3 FX Moves Inspired by the Fed

DailyFX

The Fed’s decision not to taper asset purchases caused serious price swings across the financial markets, and in the aftermath, the dollar is likely to sustain further losses against a trio of major counterparts.

The Federal Reserve decided to play it safe today by keeping asset purchases unchanged. The decision caught the market by surprise, as only a small minority of economists expected the central bank to refrain from tapering.

When the announcement was made, stocks climbed to a record high, the price of gold soared, US Treasury yields plunged, and the US dollar (USD) dropped to multi-month lows against many major currencies.

The magnitude of the market's reaction shows that the announcement was completely unexpected, and is also a sign how severely the market was positioned the other way.

We think the central bank's decision ushered in a new wave of risk appetite that could mean further losses for the greenback. At this stage, there is a very good chance that Fed Chairman Ben Bernanke will leave the choice to taper to his successor, and in fact, as soon as the Fed decided to stand down, the market was buzzing with speculation about whether leading candidate Janet Yellen had a big hand in this decision.

The argument for tapering centered around the 7% unemployment rate target that Bernanke mentioned in June, but today, the Fed Chairman backed off this call, choosing instead to say that there is "no magical number" when it comes to the jobless rate. He even admitted that the jobless rate can be an inaccurate measure of labor market conditions, and what the central bank really wants to see is an overall improvement in the labor market.

By telling everyone the Fed is worried about sluggish payroll growth, the central bank effectively changed the conversation from the need to taper before year-end to the possibility of no change until 2014.

The bond market's reaction to Bernanke's comments about tapering in July scared Fed policymakers back into their shells, and they feared that if tapering was announced today, it would lead to further tightening of financial market conditions, which the economy may not be able to handle given the fiscal restraints on growth. As a result, the Fed opted instead to wait for more evidence of economic progress before adjusting the pace of asset purchases.

There were a number of changes to the Federal Open Market Committee (FOMC) statement, but the bottom line is that the outlook deteriorated slightly from July. Along these lines, the Fed cut its 2013 and 2014 GDP forecasts quite substantially even though the unemployment rate forecasts were lowered slightly.

By holding monetary policy steady today, the central bank is effectively telling the market that it is worried about the US recovery, and while tapering is inevitable, these concerns will delay the move for the time being.

We have seen a lot of position adjustments, including US ten-year Treasury yields, which dropped by more than 15 basis points (bps), and we believe that these adjustments will continue leading to further dollar weakness.

Both EURUSD and GBPUSD have broken through important resistance levels, and we expect additional 1.5%-3% rallies in each of these pairs. While the losses in USDJPY have been more moderate, there's scope for a run to 96 in the near term.

By Kathy Lien of BK Asset Management

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