by Darrell Jobman, Editor-in-Chief TraderPlanet.com
The dollar strengthened to high around 1.4365 against the Euro in early European trading on Tuesday before weakening to around 1.45 ahead of the US opening.
The Federal Reserve cut interest rates following an emergency meeting with the Fed Funds rate cut by an aggressive 0.75% to 3.50%, which was the biggest cut for over 20 years, while the discount rate was also reduced by 0.75%. The Fed cited a weakening outlook and increasing downside risks for the action.
Regional President Poole opposed the move ahead of the scheduled meeting next week and there will be some unease over Fed credibility. In response to the decision, the US currency then weakened sharply to lows beyond 1.46 on a sharp drop in yield support.
Following the Fed move, there was still speculation that the Fed would cut interest rates again next week which will reinforce the lack of dollar’s yield support. The US currency will still gain some support from some optimism that the Fed action will underpin growth and trigger inward investment flows.
Market attention will now tend to switch towards the ECB. There will be increased pressure on the European central bank to consider an interest rate cut, especially as a co-ordinated move would strengthen credibility. The ECB rhetoric held firm in comments on Tuesday, although there were reservations over the growth outlook.
The yen continued to gain safe-haven support as Asian stock markets fell sharply on Tuesday, but the dollar found further support below the 106 level and rebounded to 106.30 in Europe as equity markets rallied. The yen weakened further following the Federal Reserve interest rate cut, but the dollar did not break above 107.00.
The Bank of Japan left interest rates on hold at 0.50% following the latest monetary meeting with a 9-0 vote. The central bank also downgraded its economic assessment with comments that the growth outlook somewhat weaker than expected.
The comments from Finance officials will continue to be watched very closely in the short term. Finance Minister Nukaga stated that Japan was not considering large-scale intervention in the currency markets and the overall stance does not appear to indicate major alarm at this stage. The 105 region against the dollar will be the first major test for the Japanese officials.
Sterling weakened to lows below 1.9350 against the dollar in early Europe on Tuesday and strengthened against the Euro. These trends were reversed sharply in US trading with the UK currency challenging levels above 1.96 against the dollar, but weakening against the Euro.
Following the Federal Reserve interest rate cut, there will be additional pressure on the Bank of England to cut rates ahead of the scheduled February meeting or announce a bigger than expected 0.50% cut in rates.
The MPC minutes and latest GDP report will be watched closely on Wednesday to assess underlying economic trends and the Bank’s thinking in January. A weak GDP report and substantial minority call for lower rates would increase speculation over an aggressive February move.
In comments on Tuesday, Bank Governor King warned that inflation could breach 3.0% in 2008. He was also generally downbeat on Sterling’s prospects with a warning that the current account position was more difficult which will tend to undermine sentiment.
The Swiss franc found support weaker than 1.11 against the US currency on Tuesday and strengthened to test levels beyond 1.10 after the Federal Reserve interest rate cut. The franc initially held firm against the Euro before weakening to 1.6065 in US trading.
The Fed rate move should ease risk aversion to some extent which will lessen immediate demand for the franc, especially as there will be speculation that other central banks will take aggressive action to support the global economy.
Domestically, the annual increase in retail sales was 2.9% in Novemberwhich will reinforce expectations of an economic slowdown, but global influences will tend to remain dominant.
The Australian currency hit lows around 0.8520 against the US dollar near the close of local trading on Tuesday. Levels of risk aversion have remained very important with the heavy falls in global stock markets undermining confidence and triggering an unwinding of carry trades.
Global stock market trends will remain a powerful influence and the Australian dollar rallied to 0.87 after the Federal Reserve interest rate cut.
The domestic trends will be important overnight with the CPI release and a high figure would provide some initial Australian support. A weak figure would reinforce expectations that interest rates will not be increased which would undermine the currency.