If memory serves me right, the last time a U.S. Treasury Secretary caused such an upheaval in both the Forex and stock markets with his mouth was way back in October 1987 when then U.S. Treasury Secretary Jim Baker suggested the need for the Dollar to fall. His suggestion triggered a massive liquidation of Dollar-denominated assets at the time.
Late Wednesday, current Treasury Secretary Geithner sent shock waves through the Forex and equity markets when he made a similar statement after being asked a question about China's proposal to use the IMF's Special Drawing Rights. These special drawing rights are a monetary unit valued against a composite of currencies.
To understand the magnitude of what he said let's set the stage. Earlier in the week China proposed a suggestion to overhaul the global monetary system. Bank of China's Xiaochuan suggested that the IMF should consider creating a super sovereign reserve currency. China made this proposal because it has become concerned about the recent moves in the financial markets by the Federal Reserve and the U.S.'s ability to protect China's assets invested in the United States.
On Wednesday, Geithner set the Dollar ablaze when he stated As I understand his proposal, it's a proposal designed to increase the use of IMF's Special Drawing Rights. And we're actually quite open to that suggestion. The mere suggestion by the U.S. Treasury Secretary to basically use a basket of currencies as the world's reserve currency instead of the Dollar sent both the Dollar and the U.S. equity markets sharply lower. Does the prospect of massive liquidation of Dollar-denominated assets ring a bell?
How could traders not believe what he was saying? This is the same guy who suggested this week that the Treasury be given greater powers. He's the same guy who proposed a toxic bank package that puts the burden on taxpayers. He's the same guy who may have known about AIG's bonus plan but kept his mouth shut until the news became public. He's also the same guy who triggered the February to March break in the stock market when he failed at the time to deliver the most important speech of his life.
When asked to clarify his statement, he affirmed the Dollar's role as the world's reserve currency, but the damage was done. Now the thought is out there. Traders will be wondering if he slipped up and revealed a future plan or just made a mistake. Remember way back when he first took the job he said he thought that China was manipulating its currency? He was scolded for that at Davos. Maybe Wednesday's statement was just his way of making friends with China.
Here's a suggestion when your job as U.S. Treasury Secretary is to protect the U.S. Dollar: do not make statements that put the Dollar down. Billions of Dollars exchanged hands yesterday on his suggestion. This is the real world and you just canï¿½ï¿½t make things better by saying my bad.
Volatility rocked the Euro on Wednesday following Treasury Secretary Geithner's comments. Trading has been mixed lately as appetite for risk has increased but the possibility of a rate cut by the European Central Bank next month has limited gains. Continue to look for more choppy trading as traders try to determine which storyline to follow. While it is true the Euro Zone economy is weak and a move by the ECB is necessary to revive the economy, the recent rally in the stock market and the plan to pump Dollars into the market weakens the Dollar.
The unknown is the state of the Euro Zone economy. It looks like the Euro will only weaken if economic reports come out worse than expected. On Wednesday, Business Confidence hit a 26-year low but was in line with estimates and the Euro hardly moved. A higher Euro could be devastating to the Euro Zone economy as it would hurt exports. I don't think the ECB wants the Euro to rise close to $1.40 so it will send out messages of a rate cut if it gets close. Bearish economic reports out of the Euro Zone will be the only way to truly weaken the Euro from current levels.
The British Pound felt pressure most of the day on the news that a Bank of England gilt auction failed for the first time since 2002. The failure of the auction was a strong indication that investors have lost confidence in the U.K. economy and perhaps the government.
The GBP USD did manage to rally after U.S. Treasury Secretary Geithner triggered a slide in the U.S. Dollar after he suggested the U.S. was open to using a basket of currencies as the world's currency reserve. Volatile trading hit the market as he clarified his comments later. Most traders felt his comments were overblown.
Earlier this week U.K. consumer prices showed an increase which put inflation over the Bank of England's target zone. Although the BoE said it was not too concerned about inflation at this time, it did suggest that it may slow down its plan to use quantitative easing as its main tool to revive the economy.
The wild swings in the equity and commodity markets gave Canadian Dollar traders a wild ride on Wednesday. Traders were reacting to a comment from Treasury Secretary Geithner regarding using a basket of currencies as the world's currency reserve.
Continue to look for the USD CAD to get its clues from the equity and commodity markets. A stronger equity market will increase trader demand for risk thereby weakening the USD CAD. A firmer energy complex will be supportive to the Canadian Dollar.
Traders are watching for hints as to whether the Bank of Canada will slash rates at its next meeting. This is helping to limit gains in the Canadian Dollar.
Poor export numbers continue to erode the Japanese economy. Traders are convinced that the Bank of Japan and the Japanese government are committed to seeing a weaker Yen and have no proposals on the table to prop it up at this time.
With a smattering of U.S. economic reports hinting at the start of an economic recovery and an increase in demand for higher yielding assets, continue to look for downside pressure on the Yen as the Dollar strengthens. Short-term oversold conditions seem to be the only reason to expect to see a rally in the Yen at this time.
Greater demand for a higher yield is one reason why traders have been selling the USD CHF lately. With the U.S. paying almost nothing to investors, Swiss investors are looking to place their money elsewhere. Traders are a little skeptical about how much the Swiss Franc will be allowed to rise as both the Swiss government and the Swiss National Bank are committed to keep the value of the Swiss Franc lower in an effort to encourage demand for Swiss goods.
The Swiss Franc may rally on demand for higher yields, but expect gains to be limited.
Lower equity markets hurt the Australian Dollar on Wednesday. At this time the only reason to hold the long side of the Aussie is to capture the higher yield. This reason to buy may disappear if trader appetite for risk diminishes or if demand for commodities drops.
AUD USD traders are carefully monitoring the Australian economy for any signs of weakness as they fear the Reserve Bank of Australia stands ready to cut interest rates on April 7 after it skipped a rate cut in March. The RBA believes that monetary policy is effective and will continue to use it until the economy turns around. Traders are beginning to price in at least a 50 bp cut in rates.
The New Zealand Dollar is expected to see selling pressure following the release of the 2008 4th quarter GDP tomorrow. Expectations are for this report to show a contraction of 1.1% in the economy. This would be as sign that the economy is worsening and the recession is deepening.
The Reserve Bank of New Zealand is on record as saying it will slow down the pace of interest rate cuts. This doesn't mean it will stop trying to drive interest rates lower, but it may mean that it is considering quantitative easing or a possible intervention to push rates lower in an effort to jump-start the economy.
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