Dollar index slammed as Fed keeps rates near zero

The greenback fell Tuesday on the back of the FOMC interest rate announcement where Chairman Bernanke and company pledged to keep interest rates at record lows through 2012 and into mid 2013. The Dow Jones FXCM Dollar Index (Ticker: USDollar) plummeted 0.83% amid a volatile session as equities surged on the prospect continued super low rates. North American stocks closed out a stellar performance with the Dow, the S&P, and the NASDAQ soaring 3.98%, 4.74%, and 5.29% respectively.

Although the Fed statement cited that the “downside risks to the economic outlook have increased,” the vow to leave rates unchanged through mid-2013 saw a massive surge risk-appetite as the central bank showed a willingness to respond to the weakening markets. And while nothing in the Fed's statement saw a shift in the Fed’s asset purchase program, the simple replacement of the “extended period” language with the 2013 timeframe was enough to ease investor uncertainty in the interim. However despite Tuesday's rally, super low rates may not be enough to keep markets afloat as contagion fears in Europe and emerging weakness in the Asia Pacific region continues to threaten global markets.

The implications for the greenback on this policy move are substantial as interest rate expectations diminish, leaving the dollar vulnerable for further losses. The index failed to break above former trendline support, now resistance, at 9600 before losses accelerate as traders went back on the hunt for yields. And with interest rates now seemingly locked in at near zero percent, a rally in risk will undoubtedly continue to weigh on the greenback. On the other hand, if the rally proves to be short lived, the reserve currency is likely to remain well supported on haven flows as investors shun risk.

The dollar index broke below lower-bound trendline support of the ascending channel dating back to July 29th before finding solace just below the 50% Fibonacci retracement taken from the July 12th decline at 9540. Interim support rests just above the 38.2% retracement at 9500, with subsequent floors seen at 9430 and 9400. Topside resistance is now eyed at the convergence of former trendline support at the 61.8% retracement at 9590, backed by 9650.

A look at the component currencies attests to the dollar’s rapid decline, with the greenback sliding against all the majors save the pound. Highlighting the performance chart is a 1.65% advance in the Aussie which moved a staggering 282.46% of its daily average true range. A rapid pickup in risk appetite fueled the gains as investors chased yields with the Australian dollar boasting the highest interest rate out of the developed economies. The Aussie is likely to see further gains in the sessions ahead as Asian and European markets react to the Fed’s most recent pledge. The surge of flows out of the dollar also propped up the euro and the yen which climbed 1.39% and 1.06%, respectively. Investors remained reluctant to move into the sterling however, ahead of the BoE inflation report on tap Tuesday night.

It’s worth noting, however, that the ‘safe haven’ Swiss franc continued to surge against all its major counterparts despite the risk reversal, suggesting that investors may yet still see further weakness in the days ahead. The swissie was sharply higher at the close of trade, advancing more than 4.7% against a heavy greenback.

The economic docket for Wednesday sees little in the way of event risk, with MBA mortgage applications and June wholesale inventories on tap. Later in the day the July monthly budget statement is released, with consensus estimates calling for a deficit of $140 billion, down from the previous print of -$43.1 billion. And while the calendar remains rather light, dollar price action is likely to hinge on market sentiment, as investors digest the long-term implications of FOMC’s vow for a prolonged zero rate policy.

Michael Boutros, Currency Analyst for DailyFX.com is a Technical/Fundamental Analyst specializing in the FX markets. E-mail: mboutros@fxcm.com.

Twitter: @MBForex
WEB:
www.fxcm.com

About the Author
Michael Boutros

Michael Boutros, Currency Analyst for DailyFX.com is a Technical/Fundamental Analyst specializing in the FX markets. E-mail: mboutros@fxcm.com.

Twitter: @MBForex
WEB: www.DailyFX.com

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