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Fed Bails Out Stocks With Rate Cuts, but Dollar May Tumble

By , Quantitative Strategist
17 August 2007 18:16 GMT

The Euro bounced off of fairly significant technical support, trading as many as 180 points off of lows to $1.3500 at time of writing. Forex traders likewise eased recent British Pound tumbles, with Cable erasing overnight losses to stay at $1.9822. A bounce in the forex carry trade made the Japanese Yen the only major currency to lose against the dollar, with the greenback adding ¥3.00 off of lows to ¥114.44.

The US Federal Reserve surprised markets by dropping its discount lending rate by 50 basis points to 5.75 percent—a move said to forecast a more significant Fed Funds Rate cut through its September meeting. In its surprise vote to effectively ease monetary policy, the Fed said, “Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably.” Combined with its recent injections of liquidity into Fed Funds markets, the central bank made it very clear that it is concerned over recent developments in domestic credit markets. 

Fed Chairman Ben Bernanke seems intent to soften the effects of lending market troubles on the broader US economy. The chief central banker is well known for his willingness to swiftly respond to adverse risk, earning him the nickname of “Helicopter Ben” for statements on showering economies with money through economic crises. Whether or not “Helicopter Ben” is able to stem market tumbles and keep credit troubles contained remains the key question moving forward. (For more on Ben Bernanke, see a special report here) Initial market reactions suggest that speculators remain wary of risk, with equity markets losing much of their initial rallies through afternoon trade. Given a pickup in perceived risk aversion, we could easily see the dollar strengthen against all majors other than the Japanese Yen. 

The Dow Jones Industrial Average rallied strongly on the news of interest rate cuts, adding nearly 650 points off of yesterday’s lows of 12,518.51. A later slowdown left the Dow a much more modest 147 points improved to 12,993. At the same time, the S&P 500 crossed into positive territory on a year-to-date basis, rallying 1.76 percent to 1,436.17. The NASDAQ Composite was similarly bid, up 38 points at 2,489.

US Treasury Yields likewise regained ground on the surprise rate cuts, with the benchmark 10-year Note Yield inching 1 basis point higher to 4.67 percent. Short term interest rate expectations nonetheless fell, with the December Eurodollar contract showing implied Fed Funds yields of 4.71 percent through year-end. Markets now seemingly expect at least 50 basis points in rate cuts in 2007. 

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17 August 2007 18:16 GMT