The 75 basis point Fed funds rate cut intensifies the yield assault to the U.S. dollar, leaving little chance for traders to extend speculative and directional offers in the currency. For now, the dollar is unlikely to descend into an uncontrollable decline as the easing campaigns of overseas central bankers and secular market volatility has yet to accelerate. However, the longer-term prospects appear particularly ominous for the world’s reserve currency once global economic stability starts to build up and the demand/supply schedule of commodities further moves towards price.
Why the dollar does not follow the yen, its low-yielding counterpart?
The structural imbalance situation continues to favor Japan over the United States, with Japan’s current account surplus at 3.8% of GDP versus a deficit of 4.6% of GDP in the United States. Both countries have a budget deficit, but Japan’s 4% of GDP is less than the United States’ 5.5%. Japan’s superior current account balance means the nation’s position as a major provider of global capital allows a natural return of capital back to Japan during rising economic and market uncertainty. (The same rational helps explain the pounds damage as UK's fiscal deficit breaks above 4.0% of GDP in 2009 after jumping to 3.5% in 2008 from 2.7% in 2007).
In contrast, the United States’ position as a major borrower of capital increases the riskiness of keeping money in the United States despite the dollar’s low yielding status, which served as a positive during risk aversion. In other words, the combination of ultra low interest rates and structural imbalances offers a worst-case scenario for the U.S. currency.
Elevated concerns about inflationary implications of the Treasury's swelling balance sheet to $2.25 trillion increases the quantity of money, prompting a secular decline against commodities, hence, gold's rebound to two-month highs.
Lurking threat of the Big three’s bankruptcy and its impact on the overall U.S. economy. The auto industry's overall contribution to GDP is about 4%, with 12 billion annual spent on research and development. It also employs more than 240,000 direct workers and 5 million indirect workers and provides healthcare for 2 million employees.
OPEC's insistence to protect oil prices along with 1.9 to 2.1 million barrels per day rather than the expected 1.5 million barrels per day. Russia's participation in the output cut is expected, as the need to stem the ruble’s sell-off will be helped by supporting oil prices. The oil/dollar impact will favor the fuel over the currency. I warned clients yesterday that part of OPEC's decision would be impacted by the Fed's decision. Today's zero % announcement may not prevent OPEC from cutting more than 2 million bpd.
For a practical and comprehensive guide on the functioning of global structural imbalances and currencies, see “U.S. Imbalances, FX Reserve Diversification, and the U.S. dollar,” chapter 7, of my book, details the topic (pages 161-189).
With USD/JPY breaching below 90 yen, 2 yen above last weeks 13-year lows and the rest of the yen crosses (EUR/JPY and GBP/JPY) rising, the dollar impact shows emerges despite improved risk aversion. EUR/USD breaches our year-end target of $1.37 and testing above a major resistance of $1.3750--the 38% retracement of the decline from the $1.6038 record high to the $1.2328 low. $1.3880 acts as the next obstacle. GBP/USD faces interim resistance at $1.55, a breach of which seen extending to as high $1.57.
AUD/JPY daily chart may be seen regaining the trend line resistance at 62.25 extending from Nov 25 and the bigger trend line resistance of near 62.50 extending from Oct 2007. With AUD/JPY currently standing at 60.40, there is ample room for a 2 yen rebound. A 75-bp Fed cut comprises a major catalyst to empowering JPY crosses such as AUD/JPY, while a 50-bp cut may also help risk appetite in the event of explicit FOMC statement asserting willingness to extend persistent liquidity to credit markets. Similar argument seen boosting AUD/USD (69.65), NZD/USD (58.30) and bearish for USD/CAD (1.2010)
