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By Kathy Lien, Chief Strategist of DailyFX.com
What is Up Next for the US Dollar Post FOMC?
The Federal Reserve's interest rate decision has come and gone and even though the impact on the financial markets has been substantial, the consolidation today indicates that traders are asking, What's Next?
With the EUR/USD hovering below 1.40, everyone is wondering whether it will break that level and if so, what could trigger it. The rest of the economic data due for release this week are not very market moving since we only have the Philly Fed survey and leading indicators left on the calendar. However don't rule out a break and test of 1.40 this week.
We have testimonies by Fed Chairman Ben Bernanke and US Treasury Secretary Paulson tomorrow on the state of the mortgage market. The Fed's decision yesterday received widespread applause from both Democrats and Republicans.
It would not be a stretch to say that the upcoming testimony was a factor in Bernanke's decision to make a more aggressive cut of the Fed funds and discount rate. Had he opted for a more conservative quarter point cut, we are sure that he would receive tough criticism instead of compliments by Congress tomorrow.
Today's weaker than expected consumer price and housing market reports have had little impact on the currency market. Softer gasoline prices in the month of August have eased inflationary pressures around the world. Oil prices did not climb to record highs until September which means that today's CPI number may not be an accurate reflection of current inflationary pressures.
As for housing, we all know that the housing market is doing poorly. These numbers simply validate the Fed's decision to ease monetary policy more aggressively. Although the rate cut goes a long way to relieving the risks of a recession, it does not rule out one.
We still need to see how non-farm payrolls and retail sales fare in the months forward to determine whether US growth could still slow materially. The futures curve is currently pricing in 50bp of easing before the end of the year.
With only two more rate decisions on the calendar, we expect 25bp rate cuts in October and December. Another half point cut may not be entirely out of the question if economic data remains weak since the Fed has cut rates by half point clips on multiple occasions in 2001.
Stocks Continue Higher but Carry Trades Fail to Follow
The Dow rallied another 80 points today but Japanese Yen crosses failed to track US equities higher. This price action indicates that traders are cautious and do not want to get overly optimistic.
Over the past few months, they have been burned by the problems in the sub-prime sector. Traders and investors have learned about the consequences of aggressive risk appetite the hard way.
Before carry trades even have a chance to return to the multi-decade highs that was characteristic of the first of the half the year, there needs to be proof that the US economy has stabilised and the worst is behind us.
At bare minimum, the number of foreclosures and defaults on home loans need to fall and not rise. It is no secret that the outlook for the US economy is a far bigger driver of yen movements than Japanese economic data.
For example, the Bank of Japan left interest rates unchanged last night and even though the Japanese Yen actually rallied in the hours following the monetary policy decision.
Kathy Lien, Chief Strategist, Daily FX
