If there was any doubt that the Fed was finished cutting interest rates at its upcoming meetings it was squelched on Friday as a better than expected jobs report sent signals through the Forex markets that the U.S. economic slowdown may not be as bad after all.
Although there was never any official announcement that the U.S. economy was in a recession, traders are now saying that if the economy happens to falter and slip into a recession, then it is likely to be quick and almost painless. The second school of thought is that the U.S. economy is in a recession, but it will end with a soft landing.
Even though the FOMC was not clear in its statement on Wednesday regarding future interest rate cuts, Friday's jobs data buys time to weigh the evidence of future economic reports and get a grasp of how long it will take the economy to rebound from its lowest point.
Given the magnitude of the economic situation just a few weeks ago, a better-than-expected jobs report is not enough evidence to conclude that the economy has turned for the better, but traders none-the-less bet heavily on the Dollar's recovery this past week as the EURUSD daily trend turned down for the first time since late January.
Traders have to keep in mind that the Fed appears to have conquered the credit crunch and the economic slowdown. The dismal housing industry is still showing signs of extreme weakness along with food and energy inflation and weak consumer confidence.
With the sluggish economy seemingly on a rebound and credit streams open and flowing, the Fed can place its maximum effort on jump-starting the housing market. As housing begins to improve, consumer confidence is likely to improve also.
The next battle the Fed is likely to fight is going to be fought along the thin line of nurturing the economic recovery while simultaneously preventing an inflationary flare up.
Continue to Monitor the Interest Rate Differential
When trading the forex pairs do not only look at the price action, but know why they move. For example, as mentioned in my April 18 report, one clue as to the direction of the Dollar is the U.S. treasuries. Despite the fact that the ECB was holding its benchmark rate at 4% while the Fed was lowering its benchmark to 2%, the yield advantage of two-year German bunds over two-year treasuries has tightened to 1.40 percentage points. At its peak on March 31, the interest rate differential stood at 1.85 percentage points. This decline has made Dollar-denominated assets more attractive, hence the large inflow of cash into the U.S. equity markets.
With the Bank of England quite confident that the worst of the credit problems are over in the U.K., traders have been lifting their bets that short-term interest rates would be lowered over the near term. As the yields begin to rise in the U.K., the spread between the gilts and the Bund tightens. Traders seeking more yield in return for a little more risk are beginning to buy the Pound over the Euro. This is putting some downside pressure on the EURGBP.
As the top begins to develop in the EURUSD and EURGBP use the information from the interest rate differential in timing the trend changes.
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