Almost three months the day the Federal Reserve inaugurated its Term Auction Facility (TAF), the central bank invents a new liquidity driving mechanism, calling it Term Securities Lending Facility (TSLF). Through it, the Fed will lend $200 billion to its primary dealers. Recall, the Fed had just extended its lending facilities to 28 days after Friday’s dismal labor report.
Today’s latest coordinated interventions by the Federal Reserve, Bank of Canada, Bank of England, Bank of Japan and the Swiss National Bank have delivered the short-term equivalent of an inter-meeting Fed cut by increasing overall market liquidity and increasing risk appetite. The U.S. dollar soared across the board as markets eliminated all chances of a Fed inter-meeting rate cut, thereby sparing the currency from further yield erosion from the U.S. central bank. This means the most likely outcome is for the Federal Reserve to stick to a 50 bp rate cut at its scheduled Federal Open Market Committee (FOMC) meeting next Tuesday.
Nonetheless, in light of the increased chances of a U.S. recession, broadening losses in equities and the strong fundamentals in the euro zone, today’s dollar rebound will be short-lived against the euro and the yen.
We should remember that the EUR/USD hit a fresh all-time high of $1.5495 following further evidence of improvement in German business confidence. The ZEW investor expectations index improved to five-month high of -32 in March from -39.5, one week after the IFO index hit a three-month high in February. The reports are a strong illustration of superior fundamentals, relative to the Fed-driven USD gains, which are unlikely to last. The ZEW survey solidifies the euro’s broadening rally by dampening expectations of an ECB rate cut and further damages sentiment in the dollar.
Short-term EUR/USD outlook sees downside extending towards $1.5260, followed by 1.5220, at which point we expect renewed gains in the pair ahead of the Fed’s anticipated 50 bp rate cut. Upside is seen extending towards $1.5340, followed by the $1.5390-95 region.
Nonetheless, the impact of today’s actions must not be compared to an interest rate cut.
Remember Dec. 12 and March 7?
Just a few days after Friday’s post-labor report, the Fed announced that it would raise the amount of liquidity in its TAF auctions to $100 billion to "address heightened liquidity pressures in term funding markets.” Now the Fed steps in with a fresh announcement to increase lending by $200 billion. Separately, the ECB has issued a statement indicating it is willing to provide extra dollar liquidity, as it did back on Jan. 22 and Dec 12. Indeed, Dec. 12th was the day to remember, which triggered the U.S. central bank to step inaugurate its Term Auction Facility (TAF) after it had disappointed markets the preceding day (Dec 11) with only a 25 basis point rate cut. Despite the Fed’s announcement and the ECB’s injection of more than $500 billion in liquidity, the resulting stock rally lasted no more than one day (see chart).
The chart also shows that markets are more likely to make a prolonged rally following interest rate cuts, which aim at lowering the benchmark target of the cost for loanable overnight funds, rather than following term lending facilities that aim at preventing liquidity from falling further.
These liquidity-injection operations may help stabilize the normal functioning of credit markets but will neither soften the loosening in the deteriorating jobs market nor lower the increasing burden on consumers’ falling purchasing power in light of rising oil and negative real average hourly earnings growth.
Ashraf LaidiChief FX StrategistCMC Markets USa.laidi@cmcmarkets.com
