US Dollar Down Amidst Fed Rate Cut, What Impact Will US GDP Have on Thursday?

The US dollar plunged across the majors on Wednesday, but the decline came primarily during the European trading session and start of the New York trading session in anticipation of the Federal Reserve’s rate decision. The Fed pulled no surprises as they cut rates by 50bps to a more than 5-year low of 1.00 percent amidst a marked slowing in economic activity and weak consumer spending. Likewise, slowdowns in many foreign economies has created dim prospects for US exports, suggesting that upcoming GDP figures on Thursday should signal a recession. The Fed touted an array of different policy actions implemented recently, including the October 8 coordinated rate cuts and efforts to boost liquidity, saying that they should help to "improve credit conditions and promote a return to moderate economic growth." However, the central bank also noted that "downside risks to growth remain," and combined with outlooks for more moderate inflation, the Fed seems likely to cut rates even further before year-end. In fact, fed fund futures are fully pricing in a 25bp cut at their next meeting on December 16.

Looking ahead to the next 24 hours, where the US dollar goes will depend heavily on risk appetite. Our latest forex correlations report shows that there is a solid inverse correlation between the greenback and the Dow Jones Industrial Average as bouts of risk aversion tend to send the currency spiraling higher on safe-haven flows while the US stock markets plunge. Upcoming US data could have a huge impact on the financial markets as Q3 GDP is anticipated to fall to a 7-year low of -0.5 percent after surging 2.8 percent in Q2 on robust export growth. However, with global growth slowing, foreign demand for US goods is simply not there. Add to that the sharp pullback in consumption and the outlook for the US is not good. Looking at the Bloomberg News poll of 75 economists, consensus forecasts range from -1.9 percent to 1.2 percent, but with the majority calling for a negative result, there are potential downside risks for the figure. Given the US dollar’s inverse correlation with US stock markets, the greenback could actually gain following this release though, as the indications of recession may trigger selloffs in the DJIA and S&P 500. However, if equity traders brush off the data, fundamentals could finally start to have more of an impact on the forex markets and the US dollar could tumble. Unfortunately for those looking for a sustained drop in the greenback, the former scenario may be more likely to occur.

Euro Continues to Strengthen, But This May Not Be The Case Next Week - Why?

The euro rocketed higher throughout the day, but the move had little to do with European fundamentals and instead marked a shift in risk trends. Lately, EUR/USD has been hit hard as risk aversion drives safe-haven assets like the US dollar and Treasuries higher. However, the 50bp cut by the Federal Reserve helped to boost risk appetite, leading the euro higher. While risk trends should remain the primary driver of the forex markets, European fundamentals and the potential for a rate cut by the European Central Bank next week could weigh on the euro. Indeed, German CPI fell to a 6-month low of 2.4 percent in October from 2.9 percent. Such a decline signals that price pressures throughout Europe are cooling as well, which should be confirmed upon release of the Euro-zone CPI estimate on Friday, raising the risks that the European Central Bank will cut rates when they meet next week.

British Pound Shrugs Off Dovish Comments As Carry Trades Gain

The British pound gained nearly 3 percent against the greenback on Wednesday as a broad surge in carry trades signaled an improvement in investor confidence. Indeed, with interest rates in the UK at a relatively high 4.50 percent, GBP/USD essentially qualifies as a “carry trade” pair. It was interesting to see that the currency completely brushed off dovish commentary by Bank of England Monetary Policy Committee member David Blanchflower. Indeed, Mr. Blanchflower has long been the most dovish of all the members since joining the Committee in mid-2006, as he has consistently voted for rate cuts since October 2007. He remains as staunch in his bias as ever, as he said this afternoon that UK interest rates must be lowered significantly and quickly, adding to speculation the BOE will cut rates aggressively on November 6 from 4.50 percent by at least 50bps. Mr. Blanchflower also indicated that deflation was a bigger concern than inflation, and that CPI may fall from the September reading of 5.2 percent down to 1 percent, or could even go negative. Overall, fundamental factors present hefty risks for the British pound and could come into play tomorrow morning as UK Nationwide home prices are forecasted to show that they dropped 14.7 percent in October from a year earlier, the worst reading since records began in 1992.

Japanese Yen Down Sharply On Rise in Risk Appetite, Speculation of BOJ Rate Cut

Forex carry trades rocketed higher on Wednesday, as the Japanese yen tumbled more than 3 percent versus high-yielding currencies like the New Zealand dollar and Australian dollar, while falling over 1.5 percent against the euro and British pound. This had mostly to do with an improvement in risk appetite, but some are speculating that the Bank of Japan may actually cut rates tonight. According to a Bloomberg News polls, only 2 of the 32 economists surveyed think the BOH will do so. However, I’m with the majority on this one, and I would be absolutely floored if the BOJ did anything but leave rates unchanged at 0.50 percent. It was just in the summer of 2006 that the central bank finally moved away from ZIRP, or Zero Interest Rate Policy, which they implemented in 2001. With interest rates already so low, a reduction is highly unlikely to have a significant impact on Japanese growth, so I don’t think the BOJ will believe it’s worth their while to cut. While BOJ rate decisions don’t usually have a big impact on the Japanese yen, the speculation surrounding this news could lead the low-yielding currency to gain if they do indeed leave rates unchanged.

Terri Belkas is a Currency Strategist at FXCM.