Posted December 16, 2008
The US Federal Reserve cut interest rates to no more than .25% leading to a stock market surge. The dollar slides rapidly on the news.
It was the US currency market which took the headlines today. The US Federal Reserve surprised everyone today by cutting the benchmark interest rate to a range of 0% to .25%. In doing so, Federal Reserve Chairman Ben Bernanke backed up the reduction by letting everyone know the US will improve the economic conditions by any means necessary. Of course, the Federal Open Market Committee said it a bit differently. The FOMC said the Fed “will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.”
The interest rate reduction actually signalled a change in approach to the recession. The US government is now focusing on turning the housing market around instead of propping up banks and financial lenders. The Feds intends on purchasing mortgage securities and improving lender balance sheets in the process. It is expected that mortgage rates will fall as a result which will hopefully spur home buying and mortgage lending again. It is also intended to increase consumer spending.
The reaction to this decision to slash the Fed fund rate to 0% was mixed. Some investors threw a party in the equity market and the DJIA surged by triple digits again to 8,924.14 which was a 4.2% increase. The S&P 500 broke the 900 range finally to reach 913.18. Treasury notes rallied in the expectation the Feds will buy the securities to reduce yields. That leaves the question of the fate of the dollar.
When stocks go up, the currency usually goes down, and that is exactly what happened. The US dollar weakened against most major global currencies. In fact, it saw its greatest drop in 5 days against the euro $1.4045. The US dollar also saw a 13 year low against the Japanese yen ($.0111).
The euro got a boost against the pound because the European Central Bank has implied it is not planning on cutting interest rates again at this point. The euro rose to £.9042 against the pound which represents a 1.1% increase. The Norwegian krona (NKr 9.5705), on the other hand, weakened against the euro as investors wait to see if the central bank plans on reducing the Norwegian benchmark rate.
In effect the Feds are saying they are out of ideas about how to fix the US economy and that means drastic actions must be taken. All that is left to do is print more money and inject it into the economy. This is a policy called quantitative easing which was first used by Japan in the early 2000s to fight a situation of currency deflation. The US interest rate is now below the lowest of low rates which is found in Japan. The Bank of Japan currently has a .3% benchmark rate.
Other currencies which rose after the US Federal Reserve interest rate announcement were the Canadian dollar ($.8248) and the Mexican peso ($.0749). The dollar also weakened against the Australian dollar ($.6911); the New Zealand dollar ($.5722); and the Swiss franc ($.8861). The South African rand remained at $.0983.
The economic news remains grim around the world. The UK unemployment rate continues to rise, Chinese exports continue to drop, and many banks remain in precarious conditions. In the US there have been 25 bank failures in 2008 whereas there were only 3 in 2007. There is also some concern that the mortgage and housing problems in countries with high unemployment are just beginning. As people lose their jobs, it is inevitable that more homes will go into foreclosure. This in turn depresses housing prices.
All you can do at this point is hope that “any means necessary” works.