It appears that currency traders are twisting the Fed's words out of shape having fully digested the latest policy statement and creating a sudden reversal in demand for dollars. The FOMC didn't really tell the market anything new and although they haven't necessarily caved in to pressure building since the WSJ floated the notion of reinvesting maturing mortgage securities, there is a post-meeting sense of elevated panic. Both traditional safe haven destinations of dollar and yen are higher midweek while headlines on the major wires portray a 15-year high for the yen versus the dollar. Selling in global stock markets upon reiteration of a slowdown have caused pinned formerly optimistic S&P index futures to the floor.


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U.S. Dollar - When shorter-dated mortgage securities purchased by the New York Fed expire in coming days and weeks, its trading desk has been instructed to take the $15-$20 billion proceeds and reinvest in treasury bonds. That way the Fed will maintain an even keel by maintaining the size of its balance sheet, which has become prone to inadvertent shrinkage as those securities expire. The dollar had weakened last week following a string of data confirming a slowing economy and in advance of growing expectations that the Fed would resume its bond purchase operations. However, the dollar has knocked both the euro and riskier currencies right off the perch from which they had been swinging happily in hopes that the Fed would indeed resume its stimulus program.

The driving force appears to be the notion that the Fed sees slower growth and a weaker recovery. Hands up anyone who didn't already read that message from either recent statements or hear it directly from Fed speakers. This new news, which really isn't news, has caused global investors to jiggle their portfolios as they accommodate a different market reaction. The judgment call now will be over how many days it will be before the market realizes that they actually got what they asked for. A 15-point S&P decline could very easily turn into a 15-point gain by the end of the session.

Japanese yen -The yen reached its highest level per dollar in 15 years having raced through the November resistance to hit an intraday peak at ¥84.73 after investors sold stocks and winced at the words from the Fed about a slowing economy. A measure of business confidence also sparked concerns that the rampant yen would starve exporters of profits. Machine tool orders for June only rose 1.6% instead of the expected 5.4%. Meanwhile official comments warned against the impact of a rising yen but fell short of hinting that either the Bank or government could stop it. Typical official comment warns on excessive currency volatility. However, volatility implies sharp back and forth movements. The pattern has been one-way yen strength, making the volatility argument the most unstable item on the agenda.

Euro - The euro hit $1.3000 again for the first time this month as dollar purchases in search of safe haven status remind investors that the currency market is indeed a fickle creature. A three-cent gain for the euro in two weeks has been reversed in just three days after a weak U.S. jobs report. Once again it seems appropriate to point out that the weakness in the labor data that inspired a jolt to the peak of $1.3334 on Friday is from the same stable as the Fed's worries repeated in yesterday's statement. The euro fell sharply against the almighty yen to trade at ¥110.58 from ¥112.58 on Tuesday.

British pound - Fears that the British economy was sinking beneath the sand drove the pound to a triple-play of losses for the week. The pound was further upset by downward revisions to inflation and growth from the central bank while employment data was sub par. The pound reached just about $1.6000 last week and a slide today to as low as $1.5667 was likely caused by a slaughtering of some of the bulls joining the move at its Friday extreme. Fears of a slowing economy were fanned by the July employment report showing job creation for just 3,900 workers. The shortfall and a negative backwards revision means that for the latest two summer months the overall job addition is just half of the expected 37,000 positions heading into today's data. During the second quarter the economy created 49,000 positions.

The Bank of England's quarterly forecast revised down a peak of GDP growth from 3.6% to 3.0%. made just three months ago and said that based upon current market forecasts for interest rates, inflation will be 1.5% in two years time. That's short of the 2.0% central target. Governor King blamed still tight credit conditions and planned budget cuts to spending as elevated downside risks to the economy. The news seems excessively bad on a morning after the Fed's reiteration of weaker recovery.

Aussie dollar - Commodity dollars took a pasting as a result of the rising tide of demand for the dollar. The Aussie slumped to an early morning low of 90.13 U.S. cents as investors slashed positions that would benefit from a focus on the independent demand pull across Asian markets. Recently investors have bolstered commodity-linked plays because they grew optimistic that China had achieved a soft-landing for its overly hot economy. Fresh data released today confirms that as industrial production for July dropped to its weakest pace in 11 months. Still the 13% boost confirms a decent pace of domestic growth in China. However, the focus remains that as the main engine of Asian growth, China has slowed.

Canadian dollar - The Canadian dollar is less than happy about the dollar's rally and deeper discussion over a slowdown for the world's biggest economy. Of course a decline in the Canadian dollar is a boon for exporters, but is symptomatic of a slide in crude oil prices, which today easily abandoned an $80 dollar handle. The loonie slid to 96.28 U.S. cents.

Andrew Wilkinson

Senior Market Analyst       

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