by Darrell Jobman, Editor-in-Chief TraderPlanet.com
The dollar traded in narrow ranges ahead of the Federal Reserve interest rate decision and was unable to sustain a break of the 1.3850 level. The US currency weakened sharply to record lows around 1.3980 following the Fed’s rate announcement.The FOMC unanimously voted for 0.50% rate cuts in the Fed funds and discount rates. In the statement accompanying the decision, the Fed stated that the action was taken to forestall harm to the wider economy caused by the housing downturn. The Fed retained some reference to inflation risks, but downgraded it as an issue.
The more aggressive Fed stance on interest rates will undermine the dollar in the short term on yield grounds, although it may increase confidence in growth prospects which will limit selling pressure.The July capital account data recorded a sharp drop in long-term capital inflows to US$19.2bn from US$97.3bn previously as corporate bond issues fell. Overall capital inflows were stronger as credit fears led to a demand for short-term securities.
Foreclosures rose sharply according to the latest data and the data will be watched closely on Wednesday for further evidence on the housing sector. Only a surprise recovery in starts and permits would ease short-term fears and support the dollar. A high reading for core consumer prices would increase stagflation fears.The German ZEW index fell further to -18.1 in September from -6.9 the previous month which will maintain expectations of a slowdown in the Euro-zone economy. Markets are continuing to edge away from expecting further ECB interest rate increases.
The yen drifted weaker against the dollar and Euro ahead of the Fed’s interest rate decision with cautious buying of high-yield currencies. The yen weakened further to 116.20 after the Fed rate cut with sharp losses against the Euro.
Following the UK stresses, rumours of Australian difficulties boosted the yen on Tuesday. Immediate fears were, however, lessened by better than expected Lehman’s earnings and the strong Wall Street rally triggered by the Fed rate cut.
The domestic data was subdued with the latest Reuters PMI index weakening to the lowest level since October 2005. Even if the Nikkei recovers, there is little chance that the Bank of Japan will be in a position to increase interest rates on Wednesday, but the yen will jump stronger if rates are increased.
Sterling weakened to lows below 1.99 against the dollar in early Europe on Tuesday before recovering back to 2.00. The UK currency spiked higher to 2.0140 following the Fed’s interest rate cut. Sterling also found some support weaker than 0.6950 against the Euro.
Banking fears eased during the day as the Northern Rock panic subsided. The Bank of England also eased money market conditions through an extra injection of liquidity. This combination will ease immediate fears over a credit crunch, but will also tend to reinforce expectations of lower interest rates.
The August headline inflation rate fell to 1.8% from 1.9% previously while the core rate edged higher to 1.8% from 1.7%. The subdued data will make it slightly easier for the bank to cut rates if economic conditions deteriorate, although there will still be concern that the Retail Prices Index (RPI) rose to 4.1%, especially as this has an impact on earnings growth.
The Swiss currency lost ground against the Euro on Tuesday, especially once the Fed announced a 0.50% cut in interest rates as this encouraged a renewed interest in carry trades. The dollar found further support close to 1.18 against the franc.
The National Bank’s signal that interest rates may now have peaked will tend to weaken Swiss currency demand, although the impact will be lessened by the fact that expectations have also been downgraded elsewhere.
Following selling due to the improvement in risk tolerances, a sustained recovery in global stock markets would tend to weaken the Swiss currency despite the longer-term risks.
The Australian dollar weakened to lows below 0.83 in local trading on Tuesday before rallying to 0.8350 ahead of the Federal Reserve interest rate decision.
Unease over the global banking sector undermined the Australian dollar and confidence dipped further in local trading on Tuesday as there were rumours that Australian banks had requested emergency support from the central bank.
Confidence in high-yield currencies was boosted by the Federal Reserve’s interest rate cut and the Australian currency rallied strongly to highs above the 0.85 level in US trading.