A 75bp Fed Cut Seems Guaranteed, But What About the Dollar?
The double dip has come and gone. The dollar has plunged to new lows against many of its major counterparts. However, wading into the action, the most significant moves came on the part of the risk-related, carry pairs: USDJPY and USDCHF. Marking another remarkable milestone for the currency market, USDCHF dropped below parity for the first time in history. For the yen pair, 100 seemed a strong floor that would require a higher power (like BoJ intervention) to produce a significant break or rebound before next week’s Fed rate decision. In the end, all that was needed was the same driver that ushered the pair to its 12-year low over the past two weeks – risk sentiment. US policy makers made yet another concerted effort Friday to right the roiled credit markets. Just three days after announcing the new TSLF program, the Fed was prompted into action once again by the imminent collapse of one of world’s largest investment banks. Bear Stearns CEO Alan Schwartz said in a statement this morning that his firm’s liquidity position had “significantly deteriorated” from Thursday as investors made significant withdrawals on rumors the firm was facing a cash crisis. Playing out much like the Fed’s bailout of Long Term Capital Management back in 1998, Bear Stearns tapped the Federal Reserve of New York for temporary funding. And, since the broker does not have access to the discount window, the loan was actually made through JP Morgan on Bear Stearns behalf. This was certainly a necessary move as the collapse of a major investment firm like Bear Stearns in these fragile markets could trigger a global market crash. To further bolster confidence in the US markets, the Fed released a two sentence statement stating the bank stood ready “to provide liquidity as necessary to promote the orderly functioning of the financial system;” and President Bush reiterated his confidence in the US economy in a speech in New York. And, while the liquidity injection and assuring words may calm credit market fears, they also practically guarantee a 75 basis point rate cut (or greater) when the FOMC announces its policy decision on Tuesday. Fed funds futures have fully priced in 75bp of easing and set a 60 percent probability of a 100bp cut. If the Fed does lower rates to 2.00 percent, it will only be a mater of time before the market begins to realize the policy group is running out of options to salvage the economy and markets. What’s more, this attempt at securing the stability of financial stability has left the dollar out to dry. This has been the basis behind speculation that global central banks will collaborate for the first time in 13 years to rescue the dollar. The timing of such an effort will be critical.

Japanese Yen Crosses Plunge As Risk Aversion Comes Back
The Japanese yen crosses resumed their descent on Friday as investor sentiment took a beating on news that Bear Stearns faced a massive liquidity crunch. Indeed, shares of the firm fell over 40 percent as JP Morgan Chase & Co. and the Federal Reserve Bank of New York have joined forces to provide the financial institution with secured funding for up to 28 days. The DJIA fell as much as 300 points shortly after the announcement, though the index closed -194.65 points at 11,951.09. The marked spike in risk aversion led the USD/JPY pair to finally break below the 100 mark, a level that we questioned as being excessively low in a recent special report. Nevertheless, the Bank of Japan is known to wait for the Japanese yen to hit speculative extremes before considering intervention, which are nearing (look for the release of Monday’s weekly COT report for more). Furthermore, intervention is most effective in the short-term at times of lower liquidity, which leaves us wondering if the Bank will take action at the market open next week or during the US holiday next Friday.

Euro Sets A New Record, Inflation Near 15-Year High
EURUSD set a new all-time high through the close of the week. For a fundamentally light Friday, the Euro Zone economic calendar had the reigns on event risk before the ruckus in the New York session began. Inflation was the theme of the day between the Euro Zone’s fourth quarter labour cost report and February consumer-level inflation. Strong employment was accompanied by higher wages through the end of 2007 as annual growth in labour costs accelerated to 2.7 percent, the fastest clip since the second quarter of 2006. Far more critical to the outlook for the ECB’s policy stance was the unexpected uptick in both headline and core inflation to 3.3 and 1.8 percent respectively. This is the fastest pace for the headline gauge since 1993, and confirms President’s Trichet’s concerns of upside risks to inflation.

Commodity Dollars Weighed Down As Gold Backs Off from Record of $1009
During the US trading session, gold futures rocketed to a record high of $1,009/oz on the Bear Stearns news, but the metal subsequently pulled back, while oil futures fell to $110.10/bbl after hitting a record of $111/bbl yesterday. The price action weighed on the commodity dollars – including the Australian dollar, New Zealand dollar, and Canadian dollar – but it is worth noting that NZD/USD tested the 26-year highs near 0.8200 once again today, as manufacturing sales gained 8.3 percent in Q4 as production of meat and dairy products surged. This was the sharpest increase since record-keeping began 15 years and was led by a 26 percent jump in meat and dairy output.

British Pound Trade Remains Volatile – Risks to the Downside Next Week
The Federal Reserve’s meeting will clearly be the primary central bank news to watch next week, but the release of the minutes of the Bank of England’s Monetary Policy Meeting is a known market-mover for the British pound. The news could weigh on the pair as there were likely a few votes for at least a 25bp rate cut. We can bet that über-dove David Blanchflower was one of the MPC members in favor of a cut, but the more members in favor of a rate reduction, the more bearish the minutes will be for the British pound pairs.

Kathy Lien is the Chief Currency Strategist at FXCM.