Dollar Tumbles on Fed Rate Cut Expectations, but is the Move Overdone?

Forex speculators continued to sell the US dollar, as an inconclusive speech from Fed Chairman Ben Bernanke left markets to believe that the central bank could cut interest rates by up to 50 basis points through its coming meeting. The euro subsequently fell marginally short of record highs against the greenback, while a simultaneous rally in global equity markets made the Japanese Yen the largest decliner on the day.

The dollar reached lows of $1.3847 against its major European counterpart, as the NYBOT-traded Dollar Index fell to a fresh 22-year trough. Demand for high-yielders likewise sent the British Pound Sterling higher, as the GBP scaled monthly highs of $2.0335. Improving risk appetite made the Japanese Yen and the Swiss Franc the only major currencies to lose against the greenback, with the dollar gaining ¥.60 to ¥114.30 and ?.0030 to ?1.1893.
Markets largely ignored early morning Trade Balance data, instead reacting to an uneventful speech from Fed Chairman Ben Bernanke at 11:00 EST, 14:00 GMT. The head of the domestic central bank was expected to address overall economic outlook and give hints as to what the Fed may do at its September 18th meeting. Yet Bernanke took the speaking opportunity to discuss the domestic trade and current account deficits?making no overt mention of his stance on economic conditions and implications for monetary policy.

The omission sent mixed signals across financial markets, with some claiming that the Fed Chairman effectively showed little objection to market expectations for up to 50 basis points in Fed Funds rate cuts on the month?s meeting. Such a concept likely explains the dollar?s immediate drop against the Euro, which set intraday highs in mere minutes following the uneventful speech. Yet markets subsequently tempered their reaction to the event, with the Euro easing through subsequent trade. Needless to say, markets are unsure of what to expect from the Fed through their upcoming meeting. Fed Funds futures currently show a nearly 50 percent chance that the Fed will cut interest rates to 4.75 percent, but such an outlook may easily change on upcoming economic data.
Domestic equity markets initially showed a bearish reaction to the morning Fed Chairman speech, with skittish investors suspecting that the uneventful communiqué signaled the central bank?s unwillingness to cut rates. The Dow Jones shed some of its early gains in the trading that followed, but the index remains significantly higher just 40 minutes ahead of the close. Indeed, the Dow has added 1.5 percent to 13,318, while the S&P 500 has rallied 1.4 percent to 1,472. Tech stocks were the largest percentage gainers, with the NASDAQ Composite improving 39 points to 2,598. The strong gains signaled healthy risk appetite on the relatively quiet week of event risk, with a subsequent Japanese Yen tumble only reinforcing said view.

Treasury Yields were unsurprisingly higher on the improved market conditions, with the 2-year Note adding 9 basis points to 3.94 percent. Longer-dated bond yields were likewise higher, with the 10-Year up 4 basis points to 4.34 percent. The drop in bond prices signals that investors feel more confident on future economic prospects. Yet recent volatility has shown that gains in yield may prove transitory in the upcoming days of trade.

Written by David Rodriguez, Currency Analyst for