Federal Reserve Cuts 50bp, Dollar Tanks, More Rate Cuts to Come

The Federal Reserve wants to be ahead of the curve.  They no longer want to be criticized for doing too little, too late and for that reason, they cut interest rates by 50bp today to 3.00 percent.  In a little more than week, the Federal Reserve has lowered interest rates by a total of 125bp, which is more than all of the rates cuts that they made last year combined. 

They are 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 efforts thus far 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.  Inflation is not a problem at the moment; they expect it to moderate in the coming quarters. 

The rate decision has pushed the US dollar lower against every major currency as it quickly becomes a carry trade funding currency.  A little more than 5 months ago, US interest rates were the fourth highest in the developed world and now it is the third lowest. If you want to understand the price action post FOMC, just take a look at the following table. The US dollar now offers a yield that is 100bp less than Canada and 525bp less than New Zealand.  It is yielding only 25bp more than Switzerland which means that once the Fed lowers rates again in March, and we expect them to, the US dollar will be tied with the Franc as second lowest yielding currency in the developed world.  

 
Before this easing cycle is over, we expect the Federal Reserve to bring US interest rates down to at least 2.50 percent.  If the economy does not improve, interest rates could realistically return to 1.00 percent.  As a result, the US dollar will not escape further weakness. 

About the author

Written by Kathy Lien, Chief Strategist, DailyFX



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