The Federal Reserve is getting desperate and they are pulling out all of the stops. Minutes after the US trade balance numbers were released this morning, the Fed announced auctions to lend as much as $200 billion in US Treasuries. Yesterday, we indicated that the dollar could rally this week and even though this wasn't the trigger that we had expected, it achieved the outcome.Whether the dollar will continue to rally is dependent upon tomorrow's retail sales report, Friday's consumer price index and the amount of easing that the Federal Reserve delivers next week. In response to today's announcement, Fed fund futures are now pricing in only a 62 percent chance of a 75bp rate cut, down from 86 percent yesterday and 98 percent on Monday.
Today's plan helps to reduce the Federal Reserve's urgency to lower interest rates, but is that the main reason for their move? Yes and no. Over the past few months, the Fed has been growing increasingly frustrated with banks and their resistance to lend or to offer more flexibility to struggling homeowners. Not only has this hindered the central bank's efforts, but it has also exacerbated the liquidity strains in the financial markets. In response, the Fed is allowing primary dealers to swap their mortgage banked securities for Treasuries to raise cash. If the banks take the bait, the Federal Reserve may be able to avoid stepping up the degree of their rate cuts once again. In late January, the Fed slowed down by cutting interest rates 50bp.
If they have to step up the pace, it would immediately send a message to the markets that things are getting worse and the Fed is quickly losing control. (Will the Fed Cut by 50 or 75bp?) For currency traders, the announcement has been dollar and carry trade positive, but if tomorrow's retail sales report is weak, the dollar could easily give back a significant portion of today's gains.
We expect the volume of retail sales to decline, but with food and gasoline prices on the rise, the value of goods sold could increase which makes forecasting the retail sales report a particularly tough call. Nonetheless, consumer spending is the backbone of the US economy and if it is weak, even the generous move by the Fed today may not stop the dollar from falling.