Interest Rate Roundup

Thursday, December 18, 2008

More on the dollar

I've been banging away at the currency market's "thumbs down" response to the Fed's "money-printing extravaganza" policy for a few days. Now it's getting some more notice in the mainstream press. Here's an excerpt from the Washington Post:

"The dollar yesterday staged one of its biggest one-day drops against the euro and fell to a 13-year low against the Japanese yen as near-zero interest rates and the Federal Reserve's plan to print vast sums of cash dilute the value of the greenback.

"The drops dramatically accelerated the dollar's reversal of fortune over the past three weeks after months of solid gains. The slide underscores the risks the Federal Reserve is taking to jump-start the U.S. economy through aggressive monetary policy.

"On Monday, the Fed cut its target for the federal funds rate, at which banks lend to each other, from 1 percent to a target range of 0 percent to 0.25 percent, and effectively vowed to print as much money as it needs to try to pull the United States from a worsening recession.

"While that policy may ultimately aid an economic recovery, it is robbing the dollar of value as investors anticipate less interest on their dollar-denominated investments and more bills in circulation, making each one worth a bit less. In response, investors are dumping the dollar and buying up other currencies.

"If the dollar's fall is unchecked, it could jeopardize the long-term faith of foreign investors in the value of the American currency and could cause foreign investors to dump U.S. stocks and other assets, whose value would be worth less in euros or yen. The Dow Jones industrial average fell 1.1 percent yesterday."

The Japanese are starting to get fed up (if you'll pardon the pun). Overnight, they "verbally intervened" in the currency markets to stop the yen's appreciation. More from Bloomberg:

"The yen fell from near a 13-year high against the dollar and tumbled versus the euro after Japan’s government signaled it may intervene in the foreign- exchange market for the first time in four years.

"Finance Minister Shoichi Nakagawa said he has “the means” to limit the yen’s advance, which undermines Japanese exporters by raising prices for overseas customers. The dollar erased its annual gain against the euro on bets the Federal Reserve’s near- zero interest-rate policy will reduce the appeal of U.S. assets. The pound tumbled to a record against the euro for a ninth day.

“The rhetoric from Japan picked up in a fairly significant way in the past 24 hours,” said Jim McCormick, London-based global head of foreign-exchange and local-markets strategy at Citigroup Inc., in an interview on Bloomberg Radio. “If you’re going to intervene, why not do it in what is probably going to be one of the most illiquid periods of what has been a pretty illiquid year, which is the time between now and the end of the year.”

"The yen fell 1.2 percent to 88.29 per dollar at 8:46 a.m. in New York, from 87.24 yen yesterday, when it reached 87.14, the highest level since July 1995. The euro increased 2.7 percent to 129.23 yen from 125.80 yesterday. The dollar dropped 1.5 percent to $1.4639 per euro from $1.4419, weakening beyond $1.47 for the first time since Sept. 25.

"The dollar depreciated 21 percent against the yen this year, the most since 1987, as more than $1 trillion of credit- market losses sparked a seizure in money markets and threw the world’s largest economy into a recession."

The question is now whether Japan puts its money where its mouth is. And of course, we have to wonder if the European Central Bank will continue to put up with the euro's appreciation, which puts Europe's economy at a competitive disadvantage. As for bonds, there has still been no discernible impact from the dollar fluctuations. Bonds continue to rise in price in what has truly become an unprecedented move in terms of magnitude and speed.


  • Hi, and thanks for the informative posts.

    A question from a bond newbie.

    In a "normal" recession, short term rates are lowered to make a steep yield curve, which encourages banks to lend more. So we did that.

    Now, with the effort to push the long end down making the yield curve flatter, in theory banks spreads are smaller and there is less incentive for banks to lend.

    It would seem that the policy of low, flat yield curve would imply that the fed is saying that the problem is a demand problem - noone wants to borrow - as opposed to a supply problem (which would be helped more by a steep curve than a low curve).

    Given the CP market etc, it seems odd to come to the conclusion that its demand driven.

    What am I missing here? If the problem is not demand for loans but lack of supply should not the fed be trying to make longer term yields higher?


    By Anonymous Anonymous, at December 18, 2008 at 9:14 AM  

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