There was intense volatility in the trade-weighted dollar index leading up to the release of yesterday’s statement by the Federal Open Market Committee (FOMC) – a familiar pattern witnessed by traders this summer as liquidity concerns continue to affect the currency markets.
As expected, the Federal Reserve didn’t change the overnight lending rate, leaving the Fed target at .25 basis points. The FOMC did quickly settle what drama there was by announcing an end to the $300 billion Treasury purchase program, but the Board of Governors didn’t do any favors for U.S. dollar investors with their released statement.
The Fed noted that “economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”
The comment is viewed positively by equity and dollar-denominated commodity traders, especially now that many Wall Street economists do not expect the first Fed rate hike until 2011. But for currency traders, the lack of activity for rate changes signals a move away from currencies and into other assets as investor’s risk appetite improves.
Kazuyuki Kato, treasury department manager at Mizuho Trust & Banking, had this to say to Reuters: “The prospect that the Fed will keep rates low will likely be one factor causing dollar weakness in the long term.”
Many quantitative analysts had forecasted short-term weakness for the U.S. dollar, noting a summer correction in riskier assets. However, stocks have been on a tear this season, with the S&P 500 index posting a gain of 6.7% since June 1, while oil is up 8.3% for the same period.
One asset class certain to gain a lot of attention from a weaker dollar is gold. As I'm writing this, gold is showing a bid of $959.10 an ounce, up $6.60 on the day. Commerzbank analyst, Eugen Weinberg, had this to say: “The most dynamic one (component) is the positioning of the speculators on the COMEX (futures exchange), and this is probably mostly based on the outlook for the U.S. dollar.”
Another bullish sign for gold bugs is the Fed’s sentiment regarding economic growth, but also its surprisingly benign feeling on inflation. In the statement, the Fed noted that inflation will remain “subdued for some time.” Historically, inflation has become a factor when it comes to economic prosperity, and investors typically use the precious metal as an inflation hedge.
“Gold should remain supported by the inflationary impact of the Fed’s rate decision, in addition to the boost to general risk sentiment,” said TheBullionDesk analyst, James Moore, to Reuters.
Moore also added, “But we still expect scaled-up resistance above $965 to slow the metal’s advance.”
Trying to make sense of the U.S. dollar will be the challenge for traders in the short-term as the currency is expected to remain weak until 2010, when many economists predict the U.S. economy to be well removed from the recession.
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