Coordinated Interest Rate Cuts – Too Little, Too Late?

We have been literally begging the Federal Reserve, the European Central Bank and the Bank of England to work together to stem the bleed in equities and they have finally done it (What is the Fed Waiting For? And Panic Selling in FX Begs Coordinated Easing). For the first time since Sept 2001, central banks around the world have delivered a coordinated interest rate cut. Coming 2 days before the G7 meeting and 1 day before the BoE interest rate decision, their move sends a strong message to market that the central banks are holding nothing back in their attempt to unlock the credit markets, stabilize the stock market and stimulate growth.

Given that the Bank of Japan stood aside, the move is bearish for USD/JPY. However the impact on the Euro and British pound is limited because the interest rate differentials between those currencies and the US dollar remain unchanged. Unprecedented is the buzz word in the financial markets these days and today’s rate cuts were nothing short of that.

Unfortunately despite an initial rally in stocks, equities have given back all of their gains as investors believe that the actions by the central banks are too little too late. This is undoubtedly the right move for the central banks, but the right time to have made the rate cuts was last Friday after the TARP approval. Stocks continue to sell off because this has not solved the funding issue. The LIBOR – OIS (Overnight Index Swap) rate hit a record high indicating that credit is still tight. The Reserve Bank of Australia’s full percentage point rate cut earlier this week has raised the bar.

Time for Halloween Treats – Next Stop Could be 1% for the Fed?

Given the market’s lack of a reaction to the rate cuts, the Federal Reserve may still give investors a Halloween treat by cutting interest rates 25bp at the end of the month and the next step after that could be a move to 1 percent.

The outlook for the US economy is certainly bad enough to warrant bringing interest rates back down to the 1 percent levels that we saw during Greenspan’s tenure. The financial crisis that we are facing now is more damaging than the burst of the technology bubble. When Greenspan cut rates from 6.5 percent down to 1 percent, USD/JPY fell from a high of 135 to a low of 103.40. This 25 percent move represented the dollar’s shift to a funding currency. Since the Fed started cutting interest rates last August, USD/JPY is down 18 percent. If 1.00 percent becomes a reality in the US, USD/JPY could hit 95.

More Rate Cuts in Europe as Well

We also expect more interest rate cuts from Europe. The Bank of England announcement for Thursday has been canceled. As for Trichet, once he commits to a monetary policy direction, he sticks to it and in this case we believe that Eurozone rates could come down to as low as 3.25 percent over the next 12 months.

A G7 Meeting is still being held on Friday, so we do not rule out the possibility of major changes to the communique. In the past, G7 meetings have led to major turns in the US dollar.

Japanese Yen: The Only Winner

The only winner in today’s coordinated action is the Japanese Yen because Japan was the only major central bank that did not cut interest rates. However ultimately the move in the USD/JPY and the other Yen crosses will be determined by the market’s risk appetite.

The day is early and we could simply be seeing the final push lower before a major recovery. For the central banks, this was the best trick in the bag and if this doesn’t work, perhaps they just need to let the markets figure out the right solution.

About Kathy Lien 236 Articles

Kathy Lien is an Internationally Published Author and Chief Strategist of DailyFX.com, one of the world’s most popular online websites for currency research. Her trading books include the highly acclaimed, Day Trading the Currency Market: Technical and Fundamental Strategies to Profit form Market Swings (2005, Wiley); High Probability Trading Setups for the Currency Market E-Book (2006, Investopedia); and Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game (2007, Wiley). As Chief Currency Strategist at FXCM, Kathy is responsible for providing research and analysis for DailyFX, the research arm of FXCM. She also co-edits the BK Forex Advisor, an Investopedia.com Premium Service with Boris Schlossberg – one of the few investment advisory letters focusing strictly on the 2 Trillion/day FX market.

Kathy is also one of the authors of Investopedia’s Forex Education section and has written for Tradingmarkets.com, the Asia Times Online, Stocks & Commodities Magazine, MarketWatch, ActiveTrader Magazine, Currency Trader, Futures Magazine and SFO. She is frequently quoted by Bloomberg, Reuters, the Wall street Journal, and the International Herald Tribune and has appeared on CNN, CNBC, CBS and Bloomberg Radio. She has also hosted trader chats on EliteTrader, eSignal and FXStreet, sharing her expertise in both technical and fundamental analysis.

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