Dollar Firms as Fed Rate Cut in Question - Start of a New Trade?

[B]Talking Points[/B]

  • Japanese Yen: off the lows but demand for carry persists
  • Aussie: Continues to be bid as private capital expenditure climbs
  • Euro: Retail PMI bounces above 50 but unemployment indicates peak may have been reached
  • Pound: Housing remains strong
  • Dollar: GDP on tap

Generally a quiet night in the currency markets but the greenback was boosted by several reports that the Fed may not necessarily cut rates at the upcoming September 18th meeting of the FOMC. Two famous Fed watchers - Greg Ip of the Wall Street Journal and Bloomberg?s John Berry both suggested that the Fed may stand pat in light of the fact that global markets appear to have stabilized after the US Central Bank cut the discount rate by 50% last Friday.
The assumption that markets will remain stable is a huge one t make. Nothing will bring back the specter of a rate cut faster than a 1000 point drop in the Dow. Indeed the lack of Fed cut may precipitate further weakness in equities forcing the Fed?s hand to loosen monetary policy. However, for the time being with the Dow comfortably holding the 13,000 level, the interest rate story may become the new dominant trading theme in the currency market next week.
For the past two weeks, all of FX trading has been governed by one dynamic only - risk or no risk. As carry trade rallied the dollar gained against the yen and lost against all other G10 currencies. As risk aversion swept the market the reverse took place. Tonight for the first time since turbulence hit the credit markets, the dollar held its own against the yen while gaining on all of it G10 counterparts as interest rate differentials once again came into focus. Indeed, if the Fed holds rates steady while the ECB shies away from a rate hike next week, the greenback may see more strength as the rate spread between the two currencies will not contract any further for the time being.
There is good reason to believe that the ECB may remain stationary in September. It appears as though EZ growth may have peaked earlier in the year as today?s eco data showed that German unemployment rolls were reduced by smaller than expected -15K. Conditions in the 13 member region remain expansionary but with growth decelerating the ECB may feel pressure to maintain a neutral monetary policy until it sees stronger signs of a pick up in demand.
Meanwhile US sees Q2 GDP revisions which are expected to raise the growth rate above 4%. The GDP figures however are backward looking and it will be interesting to see how equity markets react to the notion of no rate cut. If stocks hold firm the greenback may see more bids on the assumption that the worst of the credit market volatility is behind us - but we are skeptical that this will indeed be the case as we head into the fall.