US Dollar Slump Continues in the Aftermath of Tuesday’s Aggressive Fed Rate Cut - More Losses to Come?

The US dollar index broke straight through the support we noted yesterday at the 50 percent retracement level of 71.31 - 88.40 at 79.85, and extended its losses for the sixth day in a row. The Federal Reserve’s aggressive reduction in the fed funds rate to a record low range of 0.0 percent - 0.25 percent has had a major impact on the greenback, especially as the central bank has essentially indicated that they are shifting their focus away from the economy and on to the financial markets. Indeed, from a monetary policy perspective, there isn’t much more that the Fed can do for growth so they may as well direct their efforts toward providing liquidity. The Fed has already announced plans to buy “large quantities of agency debt and mortgage-backed securities” and “stands ready to expand its purchases…as conditions warrant.” The new twist though, is that the Fed is ready to evaluate the possible benefits of purchasing longer-term Treasuries, aka pursue quantitative easing. Simply put, this is a different method by which to bring down interest rates, and it is the potential of such a result that is helping to drive the greenback lower. There won’t be much in the way of key US economic data through the end of the week, and for that matter, through the next two weeks. Given the lower volumes typical of this time of year, it seems like the countdown to 2009 could be quite volatile and punctuated by extensive declines in the US dollar.

Euro, Swiss Franc Surge to Record Highs Against British Pound

The euro and Swiss franc both rocketed higher against the greenback and reached record highs versus the British pound, as the European Central Bank and Swiss National Bank have little room to cut rates further. Focusing on the euro, we saw that Euro-zone CPI fell in line with expectations by 0.5 percent during November, bringing the annual rate down to 2.1 percent. This finally leaves inflation closer to the ECB’s target, and given the persistent declines in commodities, CPI is likely to fall even lower in coming months. Nevertheless, ECB Governing Council member Axel Weber has already stated that he wanted to avoid cutting rates below 2.00 percent, suggesting that further reductions will not be nearly as aggressive as they have been in recent months. Likewise, the SNB has already slashed rates to a 4-year low of 0.50 percent, and now finds itself with limited room to loosen monetary policy further. Looking ahead to Thursday, the German IFO survey of business sentiment is likely to slip to a fresh 18-year low, as recent policy actions haven’t helped to improve confidence. However, as we saw with the CPI figures, readings in line with expectations shouldn’t be very market-moving for the euro.

British Pound the Only Major Currency Weaker Than the Dollar as BOE Minutes Signals More Rate Cuts

The British pound took a beating on Wednesday as the currency fell over 5 percent against the Swiss franc and more than 3 percent versus the euro to record lows. Meanwhile, the GBP/USD pair ultimately ended the day lower as well, leaving the British pound as the only major currency to be weaker than the greenback. This currency was hit hard by the release of the minutes from the Bank of England’s December meeting, during which the Monetary Policy Committee slashed the Bank Rate by 100bps to 2.00 percent, as expected. The surprising part was that the unanimous decision was accompanied by discussions of cutting rates even further, though the MPC ultimately decided against it in order to avoid an “excessive” drop in the British pound. This news was accompanied by the release of UK jobless claims, which rose for the tenth straight month and by the most since 1991, when the economy was experiencing its last recession. Seeing as though BOE Governor Mervyn King has said in the past that the MPC will cut rates further if needed and Credit Suisse overnight index swaps are pricing in at least a 25bp cut in January, there is still bearish potential open for the British pound.

Japanese Yen Intervention Risks Rise as Rally Accelerates, Commodities Brush Off OPEC Output Cut

The Japanese yen rally accelerated against the British pound, US dollar, Canadian dollar, and Australian dollar on Wednesday, increasing the risks that it’s only a matter of time before the Bank of Japan steps in to intervene. With the BOJ scheduled to meet this week and announce their rate decision between 23:30 ET on Thursday and 00:00 ET on Friday, subsequent comments will be important to watch as the central bank may cite excessive moves in the currency as a reason to possibly intervene. It will be rather easy to tell if they’ve done so just by looking at a chart of USD/JPY, which will show a rapid reversal, and history shows that the BOJ tends to be very successful in their efforts as Japan holds the second largest amount of foreign currency reserves (China holds the most). As a result, those trading the Japanese yen should be cautious as we near the end of the year.

Meanwhile, oil actually dropped below $40/bbl for the first time since 2004 despite OPEC’s announcement of a record cut in production, amounting to 2.2 million barrels a day. While commodity bloc - including the Australian dollar, New Zealand dollar, and Canadian dollar - ended the day higher against the US dollar, the decline in oil did cool rallies in these currencies. Looking ahead to Thursday, the Loonie faces downside risks as Canadian retail sales will be released at 8:30 ET. Spending is anticipated to drop 1.1 percent, but given the sharper-than-expected decline in wholesale sales, there is potential for this report to be disappointing. That said, any sort of reaction by USD/CAD could be short-lived, especially if the US dollar continues to plummet.

Terri Belkas is a Currency Strategist at FXCM.