Fed Cuts Interest Rates to 0.25% and Formally Enters QE

The Federal Reserve cut interest rates by 75bp to a range of 0 to 0.25 percent, the lowest level that this generation has ever seen.

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 formally adopt Quantitative Easing even though they refuse to use those words explicitly.

It is no surprise to see the US dollar selling off aggressively as it is now the lowest yielding G10 currency. This was the right move for a central bank that wants to be proactive and no longer just reactive. There is no point for the Federal Reserve to play games anymore by denying what is already being priced into the markets. Cutting interest rates to 0.25 percent was inevitable and they rather deliver this stimulus now than later. Fed funds were trading as low as 0.15 percent going into the FOMC meeting. 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, the Federal Reserve is telling us that they are formally moving to Plan B, which is Quantitative Easing.

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 rather than under 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.

The US dollar has embarked on a new downtrend and today’s interest rate decision only cements that. We expect more dollar weakness in the first half of 2009. There is a reasonable chance that USD/JPY could fall to 85 and the EUR/USD could break 1.43. And of course, I still love the AUD/USD trade.

Comparing the FOMC Statements:

FOMC Statement December 16, 2008
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In the Financial Papers: Today’s Top Forex News 07.01.08

kathysmallHere is the “In the Financial Papers Radio Broadcast” (Length: 5:04 minutes). The player should load automatically. Please let me know if you like it. Contact Kathy

In the Financial Papers:


Podcast Covers:
RBA Statement a Tad Dovish as Bank Focuses on Growth Risks
Tankan confidence falls less than expected
German June Unemployment Falls to Lowest in 16 Years
Crude Oil Rises Above $142 on Concern Israeli Attack Would Cut Iran Supply
Global IPOs Decline to Five-Year Low as Economy Slows, Loan Losses Climb
U.K. House Prices Drop Most Since 1992; Manufacturing Unexpectedly Shrinks
Debt Laden Casinos Squeezed by Slowdown
China Hopes for Stability in US dollar and Credit ahead of g8 meeting.
Fukuda’s Low Key Style Furstrates Japanese A11
ECB Expected to raise rates as prices climb
Global Shares are Damped by Economic Storms
Central Bankers Warn of Tipping Point
Dollar Shows Surprising Stability
Banks are freezing lines of credit
US Autos face worst sales in a decade
BIS Calls for World Interest Rate Rise

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In the Financial Papers: Today’s Top Forex News 06.30.08

kathysmallHere is the “In the Financial Papers Radio Broadcast” (Length: 7:02 minutes). The player should load automatically. Please let me know if you like it. Contact Kathy

In the Financial Papers:


Podcast Covers:
China’s Export Machine Threatened by Rising Costs
Business Scrambe to Offset Rising Costs of Transportation
Jobs Report will Provide Clues on Growth and Inflation
Fed’s Priority is Likely to be Oil Price Shock
Oil Rises to Record Above $143 on Concern Iran Supplies May Be Disrupted
Stock, Bond Slumps Signal Worse Than ’94 on Inflation
Yuan’s Path Seems Up Eventually
Dollar May Well Survive the Perfect Storm
Central Banks Focus on Rising Prices
Australian Wages Stable Amid Tight Market

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Even G7 and Retail Sales Can’t Help the US Dollar

– Even G7 and Retail Sales Can’t Help the US Dollar
– Stronger Economic Data Keeps Euro Near its Highs
– British Pound Rallies on Surprisingly Strong Inflationary Pressures

Even G7 and Retail Sales Can’t Help the US Dollar

The US dollar has strengthened against all of the majors but the degree of strength is marginal considering the changes in the language of the G7 statement and the better than expected retail sales report. The main reason why the dollar did not rally as much as it could have is because with both reports, there is more than meets the eye. Even though the G7 is worried about the outlook for the global economy, the stability of the financial market and the volatility in currencies, the price action in the FX markets suggest that traders and investors believe that the G7’s words do not pack much punch. More specifically, the G7 called for more self-regulation by investment banks, which the banks balked at. They are also contemplating higher capital requirements for the banks but this would be only to prevent a future financial crisis rather than solving the present one. If such a rule was to be instituted today, it could make the capital markets even more illiquid. As for retail sales, even though the headline numbers increased more than expected, meaning that consumer spending did not contract for the second consecutive month, if gasoline was stripped out of sales, consumer spending was actually flat. Gas prices have increased 11 percent this year, taking a bigger bite out of the pocketbooks of US consumers. Inventories on the other hand have increased 0.6 percent while car sales have been the weakest in 10 years. It is difficult to believe that economy is improving as indicated by the headline retail sales figure when the nation’s fourth largest bank Wachovia posted a $393 million loss and cut its dividend. More banks will be reporting earnings this week and it will be important to see if the losses continue to build. In the corporate sector, survival has become the biggest focus. The potential for a merger between Delta and Northwest as well as Blockbuster’s bid for Circuit City stems from the need to reduce costs or to save an otherwise floundering business. Meanwhile the market’s focus tomorrow will turn to inflation and manufacturing. Strong inflationary pressures are practically a given, but a turn in manufacturing is up in the air. The market is looking for dollar weakness to boost production, but that was not the case in the month of March even though the dollar had weakened that month as well.

Stronger Economic Data Keeps Euro Near its Highs

The Euro sold off aggressively when the market opened Sunday night in reaction to the changes to the G7 statement. However those losses were recuperated throughout the late Asian, early European trading session. Unlike US economic data, Eurozone economic data was strong with no glaring underlying weakness. Growth in France, Germany and Spain continued to increase, albeit at a slower pace while growth in Italy contracted. Even though these numbers tell us that the Eurozone is beginning to slow, the problems are not as bad as the ones in the US and rather than repeated disappointments (even if they are beneath the headlines), there are still positive surprises. In addition, the European Central Bank continues to be very hawkish with ECB member Mersch telling us that there is no room to cut interest rates this year and ECB member Noyer indicating that there is no contradiction between price stability and growth. Unless the ECB changes their stance or economic data slows materially, any corrections in the EUR/USD may be limited. The German ZEW survey is due for release tomorrow. Even though analyst sentiment is expected to improve, they can be notoriously pessimistic.

British Pound Rallies on Surprisingly Strong Inflationary Pressures
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Will the US Dollar Continue to Fall?

Pandemonium has hit the financial markets. The dollar is trading below parity against the Swiss Franc, it has fallen to a new record low against the Euro and to a new 1995 low against the Japanese Yen.

Will the Dollar Continue to Fall?

Yes. The futures curve is currently pricing in a 90 percent chance of a 100bp rate cut and a 6 percent chance of a 10 percent rate cut. By the end of June expect rates to come down to 1.5 percent. This is the minimum that the Federal Reserve must do to stabilize the financial markets.

If they want to put an end to the pain however, they will need to be more creative. The discount rate cut on Sunday is not enough. What is 25bp really going to do for the markets? Banks are in seizure mode and are focused on nothing but minimizing counterpary risk. LIBOR rates are skyrocketing and everyone is holding their breath, waiting for the next shoe to drop. For this reason, the dollar and carry trades will continue to weaken.

Will there be Intervention?

Not anytime soon. The Japanese have expressed concerns about disorderly movements, but since their last intervention in 2004, their top priority has been to convince China to revalue their currency. I doubt that they will be willing to risk the past 4 year’s efforts 3 weeks before the finance minister’s meeting in Washington DC and 4 months before the G7 meeting that they will be hosting.

As for the ECB, they are worried about sharp and excessive moves, but they have their eyes peeled on 1.60. As long as we hold below that price level, I don’t expect any verbal intervention because in 2004, the EUR/USD rallied 13 percent in 2 months before the ECB called the move brutal. If we count 1.59 as the high today, the EUR/USD has only appreciated 10 percent over the last 2 months. The ECB’s top priority is inflation. The strong Euro is cushioning the pain on high commodity prices.

Don’t expect the Fed to come out and buy dollars either. They need a weak currency to draw in foreign investors that may be looking for value and to boost exports.

However this is not to say that there couldn’t be a coordinated liquidity injection or a similar move reflecting solidarity amongst global central bankers.

What about Carry Trades?

With high volatility in the stock market, and 300 point swings in currencies, don’t expect a recovery in carry trades either. If anything, expect further weakness in USD/JPY to drag the other yen crosses lower. The demise of Bear Stearns has made everyone gun shy. I am sure that risk managers across Wall Street banks are on red alert, forcing their traders to minimize risk.

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