Dollar Breaks Support, Falls 10 out of last 12 Augusts

The U.S. dollar may be rebounding this morning but I think the gains will be short-lived. August is a terrible month for USD/JPY – the currency pair has fallen TEN out of the last TWELVE Augusts. Although seasonality does not equal a certainty of USD/JPY weakness, it is worth noting that 83 percent of time, USD/JPY has ended the month lower by an average of 2 percent. Considering that USD/JPY started the month at 86.46, a 2 percent move would put it below its November low of 84.83.

The reason why there is strong seasonality in favor of USD/JPY weakness this month is because of the reinvestment of bonus payments received on Toshin investments in July and the repatriation of Treasury coupon payments in mid August. Also, there tends to be more hedging by exporters ahead of Obon week, which is one of the most important holiday seasons in Japan.

Also on a technical basis, the Dollar Index has broken below the 200-day Moving Average. The following chart shows how a break of the MA has represented a major shift in trend. For example, even though the dollar index had been falling between 2008 and the first half of 2009, the break below the MA triggered another 10 percent sell-off in the U.S. dollar.

Source: Bloomberg

Discount Rate vs. Fed Funds Rate

What is the difference between the Discount Rate and the Fed Funds Rate?

On Thursday February 18th, the Federal Reserve surprised the markets by raising the discount rate by 25bp to 0.75 percent, sending the U.S. dollar sharply higher against all of the major currencies. Although the Fed went out of their way to say that this does not equate to a change in their monetary policy outlook, action speaks louder than words.

The discount rate is different from the Federal Funds or overnight lending rate.

The DISCOUNT RATE is the rate charged to commercial banks and other depository institutions on loans that they receive from the Fed

The FED FUNDS RATE is the rate that banks charge each other for loans.

By hiking the discount rate and not the Fed funds rate, the central bank has in essence encouraged banks to borrow from the market over the Fed without hurting households. The Fed also shortened the terms of primary loans to overnight from 90 days.

This is a game changer for the foreign exchange market and should lead to further gains in the dollar over the next few weeks (Kathy’s CNBC Video Interview on the Fed Announcement).

The U.S. central bank attempted to temper their comments by saying that their outlook for the economy and monetary policy is unchanged and that rates will remain low for an extended period. The most important takeaway is that the Fed is beginning to implement an exit strategy which is more than what many of the other central banks are doing and therefore this action will be extremely positive for the dollar.
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