Over the last couple of months we have been witnessing aggressive monetary actions by the Fed as they have slashed their federal fund rate from a high of 5.25% to low of 2.25%. In addition, to help control the financial crises, numerous plans - including the cooperation of central banks and auctions of assets, has allowed the Fed to pump additional money into the system, boosting the money supply and preventing a total collapse of the economy. Despite recent economic data, showing that the housing sector still remains in a dire situation, trading sentiment has slightly improved. The flow of money that was seeking at one stage safe-haven places only has been creeping out, entering more risky assets. Taking a glance at the two charts below one can see how money has been exiting Gold and U.S bonds, two popular assets that allowed investors to yield profits.
On Thursday the Euro lost its attractiveness as a secure currency, as it crashed giving up its strength to the U.S Dollar. Why should the Dollar strengthen if the Fed is going to decrease rates? Could it be that Germany’s weak economic data had such an impact on the currency pair? Why is the Euro weakening if there are signs that the ECB could increase their interest rates by the end of the Year?
These were just a few of the question that were raised towards the end of the week.
Obviously we can immediately eliminate some explanations, as it is very unlikely that one piece of economic data had such an impact on this pair, especially as the Euro has been withstanding battering news over the last couple of weeks. As I have mentioned in previous articles, currency pairs, similar to other assets are driven by market expectations. To date, some Dollar traders are expecting a rate cut of 0.25% while others are expecting a 0.5% cut. The difference between the two expectations is crucial when talking about intraday movement, but if we analyze the markets more carefully we can see that what is driving the dollar forward is the possibility that the Fed could change their stance following the rate decision. Will the Fed pause with its monetary actions following
the upcoming decision?
Is an approximate 2% interest rate enough to spark a bullish market in the dollar and stocks, changing the Fed’s policy around to a rate hiking one?
Analyzing the chart below we can see that the Dollar index (calculated against six major currency pairs) bounced off support level of $71. To date, market expectations of the upcoming rate cut are lower than first anticipated (there’s a higher probability that the rate cut will only be of 0.25% than 0.5%), and the possibility that this could be the last rate cut by the Fed is pushing the Dollar forward. In addition, as the U.S equity markets continue to touch higher peaks, it continues to attract foreign money as traders buy up stocks using U.S dollars. One must continue to take into consideration the following: Dollar strength is still classed as short term strength until a change in major trends is verified. In addition, taking a glance at previous levels of the fund rate we can see
that past interest rate levels have reached as low as approximately 1%, during previous economic turmoil. Up until now the dollar has been fighting back, ignoring weak economic data, showing us that it’s not over until the Fat lady sings...
If there are no additional surprises or write-offs in the markets adding on to current calculations, dollar strength will lay solemnly on the Feds monetary outlook.
