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Dollar Falters after Fed Maintains its “Exceptionally Low” for “Extended Period” Warning

Dollar Falters after Fed Maintains its “Exceptionally Low” for “Extended Period” Warning

2010-03-17 01:49:00
John Kicklighter, Chief Currency Strategist
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Dollar Falters after Fed Maintains its “Exceptionally Low” for “Extended Period” Warning
In a fully transparent market, a decision by the monetary policy authority to essentially maintain its expansive policy would be deemed a non-event. However, the markets we deal with are far from efficient as speculative interests have nearly as much impact on volatility and trend as tangible fundamentals themselves. With Tuesday’s close, the Dollar Index would end the session at its lowest level since February 4th, when the currency’s December/January rally finally lost momentum. And yet despite the dollar’s obvious weakness, there is still hesitation to tip sentiment towards wholesale selling of the currency. This is not only evident in the maintenance of the Index’s general congestion as the same restraint can be designated in the various pairings. EURUSD is the most obvious example of this concept (though the Index is heavily influenced by this liquid pair); but the same sentiment can be identified in GBPUSD’s curbed advanced, USDJPY’s congestion and AUDUSD’s struggle to revive a bull trend. The responsibility for extending or curtailing this benchmark currency’s retracement will likely fall to the risk appetite trends that define the market’s speculative endeavors. Today, a significant burden was lifted from the mass’ shoulders when the EU announced its loose framework of support should any member need assistance and Standard & Poor’s removed the fear of an imminent downgrade for Greece. So, while the world’s economy is facing sluggish recovery and there are still many cracks in financial stability, this removes the most immediate threat from the equation.

Then again, a recovery in risk appetite isn’t necessarily a death sentence for the dollar. Through much of the past two-and-a-half years, the US currency has had a very tight correlation to underlying risk appetite; but the reasoning for this link have shifted over time. In capital market’s rally through 2009, the greenback maintained its function as a safe haven asset; but arguably, the more influential factor in its unfavorable trend was the extraordinarily low market rates. The record low three-month Libor rate (a standard for most market participants) for US money was even lower than its Japanese counterpart. In turn, this left the dollar competing as a funding currency when carry interest was steeped in an aggressive recovery. Recently, however, we have seen strong sentiment currents level off and market rates start to climb. If the outlook for returns (as benchmarked by interest rates) for the dollar gains over its counterparts, the currency could actually start to benefit from a rise in risk appetite. Yet, the rate at which this fundamental tightening takes place will be heavily dependent on monetary policy. Today, the outlook for the Fed’s return to rate hikes was set back with the inclusion of a now infamous phrase. Though the FOMC would leave its benchmark rate unchanged and the statement itself was largely unchanged, many had expected the remark that rates would be held “exceptionally low” for an “extended period” would be absent as a natural progression in the policy stance. However, despite the pending expiration of lending facilities and the hike in the discount rate, it seems policy authority is not ready to take that hawkish turn. Going forward, this specific statement will be treated as a definable gauge of policy. When it is dropped, the outlook for hikes will be less than six months. With inflation concerns, it will be closer.

Related: Discuss the US Dollar in the DailyFX Forum, US Dollar at Risk for Further Declines versus Euro on FX Positioning

Euro Builds Cautious Optimism after the EU Issues Questionable Promises, S&P Reaffirms Greek Rating
There are those that have seen their confidence revived after at the European Union wrapped up its two-day meeting; and then there are those that consider the result lacking in substance. The topic of the gather was how to secure the financial stability of the region should Greece or some other economy face a default or worse. Not long ago, this topic was the focus of market-wide fear that financial stability was fleeting and ultimately an illusion. However, recently, speculative interests have been a little more robust. The policy officials that are tasked with ensuring the health of the EU have clearly taken advantage of this turn of events as they have been able to avoid committing to a fiscally taxing contingency plan without it negatively impacting the financial markets. At the close of this meeting, officials praised Greece’s efforts and deemed them substantial enough to meet deficit goals. In outlining a backup plan, European Commissioner for Economic and Financial Affairs Olli Rehn would say little more than noting the group outlined a framework for emergency aid; but he would then say it was not currently necessary. Unidentified media sources have suggested the plan would entail pooling funds to establish direct loans for ailing members; but this has already proven itself an unpopular solution on an individual basis. The reality of the situation is that such a trust would require capital from members; capital which they themselves are short of and which further carry the ire of local taxpayers. Nonetheless, this flimsy shift in commitment would come alongside the announcement by Standard & Poor’s that it would drop its negative credit watch on Greece. On the other hand, the outlook remains negative and the rating agency warned the nation was still at risk of a downgrade over the coming 12 to 16 months if austerity cuts were not implemented and maintained. This gives perspective to the situation. Troubles in the region will not simply disappear within a few months. Comments from the ECB’s Stark would carry the same message. He warned that there was still “clear risk” of a sovereign debt crisis.

British Pound Strengthens ahead of BoE Minutes, Employment Data
With a marked rebound in risk appetite through Tuesday’s session, the British pound would reap the benefit from its distinct correlation to the general health of global financial conditions. Like Greece, the United Kingdom faces significant hurdles to securing an economic recovery and fiscal stability. For this reason, a general improvement in investor sentiment makes it easier to facilitate a regional revival. However, the sterling may deviate from the course laid out by underlying risk trends over the coming day given the influence that scheduled event risk typically exacts. For volatility, the jobless claims figures hold the greatest potential. Yet, while this is a notable component of growth, the real fundamental drive will come through the BoE minutes. The central bank has to balance policy in order to help a recovery, stabilize finances and prevent inflation.

Japanese Yen May Experience Turbulence with the Bank of Japan’s Rate Decision
There is little probability that the Bank of Japan will change its benchmark lending rate at the conclusion of its policy meeting early in the Asian session; but the event could nonetheless prove market moving. There is substantial speculation that Governor Shirakawa and his fellow policy members will bend to government pressure and expand its stimulus efforts in an effort to fight deflation and facilitate growth. Considering the group’s 10 trillion yen lending facility started in December is coming to a close, the group will be making a decision today either way.

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**For a full list of upcoming event risk and past releases, go to www.dailyfx.com/calendar


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Written by: John Kicklighter, Currency Strategist for DailyFX.com
E-mail: jkicklighter@dailyfx.com

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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