U.S. Fed Anticipated 0.5% Interest Rate Cut

By: Ashraf_Laidi

The main question is whether today's anticipated Fed rate cut will succeed in maintaining the current boost to global risk appetite, regardless of the size of the easing. Since the beginning of the market crisis 7 weeks ago, the Federal Reserve has proven more creative in its overall actions than surprisingly dovish in its rate cuts. At the last scheduled FOMC meeting, the Committee kept rates unchanged despite the collapse of Lehman Bros but offered a bridge loan to AIG. In keeping with current Modus Operandi, a 50-bp rate cut in the fed funds rate is the most likely scenario, while a 25-bp easing is more plausible than 75-bps.

The increasingly global nature of the market and economic crisis raises the probability of a 25-bp cut from the Bank of Japan this Friday, especially given the global importance of stabilizing the value of the yen. And since Japan did not take part in this month's coordinated global rate cuts, a BoJ easing comprises a vital piece of the global policy puzzle.

Cut Locally Think Globally

Combining the aforementioned logic and the increasing coordination among major central banks, the Fed could opt for a 50-bp easing, followed by a BoJ 25-bp cut on Friday. A 25-bp cut from the Fed today would increase the probability of a BoJ action. A 75-bp Fed easing is unlikely because not only it would diminish policy firepower, but does not fall under the past practice of the Bernanke Fed, especially after yesterday's 10% rally in US equities.

Yen or Dollar ?

The currency market reaction will be primarily shaped by the resulting perception of risk appetite as reflected in equity markets and swap spreads. In the event that today's Fed action is applauded by equities (ie. no major sell-off), we expect renewed selling in the dollar and the yen against European and antipodean currencies, but with the dollar likely to underperform the yen due to the deepening erosion on the dollar's interest rate foundation. Only a BoJ cut this week would prevent extended dollar underperformance of the yen.

The high yielding AUD, NZD and GBP will be seen as the biggest losers in the event that markets sell-off (due to disappointment on a smaller easing or lack if 75-bp cut). In contrast, the Canadian dollar is expected to come out among the big winners in the event of protracted market gains as has been proven to be the case in the last 24-hours due to prospects of a widening in the reflationary trade (boosting oil and gold on Fed easing). USDCAD has dropped by more than 4 cents, to 1.2420 and is expected to extend losses to as low as 1.21 before week's end .

USDJPY's chances of regaining yesterday's 98 yen highs may only come to fruition in the event of extended market gains and prolonged expectations of a BoJ easing later this week.

EURUSD remains the quiet observer in the currency complex as the anticipation of ECB cuts limits any resulting Euro gains from a falling risk aversion. Upside remain capped at $1.2920, while negative bias crops back up towards 1.2760.

GBPUSD remains vulnerable to renewed pullbacks despite current recovery past $1.62, due to predominant expectations of BoE easing to as low as 3.75% by end of year from current 4.50%, coupled with pace of UK economic deterioration. Short-term upside seen extending to as high as $1.6325, before renewed offers seen dragging the pair back towards $1.60.

By Ashraf Laidi
CMC Markets NA
AshrafLaidi.com

Ashraf Laidi is the Chief FX Analyst at CMC Markets NA. This publication is intended to be used for information purposes only and does not constitute investment advice. CMC Markets (US) LLC is registered as a Futures Commission Merchant with the Commodity Futures Trading Commission and is a member of the National Futures Association.

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