Dollar likely to drop no matter what Fed does
Greenback to stay under pressure whether the Fed cuts a lot, a little or not at all
By Lisa Twaronite, MarketWatch
Last Update: 5:20 PM ET Oct 30, 2007
SAN FRANCISCO (MarketWatch) -- As analysts ponder the U.S. Federal Reserve's next move on interest rates, currency investors ponder the likely market reaction, and the consensus for both is that it's a matter of degree, no direction.
Just as no one is expecting an interest rate high Wednesday, no one is betting on a sustained dollar rally this quarter, either. And just as bad economic or corporate headlines -- or even record-high crude oil prices -- rarely seem to derail stock market rallies these days, nothing the Fed delivers is likely to halt the greenback's slide.
Whether the Fed cuts its benchmark a quarter percentage point, as expected, or a half-point -- or even not at all -- the dollar is likely to bear the near-term brunt of the market's kneejerk reaction either way, and then move in one direction: down.
Regardless of whether or not the Fed cuts rates, "the dollar is in for a beating," said Marilyn McDonald, marketing director at Interbank FX.
"The U.S. dollar is finally in trouble. For quite some time now, it has been onof the top five yielding currencies among the [Group of 10 industrialized] nations, which is why it has been used in the carry trade for so long," she said.
Carry trades involve borrowing lower-yielding currencies, such as the yen, and investing it in high-yielding assets. The dollar has long benefited from such trades, but the benefits are dropping in line with U.S. interest rates.
"While this doesn't mean it has a bright future as a funding currency -- that will only happen if it drops into the 3% range -- it does mean that the carry trade is in trouble," said McDonald.
Many economists and investors are betting that the Federal Open Market Committee will lower the target on the federal funds rate to 4.5%, down from 4.75% currently, and a few are betting on a large cut to 4.25%. Read story on Fed meeting outlook.
But Wall Street Journal Fed watcher Greg lp suggested that central bankers may not cut interest rates at all on Wednesday, contrary to market expectations lp said inflation concerns persisted, especially when the dollar's recent weakness.
"The behavior of financial markets implies near certainty by investors of a quarter-point cut in the Fed's key short-term interest rate," wrote lp. "But for policy makers, the decision is between the quarter-point reduction and no cut at all."
Since the lower rates erode the returns on dollar-denominated assets, all things being equal, the dollar should theoretically benefit if rates stayed steady. But all things are not equal, and the dollar would probably drop if the Fed stands pat.
"No cut would be a shock and be viewed as a negative for the dollar," said Meg Browne, senior currency strategists at Brown Brothers Harriman.
"The Fed would be seen as not proactive especially given warning that [the forth quarter] was likely to slow. Expectations for a 50 basis-point cut would shift to the next meeting in December. The dollar would likely sell off and stay sold off, " she said.
"We don't expect the dollar's downtrend to come to an end until sometime in [the first quarter] when the U.S. economy shows signs of stabilizing," she added.
Tuesday afternoon, the euro touched a fresh record high of $1.4440 against the dollar since the European unit began trading in January 1999.
The euro is now testing strong resistance between $1.4500 and $1.4545, the latter being its all-time high based on the Deutschemark's record high before the European nations united behind a single currency, according to BNP Paribas technical analyst Andre Chaveriat.
The euro "has scope to reach $1.4500 or $1.4545 to $1.4600 with an 'as-expected' 25 basis point cut, and if they surprise with a 50 basis point cut, we could see $1.4700 to $1.4750, " he said in emailed comments.
Other technical analysts, even those who believe the dollar's downtrend is intact, did not rule out a brief dollar rally after Wednesday's Fed announcement. If the dollar doesn't fall as much as some investors expected, those who bet on a plunge might be forced to buy back the dollar to cover their short positions.
"We expect to see the dollar remain under pressure until the Fed announces, " predicted said Adam Hewison, president of INO.com, a technical analysis Web site.
"I think this could be a case of buy the rumor/sell the news. In this case it would be sell the dollar then cover when the Fed announces, " he said.
"We are close to our $1.450 euro/dollar target zone and like any good player it pays to take some chips off the table," he said.
*MarketWatch is a registered trademark and belongs to the Dow Jones Companies