Rate Cut Talk Hurts More than it Helps

Rate Cut Talk Hurts More than it Helps

The Federal Reserve all but guaranteed a rate cut on or before its October 28-29 meeting, but markets fell on renewed fears over the economy's health. The DOW has now lost nearly 900 points this week and the S&P 500 and NASDAQ have lost about 10% over the past two trading sessions. The CBOE Volatility Index made a new record for a second day, closing at near 54. The VIX hasn't closed above 51 since 1987.

"If you really think about it, a rate cut should be taken as a net negative by investors," said Matthew Carniol, chief currency strategist at TheLFB-forex.com. "The reason is because the Fed would only consider cutting rates when things are going badly. It isn't so much that markets think the government and Fed aren't doing enough, it's more that all the extraordinary measures which have been put into place have so-far been ineffective. Sheer, unadulterated panic is driving the markets now."

At the close of floor trading on the NYSE, the DOW was on 9447.11 after losing 508.39 points (-5.11%). The S&P closed on 996.34, down 60.55 points (-5.73%), closing below 1000 for the first time in 5 years. The NASDAQ finished the day's trading on 1754.88 with a loss of 108.08 points (-5.80%). Traders sold Treasuries after the Fed announced its new facility to purchase commercial paper directly from eligible businesses eased fears regarding the ability of firms to fund their short-term debt. Yield on the ten-year note rose 34.9 basis points to 3.488% while the two-year note's yield gained 15.2 basis points to 1.445%. The dollar suffered as talk of a rate cut spread. The greenback suffered a 0.86% loss on the euro, a 0.28% loss on the pound and a 0.54% loss against the yen.

Crude oil for November delivery was recently trading up $1.50 (1.7%) to $89.30 per barrel as traders speculated OPEC would cut supply.

Gold for December delivery was recently moving up $12.80 (1.48%) to $875.50 per ounce as traders sought a safe haven.

Currency Pair Overview

Overall: There was no economic data released in the U.S., but the Federal Reserve hinted strongly that a rate cut will occur on or before the FOMC meeting scheduled for October 28-29.

"Overall, the combination of the incoming data and recent financial developments suggests that the outlook for economic growth has worsened and that the downside risks to growth have increased," Mr. Bernanke said in his speech today. "At the same time, the outlook for inflation has improved somewhat, though it remains uncertain. In light of these developments, the Federal Reserve will need to consider whether the current stance of policy remains appropriate."

The minutes of the September 16 meeting, released Tuesday afternoon, also seemed to lay the groundwork for a rate cut by saying "some members emphasized that if intensifying financial strains led to a significant worsening of the growth outlook, a policy response could be required." The FOMC noted that "available indicators pointed to a sharp deceleration in economic activity in the third quarter," and also said "participants generally were somewhat more confident about the outlook for some moderation in inflation over the forecast horizon."

The Euro (Eur/Usd) traded higher for the first time in more than a week. In the early European session the pair advanced as much as 130 pips even though the pair was unable to hold onto all of the gains. The euro advanced as S&P futures traded 2% higher in the overnight session, but the euro's gains were capped after Wall Street declined.

The Pound (Gbp/Usd) advanced during the overnight session, gaining 200 pips at one point, however, as the news spread that two well known U.K. banks will receive government funding, the pair moved lower. The pair traded in a tight range in N.Y. as equity markets declined, and looked to finish the day virtually unchanged. In economic news, the U.K. manufacturing output decreased in August by 0.4%, compared with analyst estimations of -0.2%. Decreases were seen in 10 out of the 13 industries, having the biggest declines in transport equipment, which fell by 2.3%.

The Aussie (Aud/Usd) had a volatile overnight trading session, after the Australian central bank cut the interest rates by one full percentage point, 50 basis points more than expected. The Reserve Bank of Australia continues the cutting cycle as the economic expansion cools and the business cycle peaks. The central bank cut for a second time this year, after the bank cut at the beginning of September, 25 basis points to 7%. The pair immediately responded to the news release, falling 170 pips, however, the pair quickly recovered. Once in N.Y., the pair was virtually unchanged as it traded through a 75 pip range.

The Cad (Usd/Cad) traded lower for the first time in 8 days as crude futures declined. The pair dropped 55 pips during the overnight sessions, moving along the neutral pivot point (1.0975). The pair continued to decline in N.Y. as crude futures advanced.

The Swissy (Usd/Chf) fell 60 pips since the new trading day opened to test the 1.1400 area, which provided strong resistance during the latter part of last week. The pair has experienced volatility intra-day, moving between the neutral pivot point (1.1415) and the high of the previous session. The pair declined about 50 pips in N.Y.

The Yen (Usd/Yen) moved higher during the overnight sessions, after the Bank of Japan maintained the monetary policy rate at the current 0.50%. The Bank of Japan has kept the Overnight Call Rate unchanged at 0.50%. It is the 23rd straight month the bank has kept rates on hold. In the bank’s words, the economy has now become “sluggish” in the face of high commodity prices. In the past, the bank had announced its intention to raise interest rates, although this will happen only when the economy is able to support such a move. The pair gained 180 pips since the Asian session started as S&P futures advanced on speculation of a coordinated rate cut but fell in N.Y. as equities declined. In other economic news, the Japanese Leading index fell to 89.3%, in August, in-line with market expectations. The leading indicator is based on 12 reports, from which most are made public before this release. Over the course of the last few months, the Leading index, suggested that the Japanese economy is weakening, due to international tensions

Written by TheLFB Trade Team, © 2007-2008 LFB Services, LLC. All rights reserved. http://www.TheLFB-Forex.com

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