Greenback Hits 2 Year High vs Euro; Odds Rise for Joint Rate Cuts

The US dollar is on steroids this morning as the sell-off in global equities sends the dollar to a 2 year high against the Euro. The EUR/USD is within 3 percent of its fair value of 1.20 while the GBP/USD and USD/JPY are now undervalued on a purchasing power parity basis. However PPPs matter little in a market environment that is driven by fear. The currencies have overshot their PPP levels for years and there no is reason why they can’t undershoot them as well. We still believe the dollar is nearing a top as the stock market attempts to stabilize, but bear market sell-offs can last for far longer than what may seem logical.

Central banks are having a very tough time dealing with the sharp moves in both the equity and currency markets. Investors continue to bail out of the funding currencies of high risk investments like carry trades, stocks, bonds, real estate, emerging markets and commodities.

Risk of G7 Intervention

The G7 released a statement on the Japanese Yen this morning, but it was all talk and no action which suggests that the Japanese are having a hard time convincing their US and European counterparts to join in on any physical intervention to sell the Yen. It is certainly not in the US’ best interest to engineer further strength in the dollar. The Japanese will have to act alone if they plan on engaging in physical intervention because the ECB will not back Yen intervention either as a weak EUR/JPY is good for exports.

Coordinated Rate Cuts

A higher probability scenario is another round of coordinated interest rate cuts by major central banks. The strength of the US dollar and Japanese Yen have been driven entirely by the weakness in global equities. Another coordinated rate cut could stabilize stocks which would help to take some of the steam out of the US dollar and Japanese Yen.

At minimum, the latest rally in the US dollar will give the Federal Reserve a stronger reason to cut interest rates by 50 instead of 25bp. Fed fund futures are currently pricing in a 68% chance of a half point rate cut and 32% of a 75bp rate cut. A quarter point rate cut has been completely discounted by the markets. To deliver anything less than a half point cut would be a big disappointment.

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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