The US Dollar rallied on the Federal Open Market Committee’s (FOMC) decision to cut its short-term Fed Funds target by 25 basis points, with currency traders buying dollars on improved yield prospects for the downtrodden greenback. Many speculators feared that the US central bank would reduce its Fed Funds rate by 50 basis points through the afternoon’s announcement, but the more moderate monetary policy decision allowed the dollar to regain lost ground against most forex counterparts. Yet a substantial tumble in the Dow Jones Industrial Average and other risk-sensitive assets made the Japanese Yen the largest gainer through the afternoon—outperforming all G10 currencies through time of writing.
An afternoon FOMC interest rate decision was the clear highlight of the day’s currency trading, with the highly-anticipated event bringing strong volatility to all relevant asset classes. The Federal Open Market Committee voted to cut its short-term Fed Funds rate target to 4.25 percent, matching median analyst forecasts but disappointing dollar bears who had hoped for a larger rate reduction. The FOMC was nearly unanimous in its vote, with 9-1 members in favor of the 25bp move. Yet traders saw the accompanying statement as lacking a sense of urgency towards future interest rate reductions. The FOMC said, “Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation.” Such rhetoric suggests that the central bank stands ready to bolster growth with an increase in the money supply. But the Committee likewise said it “judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.”
The countervailing prospects of worsening economic growth and higher inflationary pressures may leave the Fed unwilling to cut short-term borrowing costs further—hampering the economy’s ability to cope with pronounced credit, lending, and housing market crises. Medium-term money market yields rose in response to the Fed’s statement, and futures markets have subsequently scaled back forecasts for Federal Reserve interest rate cuts through 2008. Yet the dollar has seen relatively mixed price action a sharp drop in US Treasury Bond yields.
Highly risk-sensitive government bonds saw pronounced price gains through the day’s close, with the 2-Year Note losing a whopping 22 basis points in yield to 2.94 percent. A 250+ point rout in the Dow Jones Industrial Average made the Japanese Yen the strongest performing currency on the day, beating all liquidly traded world currencies by a fairly large margin. The dollar was the next-best performer of the group, but it nonetheless shed a full 1.0 percent against its Japanese counterpart.
[I]Written by David Rodríguez, Currency Analyst for DailyFX.com[/I]
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