The markets were prepared for the 50 bp rate cut from the Federal Reserve today, but can further easing turn the dollar’s three-month and multi-thousand point trend? Realistically, the currency’s aggressive appreciation over the past few months has come despite normal policy easing, a surprise rate cut and other actions aimed at flooding the global system with dollars.

The Economy And The Credit Market

The markets were prepared for the 50 bp rate cut from the Federal Reserve today; but can further easing turn the dollar’s three-month and multi-thousand point trend? Realistically, the currency’s aggressive appreciation over the past few months has come despite normal policy easing, a surprise rate cut and other actions aimed at flooding the global system with dollars. This clearly reflects a hierarchy of importance to traders in current market conditions, where security in capital is still far more important than the potential for returns. However, the panic that has driven investors to this temporary safe haven will not last forever. When the financial storm breaks and risk appetite returns, traders will be left to gauge where the dollar stacks up to its international counterparts. Will the US recover from its recession first, will investment trends there be revived more quickly and is its benchmark rate competitive when things turn? These will be the market’s long-term questions?

Closer Look At Financial And Consumer Conditions

Recently, the panic that has seized confidence amongst lenders and investors through a number of tumultuous months seems to have eased; but we have seem similar periods of relief in the past merely turn back to pessimism. The health of the financial markets going forward will be dependent upon the severity of the US and global economic slowdown as well as the level of control seen in ongoing efforts to deleverage risk. Looking beyond the fears of bankruptcies and stock crashes, the underlying issue is that banks are still heavily invested in credit derivatives and consumers have record amounts of debt.

The outlook for economic activity is quickly growing into a primary fundamental driver for the US dollar - and the entire currency market - as data brings the next step of the financial crisis to the forefront. Where the financial meltdown was at first seen just as a banking issue, it is now more than evident that the implosion has quickly undermined positive trends in employment, capital investment, housing and spending. Forecasts see Thursday’s US 3Q GDP figure crossing the wires with a 0.5 percent pace of contraction. This data will merely set the stage for speculating the depth of the recession.

The Financial And Capital Markets

The US capital markets have improved somewhat over the past few days; but this development should be taken into context. A bigger picture look at the investment environment and overall level of the markets reflects the overwhelming pessimism that has driven so many asset classes into bear markets. In the near-term, relief from the sense of panic that has dominated the landscape and has in turn overextended declines may allow for a rebound. However, any recovery will be temporary as the fundamentals for a bear market are deeply set. The credit crunch has curbed investment and lending trends for months to come. And, even when that issue has taken a turn for the better, the oncoming recession will naturally depress expected returns and capital turnover. Ultimately, with the global economy just beginning to slip into a global slowdown (perhaps recession), this bear leg has further to reach.

A Closer Look At Market Conditions

While equities and commodities have seen a sharp rebound over the past few days, it is merely a mild bounce when compared to the incredible momentum measured in the declines in the prices for financial and physical assets over the past three months. When risk appetite and volatility settle, capital will certainly find its way back into the market. However, with a recession capping revenue and investment going forward, the bear market will remain.

Risk appetite is still the primary concern for investors and policy officials – though growth is a near-second at this point. Fear is still controlling price action as can be seen in the volatility across the markets (so while the Dow may have marked a record breaking rally recently – it is still a sign of volatility). There is no lack of reason for the general state of concern as market participants are responding to slowing growth, dropping asset values and the relentless credit crunch. And, with junk spreads and default risk steadily pushing records, there is no end in sight.

John Kicklighter a Currency Strategist at FXCM.