Business-Insider

Analysis by NewstraderFX

Tuesday's FOMC statement regarding rising inflation expectations along with the announcement of the Primary Dealer Lending Facility has already exerted a profound effect on currency (and therefore commodity) markets, as seen in the sudden burst of dollar strength against the high yielders. From the release of the statement, the dollar has gained 430 pips on the Pound, 365 on the Euro, 270 on the Aussie and 180 on the Kiwi. The Reuters/Jeffries CRB Commodity Index, composed of oil, gold, corn and 16 other commodities fell 9.2%, the biggest drop since the Commodity Research Bureau started calculating the benchmark a half-century ago as the Dollar Index gained 2.14% this week.

A number of different reasons have been cited in the financial press for the move in the CRB index-commodities were in a "bubble", traders were taking profits (perhaps to now invest in equities) and the threat of a demand slowdown due to the U.S. recession being three. While all seem plausible, that fact is the change accelerated right after the FOMC's statement was released around 14:15 EDT Tuesday and after Goldman Sachs and Morgan Stanley borrowed at the PDLF on Wednesday, in an effort to show leadership and that no stigma should be attached to borrowing there, which is crucial for the program's eventual sucess. Around $58B has already been borrowed.

The FOMC's new inflation language noted for the first time in about 10 years that "some indicators of inflation expectations have risen." What this indicates is that the easing cycle, which is expected to continue, is likely to have peaked in intensity after having taken real interest rates close to zero based on either core CPI or PCE.

The Fed has also gone a long way in supporting investor confidence by lending to non-banks for the first time since the 1930's via the PDLF. The program accepts wide range of collateral, including AAA/Aaa rated mortgage-backed securities that have been marked to an actual market price while the interest rate, 2.5%, places the real rate about 25 basis points above zero. There is a lot more info on the NY Fed's website : http://www.ny.frb.org/newsevents/new.../rp080316.html

Stephan Jen of Morgan Stanley recently wrote an interesting article regarding what's required for successful monetary intervention. His conclusion was that the monetary policy of the country in question does not "need to be in sync with the intervention objective" but that "the relative monetary policies between countries needed to be." What this means is that the dollar can potentially strengthen while the Fed is still easing if the corresponding central bank is pursuing the same policy. I would extrapolate this out to how market forces can move price as well, since that does seem to be the pattern.

While one can't argue at this time that the ECB is on an immediate course to cut rates, because expectations that growth in the Euro Zone will slow and subprime loan losses will spread at European investment banks, investors may start to price in a change in ECB policy. meaning that the ECB may start to ease as the Fed slows. The BoE seems set to continue easing, as the surge in credit costs has choked off lending to consumers especially for new home loans. Australian consumer confidence plunged to the lowest level in almost 15 years in March and business sentiment in February held close to the weakest since September 2001, signaling a halt to tightening by the RBA. The average net wealth of New Zealand consumers fell for the first time in seven years as house prices declined and rising interest rates increased debt, adding to signs that household spending may slow and curb economic growth.

From a technical perspective, it does look like the dollar is vulnerable to giving back some of it's gains against the high yielders in the very short term, as it looks a bit overbought on the daily charts. There is a potential DS Overbought forming on EUR/USD if price rises a bit and closes oversold at a price less then the March 15-16 close. GBP/USD formed a weekly DS Overbought formation on March 2 at 2.0165, but has now made a DS Oversold on the daily chart. AUD/USD formed a daily DS Overbought on the close of March 13 from .9454.

The case for Dollar strength at this time also has to do with the fact the the world's reserve currency has depreciated in a disorderly way, not in terms of relative currency price perhaps but in terms of commodities. Oil has risen almost 80% the past year and while "disorderly" is subjective, it seems reasonable to suggest that an 80% increase is disorderly. More to the point, investor confidence, especially of foreign investment, has probably been shaken with the Dollar's decline. A couple of SWF's have gotten burned since their recent investments and I would suggest that while these super deep-pocket investors can handle market fluctuations, they will be less inclined to invest further if the U.S. continues to pursue a weak dollar policy.

No buy, hold or sell recommendations are being made.
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