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Euro Sets Record Highs, Dollar Plummets on Fed Rate Decision

Tuesday, 18 September 2007 19:34:52 GMT  |  David Rodriguez, Currency Analyst

The US dollar set fresh record lows against the euro, as a surprise 50 basis point interest rate cut by the Federal Reserve crushed the greenback while sending the Dow significantly higher in its wake. The Federal Open Market Committee voted unanimously to cut its target Fed Funds rate by a surprising 0.50 percent—overwhelmingly showing a monetary policy accommodation bias and concern over recent financial market troubles. This instantly trumped all other US dollar considerations and sent it to record lows against major trading counterparts.

The euro achieved fresh highs in mere seconds following the announcement, reaching peaks of $1.3965 before a modest pullback through time of writing. The violent rally initially saw resistance as the pair neared the psychologically significant $1.4000 mark, but the level seems a foregone conclusion giving overall upward momentum. Extreme dollar selling pressure was likewise seen in the British Pound, which shed aside recent UK bank troubles to rally a substantial $0.0120 in a mere five minutes following the report. Though the sterling likewise stuttered in the trade that followed, it remains apparent that speculators are taking every opportunity to sell the greenback further against major counterparts. Finally, the Japanese Yen was perhaps the least affected by the noteworthy volatility, as simultaneous equity market rallies offset much of the renewed US dollar selling pressure. The Japanese currency initially saw itself stronger against the dollar in the wake of the announcement, but the subsequent Yen selloff left the greenback ¥0.90 improved to ¥115.96.

Earlier economic data had little effect on the US dollar exchange rate, with true volatility seen on the afternoon’s Fed interest rate decision. The central bank surprised many speculators when it cut rates by 50 basis points for the first time since 2001—sending a clear signal that it stood to ease monetary policy in the face of recent market troubles. The Federal Open Market Committee’s decision will undoubtedly be the center of critique and praise for some time to come, but financial markets collectively breathed a sigh of relief on its significant announcement. Indeed, US stock markets saw themselves significantly higher in the moments that followed. The dollar fared significantly worse, however, as quickly falling rate differential doomed the greenback to declines against the Euro.  

The substantial cut in the Fed Funds rate instantly worsened the dollar’s stance against major trading counterparts, instantly sending its yield advantage over the euro to a paltry 0.75 percent. Given expectations of potential interest rate hikes by the European Central Bank, this will undoubtedly place further upward pressure on the Euro/US dollar exchange rate. In fact, Fed Funds futures for December now show expectations for a further 50 basis points in rate cuts from the US central bank by year-end. While this proves undoubtedly bullish for US corporations, it can only sink the dollar lower through the medium term.

US equity markets showed their glee with the surprise 50 basis point interest rate cut, with the Dow Jones Industrial Average up 289 points just half an hour ahead of the close. Other major indices had even larger percentage gains, as the S&P 500 rallied 2.6 percent to 1,515 and the NASDAQ Composite improved 2.3 percent to 2,640.

A tumble in long-term bond prices reflected improved sentiment over the future of US economic growth, but US Treasury bonds were mixed on a simultaneous rally in the short end of the curve. The 2-year Treasury Note lost a whopping 8 basis points in yield to 3.98 percent, while the 30-year Bond added 6 basis points to 4.76 percent.  

Written by David Rodriguez, Currency Analyst for DailyFX.com

 

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