Following the two-day FOMC meeting, the U.S. Federal Reserve unleashed its most powerful economic package to date as it announced plans to spend a massive amount of money to revive the U.S. economy. The new plan includes purchasing up to $300 billion of long-term treasuries, expanding TALF to include the purchase of other assets, and buying more mortgage securities. When you add it all up, it approaches a staggering $1 trillion of taxpayer money. The tone of the Fed's announcement and the size of the plan demolished the U.S. Dollar against all major currencies and even versus emerging markets.
In its official statement the Fed cited many reasons for its aggressive action. The number one reason is that the economy is still contracting. Jobs are being lost and equity and housing wealth is declining. Tight credit conditions are hurting consumer spending and sentiment. This is leading to lower sales for businesses which have also had a hard time obtaining credit. Consequently, fixed investments and inventories are down. In addition, businesses have stopped hiring.
One should note that the Fed removed language from its last statement which said it expected the economy to recover later in the year. This put it somewhat in line with Fed Chairman Bernanke's statement on 60 Minutes earlier in the week in which he predicted that the economy would bottom in 2009 but not start a recovery until 2010.
Although the market had anticipated an announcement from the FOMC that would reiterate its quantitative easing policy, the size of the relief package was much more than traders had forecast. The size of today's move by the Fed effectively shocked the market.
News that the Fed is printing money is a huge Dollar negative. It's clear that the Fed wants to pump as much money as possible into the system. The Fed has to be thinking that by aggressively purchasing long-dated debt and mortgages that it will drive down interest rates and send a positive ripple throughout the economy. Today's move by the Fed has effectively triggered negative interest rates.
The good news is that the Fed may have finally gotten ahead of the curve. A year ago it passed on an interest rate cut and the economy got worse. This year it feels that the time is right to act aggressively to help lead the U.S. economy to speedy recovery.
There is downside risk to flooding the market with cash however. Printing money raises the risk of inflation later in the year. The Fed thinks it has a grasp of a potential inflationary scenario. In the latest statement it emphasized that deflation was a greater risk to the economy at this time.
Some traders feel that the current move by the Fed is going to start another leg down in the Dollar. It is probably too early to tell as the global economic situation is still worsening. The latest move by the Fed hurts the Dollar in the short-run but it may lead the U.S. recovery faster than any other nation. Take a look at the numbers coming out of Japan, the Euro Zone and Great Britain and you will see that in the long-run the Fed made the right move.
The Euro screamed upward following the announcement by the U.S. Federal Reserve to flood the market with up to $1 trillion. The rally in the Euro amounts to basic interest rate differential analysis. U.S. interest rates are effectively below zero while the Euro Zone is relatively high at 1.5%. Traders are putting their money with the highest yielding currency.
The question traders should be asking themselves is what has happened to the Euro Zone economy to make it stronger than the U.S. economy? The Fed has said all along that it does not care what happens to the Dollar and today's news proves it. In the short-run the Dollar will suffer, but in the long-run, the U.S. Dollar will benefit.
The ball has been thrown into the European Central Bank's court. It can either lower rates to help revive the Euro Zone economy or it can have a higher currency. The global community is not going to buy higher priced European goods so expect to see an increase in U.S. exports.
For several months the European Central Bank has been accused of being behind the curve and the last to recognize the financial turmoil the world is currently experiencing. It is time for it to join Japan, Switzerland, Great Britain and the U.S. and start initiating a program of quantitative easing besides just cutting interest rates.
The problem is that the ECB never created a plan as to which European Union members' assets it would buy. Because a few of its members have bad credit ratings, the ECB would be running the risk of default if it bought assets from the wrong government. It€™s going to be interesting to watch how the ECB reacts while the other main central banks are being proactive.
It€™s easy to write that the GBP USD rallied as the Fed drove down the U.S. Dollar but there is more to it. As a trader, of course you want to stay on the long side of the strongest currency. In this case flooding the market with U.S. Dollars has driven down the Dollar but pushed up the value of the British Pound. This means that all the work the Bank of England did last week to drive the Pound lower with its quantitative easing has effectively been erased.
Sure, the Dollar has been weakened in the short-term, but has the U.K. economy gotten better because the Pound went up? The answer is no. Longer-term traders should not think that the U.S. has sacrificed its currency in the short-run for a faster recovery from the recession. At some point longer-term traders are going to realize that long the Dollar is the right move and they will sell the Pound back down again.
The economy in the U.K. continues to worsen and it does not look like anything the Bank of England has been doing is helping. Its rate slashing has produced no positive results and its stimulus plans have failed also. Last week it embarked on a policy of quantitative easing but any benefit was most likely wiped out by the Fed's action today.
If the economy is to recover in the U.K. then the Bank of England is going to have to take more aggressive action. This may mean more quantitative easing and perhaps an intervention. If the economy continues to deteriorate, the BoE is going to have to take drastic action. This means the Pound will go lower over the long-run.
The USD JPY fell sharply lower on Wednesday. This move was triggered by the Fed announcement to spend up to $1 trillion to help stimulate the economy. Flooding the market with cash weakens the Dollar. This is why the Yen appreciated. This is one of the reasons why the rally in the Yen will be short-lived.
The Japanese economy is still in shambles and the government and the Bank of Japan want to see a lower Yen. Although they will tolerate a weaker USD JPY in the short-run, it is no secret that they are willing to do whatever it takes to drive the Yen lower.
Let's take a look at what the Bank of Japan said following its policy meeting. First of all it is going to leave interest rates at 0.10%. Secondly it recognizes that the economy remains under stress, but is willing to provide substantial liquidity to ensure the stability of the financial markets. Thirdly, it is going to outright purchase Japanese government bonds as well as subordinated bank debt. Finally, it cites the fact that the Japanese export market will not turn around until the deteriorating conditions overseas start to improve.
If we break it all down, what the BoJ is doing is flooding the Japanese economy with Yen to keep it liquid but no matter what it does the economy will not turn around until the rest of the work starts to improve. This does not sound like reasons to buy the Japanese Yen. This is why the Yen will eventually break lower.
If the economic conditions are not enough to trigger a decline in the Yen then look for the Bank of Japan to help things along by providing more liquidity through quantitative easing and perhaps an intervention. Last week the Swiss National Bank intervened and the Swiss economy is in ten times better shape than the Japanese economy.
The USD CHF broke sharply lower after the U.S. Federal Reserve announced an aggressive plan of quantitative easing designed to stimulate the U.S. economy. This is a short-term move and may be countered by more aggressive quantitative easing by the Swiss National Bank.
The SNB wants the Swiss Franc lower to stimulate its export business, but the Fed also wants to see its economy prosper. The central bank which makes the right decisions in the long-run will come out the winner. Over the short-run the Swiss Franc is expected to rally from the weaker Dollar, but longer-term traders should note that the U.S. economy will recover before the Swiss economy.
The U.S. Dollar lost more ground to the Canadian Dollar on Wednesday as actions announced by the U.S. Federal Reserve lowered its value. The FOMC announced plans to pump up to $1 trillion of liquidity into the markets. This move effectively sent interest rates below zero and made higher yielding currencies more attractive.
Lower interest rates and the prospect of a speedy recovery by the U.S. economy helped rally the U.S. stock market which gave the Canadian economy a boost. For weeks the Canadian Dollar has been following the U.S. stock markets and this current rally has the potential to drive the USD CAD sharply lower over the next two to three weeks.
At this time Canadian Dollar traders are not focusing on the Canadian economic numbers. Most feel that the banking system is in good shape and should help the economy to recover more quickly because of its limited exposure to toxic assets.
Furthermore, as a country that relies on commodity exports what can Canada do to stimulate interest in its goods? Recognizing the fact that its economy will not recover until its trading partners' economies get better is the right thing to do. Part of the reason the Canadian Dollar went up was because the moves by the Fed are designed to help the U.S. economy recover. If the U.S. economy gets back on track then the Canadian economy will benefit.
The AUD USD rallied sharply higher as traders increased their demand for higher yielding, higher-risk assets. The rally comes down to the interest rate differential. The U.S. is paying near zero interest while Australia is paying 3.25%. Traders are buying the Australian Dollar because they are chasing the yield.
Look for the rally to continue as long as equity markets are moving higher and traders are forgetting about banking issues and tight credit. A break in the equity markets or a renewal of concerns about bank failures will be two reasons why the Aussie may break.
The upside could be limited if the economic numbers from the Australian economy do not recover. Look for higher markets in the short-run, but be prepared to go the other way if economic pressures return. Poor economic reports could lead to another rate cut by the Reserve Bank of Australia. This action will also be bearish for the Aussie.
The New Zealand Dollar rallied on Wednesday because of the weakness in the U.S. Dollar. Like the Aussie traders, Kiwi traders were chasing the 3.0% yield. The economy remains weak which means that the current rally is probably not going to last too much longer.
The action by the U.S. Fed is bearish for the Dollar in the short-run, but likely to lead to a longer-term recovery sooner and faster than the recovery in New Zealand.
There is talk circulating that the Reserve Bank of New Zealand is through playing around with interest rates and now is ready to hit the market with the more effective tool of intervention. An intervention will send the New Zealand Dollar sharply lower.
The equation is simple: exporting countries need to have lower currencies and in the case of the NZD USD, if the currency keeps getting expensive then exports are going to be down. This will not be good for the economy.
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