US Dollar Loses Further Support on Fed Talk - Hopelessly Resigned to Further Losses Against Euro?

The US dollar edged marginally higher on the day’s currency trading, but the euro nonetheless finished near its highest levels in two months—showing few signs of slowing its advance against the dollar. Forex traders took the opportunity to take some profits on the euro’s impressive ascent, and currency markets largely ignored further Fed commentary on prospects for the US economy and continued interest rate cuts. Both Boston Federal Reserve President Eric Rosengren and Fed Board of Governors member Fred Mishkin took a page from Chairman Ben Bernanke’s book and suggested that the central bank would cut rates further to bolster the economy. The two renowned doves received relatively little reaction from interest rates and currencies, however, as it remains clear that speculators have already priced in a sizeable 50bp Federal Reserve interest rate cut on January 30. Though unified calls for lower rates sparked rumors of a potential inter-meeting cut, such unfounded musings elicited no noteworthy reaction from major financial markets.

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Fed Funds Futures traders now price in a full probability of a 50 basis point interest cut through the FOMC meeting on January 30^th—a clear negative for the US dollar. All else remaining equal, a drop in US yields could only sink the greenback further against major forex counterparts. This is especially the case against the euro, with traders now forecasting that the European Central Bank will either raise rates or leave them unchanged through 2008. The Reserve Bank of Australia is likewise predicted to continue raising interest rates through the same period—providing strong support for the Australian dollar. Time will tell if yield differentials will continue to be one of the main drivers behind currency market volatility, but outlook nonetheless remains very dim for the hopeless US dollar.

Written by David Rodríguez, Currency Analyst for DailyFX.com, drodriguez@dailyfx.com

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