The U.S. dollar rebound becomes a more established theme, as markets gear up for an anticipated change in the Federal Reserves’ monetary policy stance. Such a change may take the form of a return to “data watch” stance by the Fed before judging the need for further rate cuts, or tempering the extent of the rate cuts from 50 basis point to 25 bps increments.
Speculation that the Fed will pause after this month is boosted by a reduction in event risk, but not necessarily in the credit crunch or the macroeconomic slowdown. The persistence of the credit crunch is underlined by rising LIBOR values, which continue to raise the daily cost of funds for U.S. and foreign banks. On the macro front, new home sales fell to their lowest in 1991 and inventories rose to 11 months, after some signs of stability in prior months.
But we also suspect that the Fed’s intention to pause its tightening cycle may be part of an international effort to stabilize the falling value of the dollar in light of the deteriorating state of world food prices. Indeed, the falling value of the dollar has been an integral component of soaring commodity prices, baring supply issues in the individual commodities. Hours ago, the United Nations Secretary General has labeled the food prices problem as “global crisis”, while the International Monetary Fund has called on the major industrialized economies to undertake emergency measures to provide funding for ailing nations.
Given the aforementioned economic and market challenges, we expect the Federal Reserve to resume easing policy, by reducing interest rates to 1.25% by year-end, revising our previous forecast of 0.75%. While the economic challenges are present, and far from having stabilized, the market challenges have the capability to re-emerge due to the current funding difficulties faced by the banks. We are also apprehensive about the equity markets’ reaction in light of a pause in Fed rate cuts, at a time when rising unemployment is in the midst of accelerating and U.S. consumers’ gloomy outlook in reflected in all sentiment surveys (Conference Board, University of Michigan and ABC Index).
Pauses in the Fed’s easing and tightening campaigns are nothing extraordinary. During the 2001 to 2003 easing, the Fed slashed rates from 6.0% in January 2001 to 1.75% in December 2001, before pausing for 10 months. It then resumed cutting rates into the ensuing eight months, taking rates to 1.00%. Since there is no scheduled Fed meeting in May, the central bank will have a chance to remain in the background, examining conditions for nearly two months, until its June 25 decision.
In currencies, EUR/USD is already charting the path we expected in yesterday’s charts strategy, where out target stands at $1.5530. Today’s low was at 1.5560. We will expect further dollar gains next week, dragging EUR to 1.5470, GBP at $1.9500, JPY at 105.30, CAD at (1.0250). We also expect Gold to approach the $870, but find support at the crucial $848.50 level
Ashraf Laidi
Chief FX Strategist
CMC Markets US
a.laidi@cmcmarkets.com
