During early deals on Thursday, the US dollar extended its yesterday's downtrend against most major currencies as the Federal Reserve slashed its benchmark interest rate by half a percentage point to 1%, in an effort to keep the economy from slumping into a deep and prolonged recession. The dollar plunged to near a 3-week low against the franc, 8-day low against the pound, 6-day low against the kiwi and a 9-day low against the euro, the aussie and the loonie.
But the dollar showed strength against the yen as a surge in stock prices prompted investors to buy higher-yielding assets with money borrowed from Japan.
The Federal Open Market Committee, the policy-making arm of the U.S. central bank, lowered its target for the federal funds rate to 1 percent - its lowest level since June of 2004. The reduction took the key rate to its lowest level in more than 4 years, as a severe slump in the housing market has led to turmoil in financial markets and has threatened to drag the country into one of the worst economic downturns since the Great Depression.
Yesterday's rate cut was widely expected, as worries about a global recession have mounted lately and a recent drop in oil prices has eased inflation pressures. The vote by the FOMC was unanimous.
In announcing the rate cut, the Fed noted signs of a weaker economy. This included indications of a drop in consumer spending, which many consider as the linchpin of the economy. The central bank also warned that a further drop in spending could come as the turmoil in the credit markets makes it difficult for consumers to borrow money. Other areas of the economy are also at risk, the Fed pointed out, with business spending falling off and economic weakness overseas likely to cut into exports.
The Federal Reserve Chairman Ben Bernanke and his colleagues pledged they would "monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability."
The Fed's half-point interest rate cut marked the second rate reduction this month. The Fed slashed the rate by a half-point on October 8 in a coordinated action with other foreign central banks.
The Fed has already trimmed the benchmark rate from 5.25 percent in eight steps over the past 13 months and created six lending programs channeling more than $1 trillion into the financial system to counter a credit crisis that started with the collapse of the U.S. mortgage market and spread around the world. Banks are still reluctant to lend to each other and the Standard & Poor's 500 Index is down almost 37% this year.
Fed's rate cut were part of a concerted drive by officials, just days before a national election, to demonstrate they are moving as quickly as possible to deal with the most serious financial crisis to hit the country since the 1930s.
Though a 1% benchmark rate doesn't leave the Fed much more room to cut, many economists are projecting further rate reductions down the road.
"Clearly the last month represents a watershed in terms of the approach taken by the Fed," Brian Bethune, Chief U.S. Financial Economist for IHS Global Insight, said after the Fed announcement. "We believe that this is a positive signal for the ultimate resolution of the crisis." Bethune predicted that the Fed will cut rates by another half-point over the next several months in order to counter mounting evidence of a recession.
Michael Hanson, an analyst from Barclays Capital, had a similar reaction as Bethune, though his projection called for a more modest rate cut. Hanson predicted a quarter-point cut at the Fed's December meeting, though he stressed that the central bank would use other methods to stimulate the economy as well.
Besides cutting interest rates, the Fed announced it was extending credit lines worth $30 billion each to the central banks of Brazil, Mexico, South Korea and Singapore in an effort to bolster financial markets in those countries and relieve investors' anxieties. The currency-swap arrangements aim ''to mitigate the spread of difficulties in obtaining U.S. dollar funding.''
The Fed's announcement coincided with a decision by the International Monetary Fund to almost double borrowing limits for emerging market countries while waiving demands for economic austerity measures. The IMF unveiled a new streamlined lending process to get support to countries caught up in the credit crisis, another effort by the 185-member institution to show it was prepared to perform its job as the lender of last resort to countries facing difficulties. The IMF already has moved to help Iceland, Ukraine and Hungary, with other nations quickly lining up for aid.
The Fed and IMF actions ''show international resolve to support strong performing emerging-market economies adversely impacted by the current financial market turbulence,'' U.S. Treasury Secretary Henry Paulson said in a statement yesterday.
Despite the interest rate cut, the Dow Jones industrial average, which soared nearly 900 points or 11 percent Tuesday, fell 74.16 points or 0.8 percent on Wednesday. Some analysts said the drop partly reflected growing worries about whether the government's actions will be sufficient to avert a deep and prolonged recession.
Asian stock markets, however, rose sharply today. South Korea's index jumped 12 percent, Hong Kong's Hang Seng index was up 10 percent, and Japan's Nikkei gained 7 percent. Asian stocks, bonds and currencies rose after China, Hong Kong, Taiwan and the U.S. cut interest rates to alleviate a credit freeze and boost economic growth, spurring a rally in commodity prices.
Central banks across the globe are trying to curb an economic slowdown as the financial crisis weighs on consumer sentiment and business spending. The People's Bank of China yesterday reduced its benchmark one-year lending rate to 6.66 percent from 6.93 percent. Taiwan and Hong Kong central banks' lowered interest rates today.
The Taiwanese central bank enacted an emergency cut today in the country's discount rate by 25 basis points to 3.00 percent, effective immediately. The bank added in a statement that risks of further economic slowdown were increasing, and that it would continue to pay close attention to market liquidity conditions. The central bank also lowered the secured loan rate to 3.375 percent, and cut the unsecured loan rate to 5.250 percent.
Meanwhile, the Hong Kong Monetary Authority or HKMA reduced its base rate to 1.5% from 2% with immediate effect, following the rate cut decision of the US Federal Reserve. The HKMA decision was based on a new pre-set formula announced on October 8 that says the base rate is set at 50 basis points above the prevailing US federal funds target rate.
The dollar's slide was also due to a rise in the oil prices, which climbed towards $70 a barrel today, building on its more than 7 percent surge in the previous session. The Fed's rate cut pushed the dollar lower, making dollar-priced commodities cheaper and more attractive for holders of other currencies.
A weak dollar is "an important factor behind oil price rise. Equity markets has also been quite firm," which further boosted prices. Investors often buy commodities such as crude oil as an inflation hedge when the dollar weakens and sell those investments when the greenback rises. Oil investors have also been tracking equity indexes as a barometer of global economic health.
The US dollar, which closed yesterday's trading at 1.1280 against the Swiss franc, fell to a 20-day low of 1.1212 during early deals on Thursday. On the downside, the dollar-franc pair may likely target the 1.113 level.
The dollar-franc pair advanced after hitting a record low of 0.9644 on March 17. Although, the US currency weakened in May, it rebounded in the middle of July and extended its uptrend in the subsequent months. The dollar has advanced 18% against the franc from a record low to reach a 1-year high of 1.1752 last Friday.
However, after hitting a 1-year high in the European session on Friday, the dollar pared its gains in New York deals and fell further this week. The dollar-franc pair has lost 5% thus far this week.
During early deals on Thursday, the dollar slipped to a 9-day low of 1.3299 against the euro, compared to 1.2970 hit late New York Wednesday. If the dollar weakens further, 1.377 is seen as the next target level.
The dollar lost ground against the euro after surging to a 2-1/2 -year high of 1.2331 earlier this week. Disappointing US October consumer confidence report released on Tuesday and a rate cut by the Federal Reserve yesterday drove the dollar down. Consumer confidence in US plunged this month, with the Conference Board's confidence index hitting its lowest level since records began in 1967.
The dollar dropped to an 8-day low of 1.6602 against the pound in early trading on Thursday. The next downside target level for the dollar is seen at 1.761. The pound-dollar pair was worth 1.6384 at yesterday's North American session close.
The pound has gained 2% yesterday after the Bank of England said lenders approved 1,000 more home loans last month than in August and the benchmark FTSE 100 Index of stocks surged 7.1 percent.
The pound was under heavy pressure last week and it has depreciated 12% against the dollar as the Bank of England Governor Mervyn King said on October 21 that the UK economy probably faces a recession and policy makers will act to prevent inflation from slowing too far after the country's worst banking crisis since World War I.
House prices will extend declines and the pound may depreciate further, King said, in his first explicit acknowledgement that the U.K. may be heading into a recession.
Although the financial crisis is global, sterling is at the centre of the storm, as its economy is perceived as more vulnerable than most advanced economies.
The U.K. is already in a recession and the economy will contract for the next three quarters, Ernst & Young's ITEM Club, which uses the same forecasting model as the Treasury, said in a report on October 20.
Adding to pound's downward pressure, a report showed on Friday that the UK economy contracted 0.5% in the third quarter from the prior quarter compared with zero growth in the second quarter. This was the first contraction since 1992. The ONS said "It has been 64 periods since the last period of negative growth in 1992 Q2." Economists had expected a just 0.2% sequential fall in the third quarter.
Following the British third quarter GDP report on Friday, the pound slumped to a 6-year low of 1.5268 against the dollar. But the UK currency recovered in the New York session and extended its uptrend this week. Thus far, the pound has gained 8% against the dollar from a 6-year low.
The greenback also plummeted to new multi-day lows against its New Zealand, Australian and Canadian counterparts as raw material prices gained for a third day on expectations that demand for commodities would increase. Raw materials account for 60 percent of Australia's exports, and 70 percent of New Zealand's.
During early deals on Thursday, the greenback dropped to a 9-day low of 0.6883 against the aussie and 1.1936 against the loonie, compared to yesterday's close of 0.6674 and 1.2251, respectively. If the US currency falls further, it is likely to target 0.708 against the aussie and 1.131 against the loonie.
Australia's currency gained as Ric Battellino, the Deputy Governor of the Reserve Bank of Australia, said the economy is set to avoid a recession and an ''inflation overhang'' may limit the central bank's scope to trim borrowing costs. The RBA has ''a big task ahead to bring inflation down and this could limit room for maneuvering on monetary policy,'' Battellino said today in Sydney.
Against the kiwi, the greenback dipped to a 6-day low of 0.5965 today. The next downside target level for the greenback is seen at 0.627. The kiwi-greenback pair closed yesterday's trading at 0.5862.
In early trading on Thursday, the dollar gained against the Japanese yen as a rally in stock prices gave traders confidence to buy higher-yielding assets with money borrowed from Japan. At about 9:15 pm ET, the dollar-yen pair reached 99.14, up from yesterday's close of 97.71. If the pair advances further, it is likely to target the 99.7 level.
The yen also declined as investors speculated that the Bank of Japan will cut borrowing costs by 25 bps to 0.25% when it meets tomorrow.
A reduction in the benchmark rate from 0.5 percent tomorrow may prompt a rebound in the yen by making the currency more attractive compared with those of countries that are cutting borrowing costs.
The Group of Seven industrial nations expressed concern earlier this week about the yen's ''excessive volatility'' and Japan's Finance Minister Shoichi Nakagawa said the same day that his government was ready to act if needed to arrest the currency's recent gains.
A rate cut by the Bank of Japan would come less than a month after it opted out of joint reductions made by counterparts in Europe and North America, saying the country's borrowing costs are already ''very low.'' Japan's financial system has until recently avoided the worst of the credit crunch that brought down banks in the U.S. and Europe.
Japan's government is struggling to halt the yen's advance and later today will unveil measures to prop up the economy and stock market. Economic and Fiscal Policy Minister Kaoru Yosano said this week that a rate cut would have a ''symbolic'' effect if done in conjunction with other central banks, showing Japan is taking part in global efforts to counter the financial crisis.
A reduction in borrowing costs may help to stem the yen's gains by narrowing the interest-rate gap between Japan and other countries. Also, tomorrow's interest rate reduction would be the first since March 2001, when the bank lowered the benchmark close to zero percent to counter deflation and lift Japan out of a recession.
Traders now await the German ILO unemployment rate, French PPI, Euro-zone business climate indicator and the consumer confidence reports, which are expected in the upcoming session.
Turning to the US, the advance third quarter GDP and the weekly jobless claims report have been slated for release in the New York morning. Markets will also be interested to hear what Fed Governor Randall Kroszner has to say on risk management, when he speaks in New York at 8:30 am ET. Also, San Francisco Fed President Janet Yellen will be speaking in Berkeley, California at 3:15 pm ET.
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