Traders and investors are wondering exactly what is happening with the world currency values. No wonder the markets are so choppy. The U.S. Federal Reserve and other Central Banks keep traders hopping in a creative move to help the economies and the world banking system. Yet the recent CPI data says that inflation in the U.S. is the highest in 2 years. And what was that little trick less than 24 hours after the Fed announcement? They have gotten very creative with our money. The falling Dollar may get a bit of relief as the Euro and sterling London interbank-offered rates known as the Libor, all fell on Friday for the second straight day following Wednesday's coordinated central bank liquidity plan. With the UK and Canada also cutting rates, it looks like the Dollar may have bottomed against those currencies for the time being. Currency traders have their eyes on the interest rate market, because relative to other rates, if outside rates go lower, then the U.S. in turn may not have to lower its own as much. This obviously creates a potential for unwinding the Dollar carry that many have been using since the Dollar gave way in August.

There has been quite a bit of uncertainty on what would happen to rates. Just as early as Tuesday, an investor about-face occurred after an opposite move in previous days, investors sold risky assets such as stocks and bought U.S. Treasuries after the Fed's quarter-percentage-point interest rate cut, which many considered too small to revive bank lending and shore up the economy. Treasuries recorded their biggest rally in more than three years during that session as investors sought the safest haven for their cash. However, the new initiative completely reversed that flight to quality, producing the biggest sell-off in benchmark 10-year Treasuries in more than three years. It also had an immediate effect on money markets, which have constricted in recent months as banks hoarded cash to write off losses related to the U.S. mortgage market. The initiative also revived some of the recently sagging sentiment on riskier assets such as stocks. The Fed is adding liquidity, which is reducing the flight to safety (if you can call it that).

Through all of this the Dollar has benefited and continues to do so. Posting its largest daily increase against the Euro in nearly three years after strong U.S. consumer price data trimmed expectations of aggressive more rate cuts from the Federal Reserve. The data also propelled the Dollar to a seven-week peak against a basket of currencies. The CPI report followed Thursday's robust U.S. retail sales and producer price data for November, suggesting the U.S. economy is far more resilient that many initially thought and allowing the cry of inflation to be heard again.

Following the CPI data, the implied chances for a Fed rate cut in January fell as low as 80% from 98% overnight.

Howard Marella

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