By Clyde Russell
A Dow Jones Newswires Column
SYDNEY (Dow Jones)--A 50 basis point rate cut from the U.S. Federal Reserve later Tuesday will take real U.S. interest rates into negative territory, raising questions as to whether the U.S. dollar is now a sell.
The Federal Open Market Committee is virtually certain to knock another 50 basis points of its fed funds rate, taking it to 2.5%, below the current annualized inflation rate of around 2.7%.
If the rate cut is delivered, it will mean a full percentage point has been slashed from the funds rate since the terrorist attacks of Sept. 11.
While the rate cut may do something to ease a battered Wall Street, analysts believe it is also likely accelerate the decline of the U.S. dollar. "The euro, sterling and the Swiss franc can continue to make gains against the U.S. dollar," said Commonwealth Bank of Australia currency strategist Michael Workman.
He believes U.S. equities will remain volatile in coming months as corporate earnings are likely to come under pressure. In this environment the currencies of Europe become more attractive, especially if Europe and the U.K. can avoid the recessions that now seem inevitable in the U.S. and already evident in Japan.
The push into negative territory for real U.S. rates could also cause investors to question the value of holding U.S. dollar positions. "A 50 point cut by the Fed is probably positive for equities, confidence and housing, but may be, for the first time in this cycle, a negative for the U.S. dollar," said Geoff Bowmer, Macquarie Bank's divisional director of foreign exchange.
But Bower cautions that bad news for the U.S. dollar doesn't necessarily translate into buy yen or euro trades. He said Monday's weak Tankan survey argues against a firmer yen, as does the intervention by the Bank of Japan to prevent the yen appreciating.
Bowmer also said the euro's recent price action is also disappointing given the positive environment for the European unit. "The price action, where the thing (euro) can't extend, or indeed even hold, US$0.9200 levels is probably the most obvious red flag," Bowmer said. The euro was trading at US$0.9163 mid-session in Asia Tuesday, higher than its pre-Sept. 11 levels of around US$0.9140 but off its post-attack highs of near US$0.9300.
Euro The Best Bet
Monica Fan, market strategist at RBC Dominion Securities, said the euro looks the best bet if you want to exit the U.S. dollar. "You'll probably see a continued move into the euro," Fan said, until the economic fallout from the attacks in New York and Washington dissipates.
The yen isn't an option for Fan, given that the financial year end repatriation is likely completed. "You should see the yen move closer to fundamentals, which are dire," Fan said.
The U.S. dollar was stronger against the yen mid-session in Asia, trading at Y120.24 with dealers believing a test up to Y121.00 or above likely, given the poor Japanese outlook and the Bank of Japan's determined intervention to prevent yen appreciation below Y118.00 to the dollar. Peripheral currencies like the Australian dollar are also unlikely to see too much benefit from any switch out of U.S. dollars.
The Australian dollar is seen as a proxy for global growth and is unlikely to perform well in the current environment of world economic slowdown. The Reserve Bank of Australia is also expected to cut rates early Wednesday local time, but the market consensus is for a 25 basis point cut. This would take the cash rate to a historic low of 4.5%, but would likely only offer the mildest of support to the Australian dollar, which is still languishing around US$0.4940, still within spitting distance of its record low of US$0.4775.
"A surprising 50 basis point (reduction) would offer some support to the ailing Australian dollar," Fan said. But such a large move is unlikely given the Reserve Bank doesn't wish to add fuel to an already strong domestic housing market.
All this leaves investors with difficult choices. National Australia Bank market strategist Greg McKenna said the euro remains "hamstrung by its own poor economic backdrop."
He said the key to the euro over the coming months will be the "relative equity market performance, in which stronger price action in the Eurozone would see the euro benefit." But in the meantime, McKenna believes range-trading is likely for the euro, until a break above US$0.9330 resistance provides a buy signal.