Will the Fed’s Chair Ben surprise us today?..

Perhaps optimism is returning. Faith in undervalued US equities sure has made an impact on world bourses. Is the aggressive desire to own the greenback overdone? Have we seen temporary highs for the US dollar? Traders have been beaten up on the way up and so far been filled in on the way down. It would be great to experience some ‘organized insanity’ for the time being. Let’s see what Uncle Ben has in store for us!

The US$ is weaker in the O/N trading session. Currently it is lower against 12 of the 16 most actively traded currencies, in another ‘whippy’ trading range.

FX Heatmap October 29th, 2008

This afternoon we have the Fed announcement at 2.15pm EST. The market expects policy makers to reduce O/N borrowing costs by 50bp to 1%, but a smaller reduction cannot be ruled out. It’s expected that the easing cycle will continue well into next year and futures have rates at 0.5% by the end of the 1st Q. Given the long and deep expected US recession, reaching 0.5% rates is warranted (even with current inflation-Analysts expect a sharp decline soon). All policy makes have to remain on the same page to restore some confidence (see below), and that includes Trichet’s smoke screen comments on ECB rates. Even Japan is leaning towards easing 25bp, this caused all ‘housewives’ to start exiting their trades. Bernanke and Co. are expected to see significant downside risks to growth. As for inflation, the statement will probably reiterate that ‘inflation has been high, but the decline in energy and other commodity prices and the weaker prospects will reduce upside risks…..’ When rates get close to ‘0’, technically traditionally monetary policy instruments will not be in vogue. The Fed will have to come up with new and innovative ways to influence monetary policy. Thus, the danger of the Fed using all their ammo in one shot could be a problem. It’s important that they have something in reserve while the economy continues to contract next year. Conclusion, the Fed will have to be more transparent with their communication, unlike their European counter parties (who remain concerned or fixated by inflation somehow).

Not a surprise, but a surprising number. Yesterdays US consumer confidence numbers managed to break the 1974 post-oil shock low of 43 and register a new record low of 38 vs. 61.4 m/m. This is recessionary in nature. There is not much to say about it, it’s a given that we would achieve close to these levels with investors pessimism being backed up by material hits to income, wealth, and access to credit. Jobs are hard to get and expect next weeks NFP to be an eye opener (north of -250k). The Richmond Fed index followed suit and registered new record lows (-26). The US manufacturing sector has slumped again this month as foreign demand for goods continues to decline. The ‘greenbacks’ appreciation and cooling global growth offers little hope of any upside in the medium term. And to complete yesterdays cycle, S&P/Case-Shiller Home Price Index showed that house prices continued its downward spiral in Aug. (falling -16.6% y/y), as a tough borrowing environment is forcing many properties into foreclosure. You can discount the positive new home sales numbers we saw earlier in the week!

The US$ currently is lower against the EUR +0.69%, GBP +0.93%, CHF +1.03% and JPY +0.93%. The commodity currencies are stronger this morning, CAD +0.70% and AUD +0.53%. The loonie climbed for the first time in almost a week yesterday, as stocks rose and prices for some commodities advanced. Creeping optimism has provided some support for the ailing CAD$ of late. The recent selling currently seems over done (High-US$ 1.3014), and traders are happy to buy loonies at current levels (until the next surprise anyways). We will have to see if the currency finds any love from the Fed decision this afternoon. It’s anticipated that the BOC will need to extend interest-rate cuts (2.25%) in the face of slowing economic growth. Expect them to follow what they Fed does today next time around. Last week Governor Carney reduced overnight borrowing costs by 25bp (2.25%), less than the market had anticipated, but added that it will probably need to act again to fend off the effects of a credit crisis and global recession (less than 2% by year end). The BOC MPR last week said that the global credit crisis will be ‘deeper, more persistent’ and more widespread than the policy makers had anticipated and signaled they will cut borrowing costs again as the economy teeters on the edge of a recession. Governor Carney said ‘that these financial headwinds will take time to dissipate, even with the extraordinary recent policy actions just announced’. Previously the BOC justified their less aggressive move in the context of how much action that has been taken since its last meeting (75 bps) and the cumulative cut in rates since Dec (225 bps). Looks like a good bet that borrowing cost could break the 2% mark by year end. Perhaps we will see month end buying of equities and selling of bonds, which will not be bad at all for the currency.

Earlier this week the threat of intervention by the BOJ and the actual intervention by the RBA caused the AUD to appreciate. Some renewed fait in global equities saw investors seek higher yielding currencies. Currently the AUD$ risk appetite and equities go hand in hand, fundamentals are of no concern. Expect investors to be better sellers on rallies (0.6434), as one expects the AUD to underperform in recessionary times.

Crude is higher O/N ($63.71 up +98c). Phew! Oil has managed to pick itself up off the floor and slowly rebound from its 17-month lows achieved earlier this week. Why? because of global equities advancing and OPEC threatening to meet again before Dec. (nice Xmas present!). OPEC has indicated that they may call a new meeting if prices fail to react to the -1.5m barrel-a-day output cut it announced last week. Their decision to curb production has failed to ease concerns that the global economic slump is curbing fuel demand (m-to-date the black stuff is off 37%). The cut in production will commence at the beginning of Nov. Do not expect crude prices to bottom out until other markets find some stability. The greenback continues to climb against the EUR, which will only further pressurizing commodity prices. Growth fears outweigh any cut in production; this will continue to keep the black-stuff from rallying hard. OPEC still produce over 40% of the world’s oil, but there are doubts that they can cut much more, the members also need cash, just like most economies do. So do not be surprised to see some members not adhere to future cut quotas. Tomorrow we have the weekly EIA report; last weeks showed that crude oil stocks rose +3.18m barrels to 311.4m, w/w. Analysts continue to aggressively pare their future price estimates, down from $90 to a year end price of $60. Sluggish demand continues to be the catalyst for rising inventories. Gold eased yesterday as the ‘big dollar’ strengthened vs. the EUR, thus eroding the appeal of the ‘yellow metal’ as an alternative investment, but this morning in London the precious metal has reversed all yesterdays work as the greenback came under pressure ($750).

The Nikkei closed 8,211 up +589. The DAX index in Europe was at 4,671 down -152; the FTSE (UK) currently is 4,091 up +165. The early call for the open of key US indices is lower. The 10-year Treasury yields eased 11bp yesterday (3.80%) and are little changed O/N. Traders began cheapening up the US yield curve after officials indicated that the Governments funding needs are ‘unprecedented’. Medium to longer term debt finally managed to give up the most in 2-weeks as even equities managed to find some traction. The 2-10’s spread widened out to 224 and probably has momentum to steepen further if equities remain somewhat positive. It’s a foregone conclusion that the Fed will ease a minimum of 25bp this afternoon; futures have also priced a 100% chance of 50% and a 32% chance of 75%. Someone renew my confidence.

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Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell