The US dollar fell significantly against the euro and other major currencies, as forex traders aggressively sold the greenback following commentary by European Central Bank and US Federal Reserve on monetary policy outlook for 2008. A strongly hawkish ECB President Jean Claude Trichet dispelled the notion that the bank could move to cut euro interest rates through the medium term—a stance almost exactly opposite to that of US Fed Chairman Ben Bernanke. Indeed, the top Federal Reserve official gave clear signal that the US central bank stood ready to cut interest rates on an increasingly dim outlook for domestic economic growth. Fast-diverging forecasts for US and European yields forced the euro near its highest levels in two months, and overall momentum clearly favors further EUR/USD gains.
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European Central Bank President Jean Claude Trichet surprised markets in showing a strongly hawkish stance on inflation—quelling speculation that the bank could cut its short-term policy rate through the first half of 2008. In a prepared statement released following the bank’s interest rate announcement, Trichet said, “[the ECB Governing Council’s] assessment of upside risks to price stability has been fully confirmed.” As a clear warning to those who expected the bank to cut rates through 2008, Trichet went on to say, “The Governing Council remains prepared to act pre-emptively so that second-round effects and upside risks to price stability over the medium term do not materialize.” The bank’s apparent monetary policy tightening bias sent the euro significantly higher through morning currency trading, as speculators clearly pulled back expectations for lower euro interest rates through 2008.
Forecasts for US yields took a turn for the worse on commentary from Fed Chairman Ben Bernanke, as the monetary policy official clearly stated that the Fed stands to cut rates aggressively in the face of a pronounced economic slowdown. Bernanke minced few words when he spoke of significant downside risks to growth and employment, concluding his statement with, “[the Federal Open Market Committee] stand[s] ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks.” His words instantly sent implied yields on Federal Funds Futures contracts lower, and the Dow Jones Industrial Average posted a sharp rebound on the Fed Chairman’s rhetoric. The combination of lower yields and fast-rallying equities was more than enough to send the US dollar substantively lower into the late New York currency trading session.
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Written by David Rodríguez, Currency Analyst for DailyFX.com, [email protected] [/I]
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