US Dollar Falls on Concerns of Monetary Policy Easing

Wednesday, 29 September 2010

In Asian trade Wednesday, the USD was seen falling against most of its currency pairs in late afternoon trade, as further speculation around the potential of monetary policy easing gripped the market. At the current moment, the USD/JPY is trading at a session low of 83.65 – which is well down (more than 2% down) – on the open.

Whilst this USD/JPY quote represents the lowest rate in a fortnight, and certainly the lowest printed quote since the Bank of Japan intervened in the currency markets just a few weeks back – investors believe that the currency pair has further room to fall. We all know that the current backstop level for the Japanese Foreign Ministry is at around the 82.00 mark. Any quote lower than that and we are at risk of a correction as a result of further intervention.

However, the focus hasn't been so much on the Japanese side of the equation today. The US has come under fire for altering its policy surrounding the pull out of financial aid for troubled banks and finance companies, in the wake of the recent recession.

As the Fed tries to reel in its previously flexible financing facilities, the market can only really interpret that in two ways. One way is that the Fed believes that the economy is no longer in need of help, and is able to support itself. The second way is that the Fed believes that it is running very close to the edge of tolerable spending levels, and that if it continues to give away "free" money – it is not going to be able to control the financial inflation which will surely show its head in the coming quarters.

In our opinion, the second view is probably the most accurate one at the current time. It is very clear that there are still parts of the economy which need significant amounts of help to get back to production and output at previous – pre-recession – levels.

Therefore, whilst the Fed would love to continue providing these companies with the funding to expand their businesses and promote growth – it is simply no longer practical.

For the USD, and currency pairs such as the USD/JPY and EUR/USD, this view of the market could have profound effects. The USD/JPY especially – which is constantly fighting between allow the Yen to appreciate as a result of USD weakness, and ensuring that the Yen doesn't appreciate (i.e. Bank of Japan intervention) – is stuck more or less in a glut.

Until one side of the equation becomes the dominant, we will be fairly directionless in the coming days and weeks.