Dec 8th, 2003
The US dollar has opened this week pretty much how it ended last week - on the defensive. The dollar is at new multi-year lows against most currencies including the euro, British pound, yen and Aussie and Kiwi dollars. The Canadian dollar seems to be the lone laggard, failing to retest highs seen the week before last. FX traders remain fixated on Friday’s weaker than expected US payroll report and the implication that report has for the FOMC interest rate decision coming tomorrow. Analysts are unanimous that the Federal Reserve will preserve the dollar’s low-yielding status by leaving interest rates unchanged at a 45-year low of 1%. Most feel that the Fed favors a weakening currency as a necessary condition to correcting the US’s current account deficit of almost $500 billion annually. Although there is no expectation for a change to the Fed Funds rate, what analysts will be looking for tomorrow are indications of a change in the Fed’s bias. That bias has been neutral for many months now, meaning the Fed has no intention of raising interest rates any time soon. As a matter of fact, in its last policy statement the Fed said it anticipated maintaining low interest rates for a “considerable period” as necessary to get the US economy on a strong footing. This being the case, most observers have been suggesting the Fed will not act on interest rates until at least the end of the first quarter 2004. However, other than Friday’s employment report, the economic news out of the US over the past few months has been very favorable. The US economy is clearly on the rebound and the deflationary threats the Fed has been worried about seem to have disappeared. As a matter of fact we are starting to see more and more signs of inflationary risks such as continuously rising commodity and real estate prices. What analysts want to seem from the Fed is acknowledgement that the world has changed and indication that the Fed is prepared to deal with this change. Specifically this means a change in the Fed’s bias to a tightening stance. If the Fed does not drop the ‘ considerable period” stance this will be a strong message that the Fed is getting behind the eight ball vis a vis inflation and interest rates. It will mean the US dollar has a long way to go yet before reaching bottom. On the other hand, if the Fed does acknowledge that inflation may warrant attention and that their bias is now towards tightening monetary conditions by raising interest rates we could see a long expected corrective rally in the dollar. The problem for the dollar, however, is the Fed has to weigh the interests of the equity and bond markets in its decision and neither stocks nor bonds will welcome a tightening bias. Today, the market is betting against the Fed, and in the last 30 minutes even the Canadian dollar is getting in the act as the currency has finally managed to push through 77 cents again. The euro is up half a cent at 1.2225, having hit new highs in each of the last seven trading sessions. The pound hit a new high of 1.7350 this morning and the yen is at a new 3-year high of 107.20. Is the market pricing in the worst case scenario and setting up for a USD bounce tomorrow?
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