The week ended with the U.S. Dollar finishing with its worst weekly performance in 24 years. The Dollar was down across the board against all of the major currencies and many of the emerging market currencies. A lot of the shine from this safe haven currency was tarnished but contrary to developing beliefs, the U.S. Dollar is still the best currency in the world.
Despite the beat down the Greenback took this week following aggressive action from the Fed, traders went home for the weekend wondering if the Dollar is down for the count or just showing the world how to take a punch. The very fact that there is doubt in the near future performance of the Dollar is enough cause for the short-sellers to worry that it will come roaring back.
On Friday the Dollar showed renewed strength following two days of weakness. Some attributed it to profit taking; others think the break was overdone given the tightness of the current interest rate differentials and the continuing deterioration of the global economy. This is important because where there is doubt, there is opportunity. If traders begin to question the size of the break in the U.S. Dollar then this opens the door to the possibility it will substantially retrace the last move down.
Some traders went home this weekend thinking the weakness in the Dollar was overblown. Some Forex traders are wondering why the markets acted as if the Fed just turned over all of the money in the treasury. The bottom line is the Fed did what it had to do to help the U.S. economy reestablish itself. While it was attempting to revive the economy, the rest of the world seemed to forget that the global community was still in a position to deteriorate further.
Smart traders will soon realize when foreign economic reports continue to come out bearish that the safest place to be is in the U.S. Dollar. The action by the Fed this week did not weaken the currency but actually moved the U.S. economy one-step closer to a recovery.
To recap the week, all one has to do is look at the events of Wednesday, March 18. On this day the U.S. Federal Reserve shocked the markets with an announcement of a very powerful economic package designed to spend a massive amount of money to revive the U.S. economy.
The new $1.2 trillion plan includes purchasing up to $300 billion of long-term treasuries, expanding TALF to include the purchase of other assets, and buying additional mortgage securities. The tone of the Fed's announcement and the size of the plan demolished the U.S. Dollar against all major currencies and including emerging markets.
The good news is the Fed appears to have finally gotten ahead of the curve. This means the U.S. may be on its way to reviving the economy. At the very minimum the economy should start to show signs of bottoming. Traders should note that the plan will not be implemented all at once. The buying spree by the Fed is expected to take up to nine months to execute. This gives global interest rates plenty of time to come down to treasury yields which will effectively take away any interest rate advantages. This means that the deciding factor as to which currency to hold will come down to the strongest economy and the U.S. economy and Dollar will come out ahead.
For the week, the Euro was a huge winner following the announcement by the U.S. Federal Reserve to flood the market with Dollars. The rally in the Euro amounts to the interest rate differential advantage as there is no reason to value the Euro Zone economy over the U.S. at this time. U.S. interest rates are effectively below zero while the Euro Zone is relatively high at 1.5%. Traders are investing their money with the highest yielding currency.
This differential should change in the next few weeks as bond yields in the Euro Zone should begin to come down to meet the U.S. bond yields. The European Central Bank is also expected to lower interest rates in April and will most likely come up with some creative way to revive the EZ economy. Both of these actions should put pressure on the EUR USD.
The higher close last week in the GBP USD was caused by a combination of short-covering and a weaker Dollar. Shorts had been building positions for weeks because of the deteriorating economy and the Bank of England's decision to buy government assets. At some point longer-term traders are going to realize that short GBP USD is the position and they will sell the Pound back down again.
The USD JPY lost ground for the second straight week as the Fed pressured the Dollar with its announcement to apply massive quantitative easing to the market. The move by the Fed is expected to expand the Fed's balance sheet and swell the current deficit.
Once the negative reaction to the Dollar wears off, investors will realize that the Dollar is still the safest currency to own as the Japanese government is still in shambles. Earlier in the week, the Bank of Japan bought subordinated bank debt in an effort to boost bank capital after the recent declines in the stock market. This move was also expected to deflate the Yen, but never got a chance to work because the Fed came out with its announcement on the same day.
It€™s no secret the BoJ and the Japanese government want a weaker Yen to help boost demand for Japanese goods. Look for the government to announce a new stimulus plan soon in an attempt to revive the economy. Since the quantitative easing was ineffective, watch for an aggressive intervention by the BoJ in an effort to shock the markets. The Bank of Japan is likely to follow a similar plan enacted by the Swiss National Bank over a week ago.
The USD CHF fell sharply lower last week after the Fed triggered a break with its announcement to increase its balance sheet by pumping over $1 trillion into the economy through quantitative easing.
The market reacted buy selling the Dollar and buying the Swiss Franc. The Swiss National Bank does not want to see a strong Swiss Franc so it may hit the market again with quantitative easing or another intervention to weaken it.
The first sign of a top in the USD CAD showed on the charts on March 13 when the market formed a weekly closing price reversal down. This bearish pattern was confirmed with the follow through break last week. The announcement by the Fed to flood the market with cash helped accelerate the break.
By flooding the market with Dollars, the Fed created a potential inflationary scenario which gave speculators a reason to drive up commodity prices. This helped the Canadian Dollar rally since the Canadian economy relies on commodity exports.
The Fed's announcement also pushed interest rates down which encouraged demand for higher risk, higher yielding assets like equities. The rally in the stock market also helped support the rally in the Canadian Dollar.
Finally, thoughts that the Fed's proactive move would speed up the economic recovery in the U.S. triggered a rally in crude oil on the thought that a recovery would lead to greater demand for crude oil.
The rally in the Canadian Dollar was the most genuine compared to the other major currencies. This is because the buying seemed to make more sense and did not seem to be too speculative but actually based on realistic scenarios. A U.S. economic recovery would actually be beneficial for the Canadian economy.
The AUD USD closed the week higher. Traders seeking a higher return on their money bought the Australian Dollar and sold the U.S. Dollar in an attempt to capture the 3.25% yield that Australia was paying. Higher commodity prices also helped support the Aussie Dollar.
The rally in the AUD USD is likely to continue as long as commodity and equity markets remain firm and trader appetite for risk increases. Any new reports showing weakness in the Australian economy could weaken the Aussie as traders will begin to believe that the Reserve Bank of Australia will aggressively cut interest rates.
The RBA is monitoring the strong Australia Dollar. It will tolerate a slightly higher AUD USD from current levels but stands prepared to drive it lower if high prices start to affect demand for Australian exports.
The New Zealand economy is still in a decline and a higher NZD USD is not what the Reserve Bank of New Zealand wants to see at this time. A strong NZD USD will lead to higher commodity prices which is likely to lead to less foreign demand for exports.
The RBNZ is also monitoring economic reports closely along with the rise in the currency. It is most concerned about the declining manufacturing numbers. A high priced Kiwi will lead to lower demand for goods which means a cut-back in production. Although it has announced a slow down in interest rate cuts, the RBNZ stands poised to intervene in an effort to crush the value of the NZD USD. It expects this move to have a more powerful effect on the economy than an interest rate cut or quantitative easing.
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