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Lex on dollar weakness, the Fed and rate cuts

Posted by Gwen Robinson on Sep 13 07:05.
With the dollar index at a 15-year low, bulls on the currency are a rare breed these days, notes Lex on Thursday. Surprisingly bad jobs data and falling home sales suggest a broader malaise affecting the US economy. “That, so the thinking goes, gives the Fed the reason it needs to cut the Fed funds rate next week,” it says.
There is no doubt that the dollar could fall further in the short term. But in Lex’s view, fear that this might stoke inflation is not likely to be a decisive factor in the Fed’s thinking.

Weak economic growth is the concern now. As monetary policy eases, it is logical, and desirable, that the dollar follows in its wake, provided it is at an orderly pace – not least to help unwind some of the more glaring imbalances that have built up.

The wrinkle for the bears, however, is that the market is way ahead of the Fed already. Never mind the possibility of a 50 basis points cut: Fed funds futures are pricing in a 60 per cent probability that Ben Bernanke slashes by 75bp by the end of October. That would reduce the differential to the eurozone rate to just half a percentage point.

It remains to be seen if any cut stabilises financial markets, notes Lex. “Even if it does not, and talk of recession heats up, the dollar is still not necessarily about to fall off a cliff. Central bankers in the eurozone and the UK are hanging tough, but it also remains to be seen how long that would last if a faltering US economy dragged down Europe.”

Widening spreads between three-month money market rates and official rates represent a de facto tightening, which reduces the pressure for more hawkish policy moves. That the Fed will cut appears a done deal. The question is whether rates have peaked elsewhere.

This entry was posted by Gwen Robinson on Thursday, September 13th, 2007 at 7:05 and is filed under Capital markets. Edit this entry.

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