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FX open: An aggressively lax Fed and a declining dollar

Date: Thursday 26 Jan 2012

FX open: An aggressively lax Fed and a declining dollar

The European session gets under way with an average gain of 0.6% for the main equity benchmarks, as the market digests the decisions taken by the Federal Reserve (Fed) yesterday.

The Fed’s Open Market Committee (FOMC) decided to keep the interest rate at 0 – 0.25% until at least 2014 arguing that “economic conditions including low rates of resource utilization and a subdued outlook for inflation over the medium run” are likely to warrant exceptionally low rates. It also opened the door a potential round of additional quantitative easing (QE3) in case the economy needs it.

In the foreign exchange market, the US Dollar majors are bearish due to the aggressively lax stance by the Fed. The euro/dollar broke through resistance at 1.3076 to set an intra-day high of 1.3133 this morning. Meanwhile, the euro/yen stopped climbing at 102. The dollar/yen rose to 77.60 and Cable rose to $1.57.

Carry trade currencies such as the Aussie, Kiwi, and Loonie are currently bullish (a "carry trade" is where an investor will sell currency of a country that has low interest rates and put it in the currency of a country with higher interest rates). The USD/CAD is near parity again and the AUD/USD is strong.

In the sovereign debt market, bond yield differentials over German bonds (bunds) are narrowing. The Spanish risk premium is at 345 basis points (bp) and the Italian risk premium is at 431bp. There are 100 basis points to a percentage point.

The Bund yield is at 1.94%, the French 10-year yield is at 3.17%, the Spanish 10-year is at 5.39%, and the Italian 10-year is at 6.25%. Additionally, the US 10-year fell from 2.04% to 1.97% following the Fed’s statements.

In terms of macroeconomic data, the German GFK consumer confidence index for February rose to 5.9 from January's 5.7. French consumer confidence also rose, to 81, as measured by INSEE. Coming up in the US later today, data on weekly unemployment claims, durable goods orders, leading indicator index, and new home sales for December.

Finally, the Reserve Bank of New Zealand decided to keep its key interest rate unchanged at 2.5% as expected by the market.

We must also point out some statements made at the Davos Forum by Morgan Stanley Asia Chief Executive Officer Stephen Roach. He said that the worst in Europe is not over and that Western central banks are running out of ammunition.



F.M.

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