One major element behind today’s Fed’s decision to cut rates by 50 basis points (bp) in both the Fed funds and discount rates to 3.00% and 3.50% respectively is that there is no meeting scheduled in February. Therefore the Fed preferred not to wait until March 18, and be forced into a third inter-meeting rate cut in less than six months, which would have further fuelled speculation and perceptions that it is behind the curve and chasing a running market.
The U.S. dollar drops across the board as the 50 bps rate cut drives down the U.S./Eurozone interest rate disadvantage to 100 bps, the highest since May 2004. The notion that the U.S. dollar will recover this year is based on expectations of time lag in the “economic recoupling” theory, which implies that foreign central banks will be forced into cutting rates later in the year. We side more with the notion of global financial markets moving in synch than all major economies being dragged by the U.S. slowdown. While we expect the Bank of England to slash rates 100 bps, we expect only 25 bps by the European Central Bank and 50 bps by the Bank of Canada this year.
While the FX play is widely favorable to all non USD currencies, AUD, CAD and NZD, as well as the yen crosses are expected to be the winners into the Asian session, along side further gains in gold, targeting $950 per ounce. However, the downside risks to the yen crosses may reemerge in the event that tomorrow's release of U.S. consumer spending comes in below 0% and Friday's labor report shows the unemployment rate remaining above 5%.
Adding the statement: “…downside risks to growth remain …the Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner,” suggests the central bank is ready for further easing, as is currently priced in the steepening yield curve (see below). Accordingly, the chart below shows the 10-/two-year yield spread has widened to 247 bps, as two-year yields drop to 2.25% and 10-year yields push to 3.72%.
This suggests Today’s FOMC decision confirms the central bank is increasingly withdrawing its troops from the war on inflation and mobilizing them fully onto the war against an economic contraction. At last week’s 75 bp cut the FOMC stated: “The Committee expects inflation to moderate in coming quarters…,” while keeping the door for further easing.
We noted earlier today this morning’s “stronger than expected 140,000 release (40,000 expected) of the December ADP survey on private payrolls should make today’s interest rate decision a contentious one especially after Q4 GDP slumped to 0.6% (exp 1.2%) following 4.9% in Q3”. Only the typically hawkish Dallas Fed president Fisher voted against a rate cut – preferring not even a 25-bps cut.
Despite the ADP survey’s correct signaling of the direction of the December payrolls report and its improved track record over the past six months, and noting the three consecutive weekly declines in jobless claims reaching 301,000 in the last release, the FOMC has decided to focus on the longer-term employment outlook, which is expected to further deteriorate as the credit market spillover is increasingly accompanied by a gradual, and drawn out, macroeconomic spillover.
Ashraf Laidi
Chief FX Strategist
CMC Markets US
a.laidi@cmcmarkets.com
