The US dollar plummeted against the euro on the US Federal Reserve’s decision to cut interest rates aggressively for the second time in eight days—forcing further dollar depreciation across the board. The trade-weighted Dollar Index fell near record-lows on the pronounced greenback selloff, and a simultaneous rally in the Dow Jones Industrial Average left it over 1000 points off of its recent 15-month trough. The rally in risky asset classes virtually guaranteed further dollar losses, and the downtrodden currency may lose further before making a worthwhile bounce through short-term currency trading.
Currency traders widely expected that the day’s Federal Reserve interest rate announcement would force substantial dollar volatility, and those predictions were certainly proven accurate. The Federal Open Market Committee matched consensus forecasts and dropped its key Fed Funds Rate to its lowest levels in two years, but the Fed decision nonetheless surprised many traders who believed that the central bank would cut by a lesser 25 basis points to 3.25 percent. The knee-jerk reaction was enough to send the euro above the key $1.4900 mark against the US dollar, and the European currency showed relatively few signs of slowing its ascent. Given that the Fed’s key policy rate now rests a substantial 100 basis points below the European Central Bank’s target rate, the euro enjoys a significant yield advantage over the US dollar. Likewise significant, markets expect that the Fed will continue cutting interest rates while the European Central Bank leaves monetary policy unchanged. (See our Federal Reserve Instant Insight  for more information on Fed Rate forecasts.)
US stock markets likewise showed expectations that they expect lower interest rates through the medium term, with the Dow Jones Industrial Average rallying significantly in the moments following the Fed rate decision. The Dow currently trades 100 points above its open at 12,580, and a close near these levels would make for the third consecutive day of strong gains. Such bullish price action bodes poorly for the US dollar, which has traded with a strongly negative correlation to the domestic stock index. If we further Dow gains, we could likewise see the greenback fall to fresh depths against the euro and other major forex counterparts.
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Written by David Rodríguez, Currency Analyst for DailyFX.com,
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