IB FX View

Soothing FOMC statement eyed as dollar eases

Tuesday June 23, 2009

Today we have bearish words from Bundesbank leaders, Herr Axel Weber pitted against the growing view that the Fed will pour cold water on the prospect of a rate tightening cycle – period. The euro is therefore stronger against the dollar, but this concept of dollar weakness is at odds with the unwinding of interest rate expectations borne out during the previous two weeks through rate futures. Going into today’s meeting Eurodollar futures predict a 40% likelihood that interest rates will rise by at least 25 basis points by year end. While last week that probability was 50%, the previous week it was closer to 70%. Yet the proximity of some announcement from the Fed playing down rate rises is to blame for dollar weakness. This is a very lame excuse for buying euros we think.


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Eurozone Purchasing Manager index data for June was a little weaker than had been hoped for. The data punctuates the standstill in recovery across services and manufacturing where the readings failed to meet rosier hopes for ongoing recovery. The composite PMI at 44.4 was lower than the hoped for 44.9 and still conveys contraction since it reads less than 50.

ECB member, Axel Weber rallied the interest rate bears in Munich today and tried to cement the view that interest rates at rock bottom are not shifting lower anytime soon. Previously the ECB “used the room for rate reductions created by waning risks and a dramatic worsening in the economic situation. Additional steps are not necessary at the moment,” he said. Today the ECB begins to ender for unlimited amounts of 12-month cash as part of their program of restoring lending capabilities across the banking system.

A groundswell of opinion senses that the Fed is nowhere near raising interest rates and as such dealers are choosing to sell dollars. The FOMC starts its two-day meeting in WashingtonD.C. today and will have two major items on its agenda. Should how announce more purchases of government debt and mortgage backed securities in an effort to lower the cost of borrowing? How should it temper off-target interest rate expectations using its statement on Wednesday afternoon? Heading into the meeting the dollar is broadly lower as investors heed Monday’s news that recovery is less brisk the euro has risen against the dollar to $1.4020 in early New York trading.

There was more dollar positive news out of Moody’s Rating agency from Tokyo, where the head of its sovereign ratings stated that the U.S. is not at risk of loss of its AAA-rating. However, the nation has certainly lost altitude in the current environment. But the agency notes that resilience of the economy means that recovery is ultimately a certainty, while it notes a government committed to both raising taxes and cutting spending. Notably Moody’s also pointed out that the dollar is hardly at risk of its loss of status as the world’s currency reserve. They note that despite being at the heart of the global financial meltdown, the U.S. economy has contracted less than most of the Eurozone.

The British pound weakened today and currently buys $1.6293 while the euro has risen to buy 85.93 pennies this morning. Comments from Chief Economist Spencer Dale of the Bank of England spurred sterling sales when he argued that a currency decline was one highly effective channel for spurring export growth. Buying government gilts from overseas holders of British debt was an integral part of their strategy.

The Aussie dollar at 78.73 U.S. cents is clinging onto a meager gain this morning. The Japanese equity market slid overnight in sympathy with Monday’s U.S. meltdown. Dollar weakness earlier and a rosier outlook for stocks instilled the sense of a commodity bounce back. However, with existing home sales coming in at slightly less than expectations at an annualized pace of 4.77 million the emphasis turned to the sharp 16% year-over-year decline in home prices. Equities are now not so warm and fuzzy and crude oil prices appear to have reversed, undermining the bullish strategists’ hopes.

The Canadian dollar appears to also be on the back foot this morning. The U.S. dollar had climbed as much as 5% since Bank of Canada governor, Mark Carney first sounded off about the impact of Canadian dollar strength on the economic recovery. He’s making another speech today and dealers remain wary of joining any commodity dollar replay for fear of getting their fingers burned should sentiment quickly turns sour. Today the Canadian dollar buys 86.52 U.S. cents.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com

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