY rally has been voracious. Unless there are new revelations from Bernanke, USD/JPY could be headed to 98. The level that it needs to hold above for this to happen is 96.15, the 38.2 percent retracement of the August to January sell-off.
Here’s his full testimony:
Chairman Ben S. Bernanke
Semiannual Monetary Policy Report to the Congress
Before the Committee on Banking, Housing and Urban Affairs, U.S. Senate, Washington, D.C.
February 24, 2009
Chairman Dodd, Senator Shelby, and members of the Committee, I appreciate the opportunity to discuss monetary policy and the economic situation and to present the Federal Reserve’s Monetary Policy Report to the Congress.
Recent Economic and Financial Developments and the Policy Responses
I want to share my piece on How Nationalization of Citigroup and Bank of America could impact the US dollar if you haven’t caught it already (so I’m am posting his before I head to the NY Traders Expo).
The rally in gold prices tells us one thing and one thing only, which is that the fear has returned to the market. There is currently a lot of speculation that Citigroup and Bank of America could be nationalized by the US government. Although this would drive equities lower, it could also trigger capital flight out of the US dollar.
When Northern Rock was nationalized by the UK government in February of 2008, the British pound fell from 1.9638 to a low of 1.9363 over the course of 3 trading days. Although the dollar initially rallied on the news that the US government was taking over Fannie Mae and Freddie Mac in September 2008, it quickly gave back those gains to end the week lower against the Japanese Yen.
Nationalization will ultimately be negative for the US dollar because it increases the debt and liabilities of the US Federal Reserve and hence taxpayers. Nationalization is by no means a foregone conclusion especially since it is not a part of the US Treasury’s Financial Stability Plan. Senate Banking Committee Chairman Christopher Dodd floated the idea of short term nationalization around but it will probably be the last option for the US government if the Financial Stability Plan fails to work quickly. In fact, the rebound in US equities was triggered by speculation that the Treasury could release more details regarding their plan to rescue the financial system next week. Also keep an eye on Bernanke’s Humphrey Hawkins Testimony on the US economy and Monetary Policy.
Can the EUR/USD rally Continue?
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.
FOMC Decisions Could Become a Non-Event for the US Dollar
The last time that the Federal Reserve drew an end to a major easing cycle was in 2003 when they took interest rates to 1 percent from a high of 6.5 percent in 2000. At that time, interest rates hit the lowest level in more than 40 years. The last rate cut that the Federal Reserve made during that easing cycle was in June 2003. The following charts illustrate how the EUR/USD traded following the next 2 interest rate decisions at which interest rates were left unchanged at 1 percent. In August of 2003, the EUR/USD fell 30 pips in the hour following the rate decision and by the open of the European trading session it was down a total of 80 pips. The move was very gradual and happened over the course of many hours, which is unlike the type of volatility seen after recent FOMC rate decisions. The same indifference to the FOMC rate decision happened in September 2003 as well. The EUR/USD fell less than 20 pips in the hour following the rate decision and proceeded to fall another 30 pips over the next 8 hours.
See charts and continue reading on FX360.com
For the first time since cutting interest rates to 0.25 percent, Federal Reserve Chairman Ben Bernanke outlined his plan of action. In a speech at the London School of Economics, Bernanke talked about the additional tools available to the Fed, an orderly exit strategy, concerns about inflation and suggestions about how the Obama Administration should use the remainder of the TARP funds.
What is the Difference Between Credit and Quantitative Easing?
Most importantly, Bernanke created a new name for his regime – credit easing. In contrast to Quantitative Easing, which Bernanke explains focuses on the liabilities portion of the central bank’s balance sheet, Credit Easing focuses on expanding the asset side of the balance sheet. However since the balance sheet is suppose to balance, this may just be a difference of semantics since both efforts ultimately add liquidity into the financial system. The Federal Reserve wants to draw a distinction between their current policies and the Bank of Japan’s policies between 2001 and 2006.
The Fed’s Toolbox
As for the tools that they have at their disposal, there was nothing groundbreaking. Their number one tool is policy communication, followed by liquidity facilities for banks, facilities for other markets and purchases of long term securities. Like Federal Reserve President Lockhart, Bernanke expects interest rates to remain low for an extended period of time.
Inflation Concerns and Exit Strategy
As we expected, inflation is not a concern because the Fed believes that weaker growth will keep inflation low. In terms of an exit strategy, he expects demand for the emergency facilities to wane as the US economy improves.
Use of TARP Funds