JPM’s announcement that it would purchase Bear Sterns for $2 per share and the Fed's 25 basis point cut in the discount rate to 3.25% will be another short-term positive for the U.S. dollar, as proved to be the case Tuesday's $200 billion injection. The Fed also tripled the maximum maturity of discount window loans to 90 days. The last time the Fed did any sort of weekend announcement was the infamous "Saturday night special” pulled off by then Federal Reserve Chairman Paul Volcker in October 1979 to target money supply, rather than interest rates, in the battle against inflation.
Federal fund futures is still pricing in a near 50% chance of a 100 bp cut to 2.00% by the Federal Reserve on Tuesday. From that, we expect:
The dollar decline below 100 yen and 1 Swiss franc will be prolonged.
We could still see 96 yen and 0.98 franc to the dollar as early as Monday, as markets expect the Fed to opt for the aggressive easing option of at least 75 bps.
Yields on two-year and 10-year U.S. Treasuries are at their lowest level since 2003-04, a time when the Fed funds stood at a 45-year low of 1.00%.
This means that today's Fed funds rate of 3.00% will breach below 2.00% before end of June.
The U.S. economy is now at the highest probability of facing sub 1.00% interest rates by year end, translating into real negative rates.
The dollar will officially become the new "funding" currency for the remainder in carry trades.
Of the many reasons the Bank of Japan is unlikely to follow with any intervention is that the trade weighted value of the yen remains is only at two-month highs, which is well above the 20-year lows prevailing last summer.
The question is not whether global central banks will intervene, but how soon the dollar will continue its decline after the intervention measures. This will be the key topic at next month's G7/IMF/World Bank Meetings in Washington next month.
For GCC policymakers who say that U.S. dollar is a "good buy,” they're in for further disappointment as the economic fundamentals are largely stacked against the U.S. currency. The cost of the currency loss resulting from a revaluation (or shift to a basket of currencies) should be borne by GCC central banks as the cost of prolonged erosion in purchasing power, rising inflation and costly government assistance programs will be greater in terms of time and magnitude.
Ashraf Laidi
Chief FX Strategist
CMC Markets US
a.laidi@cmcmarkets.com
