Dollar Rally Could Be Short Lived

With the exception of the Japanese Yen, the US dollar has rallied against every major currency. The settlement of the Lehman CDS auction, the new Money Market Investor Funding Facility, the drop in oil prices and the sell-off in equities have all contributed to the impressive strength in the greenback. However the dollar’s rally may be short-lived as the credit market continues to thaw. Although the VIX and individual currency volatilities have increased over the past 24 hours, the 3 month LIBOR and TED spreads have fallen. This suggests that lending conditions are continuing to improve, which should help to stabilize the financial markets. Since the US dollar and the Japanese Yen have benefitted significantly from market instability, calmer times should help higher yielding currency pairs recover.

Fed Introduces New $600B Money Market Investor Funding Facility

The Federal Reserve also announced a new facility aimed at relieving pressure on money market mutual funds. Over the past few months, redemptions by individual investors and hedge funds have skyrocketed. Despite prior steps to restore stability, money market investors continue to head for exits. Through JPMorgan Chase, the Fed has announced a new backstop for these funds whereby they will be buying up to $540B of certificates of deposits, bank notes and commercial papers with a remaining maturity of 90 days or less. The remaining $60B in this facility will be coming from commercial paper issued by the special purpose vehicles set up by JPMorgan. They have called this their Money Market Investor Funding Facility. Although there has been no immediate market reaction, this should help free up credit in the financial markets and restore stability in the long run.

Will the Fed Follow in Canada’s Footsteps?

With the Federal Reserve expected to cut interest rates next week, Canada’s decision to cut interest rates by only 25bp instead of 50bp could shed some light on the upcoming US interest rate decision.

According to the BoC statement, Canada opted for only a 25bp rate cut for 3 reasons:

1. They have already cut interest rates aggressively this month

2. Even though they believe further easing will be necessary, they want to save their ammunition for the coming months when times will get tough

3. The recent weakness of the Canadian dollar has offset the drop in commodity prices and softer global demand

Going into the Federal Reserve’s monetary policy meeting on October 29, the market has priced in a 72 percent change of a 50bp rate cut and a 28 percent chance of a 25bp cut. However like Canada, the Fed has already cut interest rates aggressively this month and it may serve them well to be conservative with monetary easing now to leave room for further easing later. With the massive amount of liquidity and fiscal stimulus that has already been announced, it may not be necessary for the Fed to go all in right now. The US economy will continue to weaken and more rate cuts beyond the move next week will still be necessary.

The Disparity in Economic Data

The difference between Canada and the US however is the fact that there have actually been upside surprises in Canadian economic data. The latest reports from the labor market and the manufacturing sector (IVEY PMI) have been strong, reducing the BoC’s urgency to show all of their cards. The US economy on the other hand is in worse shape. Nearly all economic data from the manufacturing sector to the labor market confirms the weakness of the US economy. Today, the Chicago FED national activity index fell to the lowest level since 1982 while the weekly ICSC and monthly Redbook chain store sales turned negative. From a fundamental standpoint, the Fed is dealing with a deeper slowdown than Canada, so a 50bp rate cut is still possible if they feel the need to be proactive.

Euro Falls To The Lowest Level Since February 2007

The Euro dropped to the lowest level against the US dollar since February 2007. The combination of weaker oil prices and dollar repatriation has weighed heavily on the currency pair. It is becoming increasingly apparent that the Eurozone financial sector is in just as bad shape as the US. According to the Financial Times’ economic forecasts for all European countries, neither Germany, France, Spain or Italy are expected to grow by more than 0.5 percent in 2009. Perhaps they are lucky not to suffer from the negative 2009 GDP growth that is forecasted for the UK. Tough times are ahead for the Eurozone which should lead to a test of the 1.30 level in the EUR/USD. There was no meaningful Eurozone data released over the past 24 hours and nothing of consequence is expected on Wednesday. Switzerland on the other hand reported a stable trade balance as exports and imports decline.

Recessionary Comments From King Drives GBP Towards 5-Year Low


The British pound fell to the lowest level against the US dollar since November 2003 as Bank of England Governor King suggests that the UK is in a recession. The prospect of a prolonged slowdown in consumer demand and further housing market weakness should thrust the country into its first recession in 16 years. He also added that a larger, faster trade and FX adjustment may be necessary. With such a dour economic outlook, the UK needs a weak currency to attract whatever export demand that may still be remaining. Prime Minister Gordon Brown also said this morning that more borrowing will be needed. Public finances are in horrible shape and is likely to get worse with the expected drop in tax revenue. The Bank of England minutes are due for release on Wednesday. The data will shed light on how close the UK is to another interest rate cut.

USD/CAD Surges As BOC Signals More Rate Cuts

The Bank of Canada cut interest rates by 25bp to 2.25%. This move was smaller than the market expected but represents 75bp of easing since the beginning of the month. The monetary policy statement was dovish, hinting of more rate cuts to come. In yesterday’s Daily Currency Focus, we talked about how there is a strong chance that the BoC may opt for a smaller move to save ammunition even though 50bp was the market’s consensus. In reaction to the dovish comments and the drop in oil prices, the Canadian dollar has fallen to a 3 year low against the greenback. Retail sales are due for release tomorrow and given the drop in wholesale sales, we expect consumer spending to be weak. The Australian dollar also came under heavy selling as the RBA minutes suggest further rate cuts for Australia as well. Consumer prices are due for release this evening and a weak report could add fuel to the currency’s weakness.

Drop In Dow Drives Japanese Yen Higher

The weakness in US equities has once again driven the Japanese Yen higher. We have long said that the Yen benefits significantly from market volatility and uncertainty. Given the 230 point drop in the Dow, the Nikkei will probably open lower. There is a decent chance that USD/JPY could also break the 100 price level. The biggest loser today on a percentage basis is once again AUD/JPY. The repeated selling of this currency pair suggests that deep interest rate cuts are expected from the Reserve Bank of Australia. There was no economic data released from Japan last night, but the all industry activity index is expected to be released this evening. Although Japanese banks have stayed out of the limelight so far, we would be surprised if they were completely unaffected by the global financial crisis.

GBP/USD: Currency in Play Over the Next 24 Hours

The GBP/USD will be our currency in play over the next 24 hours with the minutes from the Bank of England monetary policy meeting scheduled for release at 4:30 am ET or 8:30 GMT.

The weakness of the GBP/USD has pushed the currency pair deep into our “sell zone,” which we determine using by Bollinger Bands. In order to find support and resistance levels, we will have to look at monthly charts. Support in the currency pair can be found at today’s low of 1.6652 which is slightly below the 200-month Simple Moving Average. If that level is broken, the next area of support is 1.6530 which is the 61.8% Fibonacci retracement of the 2001 to 2007 rally. In order for the downtrend in the GBP/USD to be negated, we would need to see the currency pair rally back above 1.72, which at this point may be a difficult feat.

Kathy Lien is Director of Currency Research at GFT, and runs KathyLien.com.