Why the US Dollar Will Fall Further?
The Federal Reserve cut interest rates by 50bp to 3.00 percent. In a little more than one week, the US central bank has lowered interest rates by 125bp, turning the US dollar into a de facto carry trade funding currency. The greenback now yields 100bp less than the Euro and the British pound and 525bp less than the New Zealand dollar. At the same time, it only offers 25bp more in yield than Switzerland, but a comfortable advantage of 250bp over the Japanese Yen. These interest rate differentials provide a perfect explanation for the price action in the currency market post FOMC. The dollar dropped the most on a percentage basis against the New Zealand dollar and the least against the Japanese Yen. But the dollar’s weakness is not over. According to the FOMC statement, the Fed is still worried about financial market conditions, tight credit, the stability of the labor market and a further contraction in housing. Although they believe that their recent efforts will offset some of the downside risks to growth, the tone of the FOMC statement indicates that this rate cut will not be their last. We still expect US interest rates to fall to least 2.50 percent before this easing cycle is over. The pace of rate cuts however will begin to slow. Last week, the Fed cut by 75bp, today they cut by 50bp and on March 18, we expect only a quarter point rate cut. The economy will need time to absorb the easing and even though the Fed does not think that inflation is an immediate threat, by lowering interest rates too rapidly, they risk stoking inflationary pressures. By cutting interest rates 50bp instead of 25bp, we commend the Fed for being ahead of the curve. This will hurt the outlook for the US dollar in the near future, but it will pay off in the second half of the year. With the FOMC rate decision behind us, the next big event risk is Friday’s non-farm payrolls report. There is a decent chance that January job growth will be very strong. ADP reported that 130k new jobs were added to US payrolls last month which dovetails well into the surprisingly low level of jobless claims that we have seen in recent weeks. The four week moving average of claims is now at a 3 month low which indicates that non-farm payrolls at bare minimum will be more than the 18k jobs that were created last month. In fact they could be as high as 85 to 100k. Before that on Thursday we are expecting personal income, personal spending and Chicago PMI.
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