Near-Term Dollar Rally Possible As Fed's Plosser Voices Rate Hike Urgency

On Tuesday, the forex and stock markets were shaken not by corporate earnings results and not by any economic releases, but by a hawkish speech from Fed’s Plosser. The Philadelphia Fed President said there should be interest rate hikes “sooner rather than later” even if employment and financial conditions haven’t improved. This renewed signal to raise rates helped push the US dollar sharply against the Euro, Swiss franc, British pound, Japanese yen, Aussie and Kiwi, and could set the dollar on a near-term rally.

How quickly things change in the financial world; one minute, bets for a near-term rate hike are off the table, and the next, everyone’s anxious to place their bets for one again. It also reminds me of how drastically people change sides: One moment the government denies the implicit guarantee given to Freddie (FRE) and Fannie (FNM), then suddenly they are clearly in trouble and Uncle Sam is there to save the day.

Anyway, back to Plosser’s comments, I think it is a good thing Plosser has the sense to highlight inflation risks and the foresight to consider voting for a rate hike soon, and not be sidetracked by how bad sharebuyers are doing. Inflation is a bigger evil than a downturn.

EUR/USD fell to the lowest since July 11, touching an intraday low of 1.5760. With Euro struggling to make more new highs in spite of largely disappointing earnings from US companies, we could expect Euro bulls to get out of the market. Next bear targets for EUR/USD are around 1.5720, 1.5690, 1.5660.

USD/CHF finally broke above 1.0250 to a session high of 1.0335, with 1.0350, 1.0390 the next topside objectives.

Stock Markets Charmed By Oil Decline

With the dollar up, crude oil prices in turn headed downward, dropping more than $3 to below $130 per barrel. At the same time, concerns about Tropical Storm Dolly subsided, aiding the slide of oil. US stocks initially went lower on Wachovia’s (WB) poor earnings results, but later went up as oil fell during the session.

The Dow Jones industrial average closed up more than 130 points. Even Wachovia shares later rose 27% to $16.79 - not bad for a bank that posted a $8.9 billion loss for the second quarter. Washington Mutual (WM), US’s largest savings and loan company, which released its earnings after the market close, announced a loss of $3.33 billion. CBOE’s VIX index fell 8.1% to 21.18, the lowest level since June 25. It had initially gained as much as 4.5% at the beginning of trading.

How stock markets will react on Wednesday is anyone’s guess. But as for the forex markets, the US dollar seems to have the upper hand for now.

Economic Calendar For Wednesday:

Australia CPI 0130 GMT

Bank of England minutes 0830 GMT

Canada CPI 1100 GMT

Fed’s Beige Book 1800 GMT

Reserve Bank Of New Zealand rate decision 2100 GMT (rate expected to stay at 8.25%)

Japan trade balance 2350 GMT

Comments

[Lou Thomas]

It is astonishing that anyone would take the Fed's feints in the direction of a rate hike seriously, after all that has occurred. The game is so over now that even the principals can hardly bring themselves to mutter out their lines. How brave of you to continue to write about it as if it really mattered.

[bearfund]

Plosser is right but the Fed will not act. We've seen this before several times already this year: Fischer or Plosser talks sense and suddenly everyone thinks the Fed is going to raise rates and starts buying dollars. Then a few days later everyone realises that Helicopter Ben and his gang are still in charge and if there's going to be a rate hike it might be in 2009...maybe. And sure enough, the next Fed meeting rolls around, market sentiment is high and would easily absorb a modest increase and perhaps even rally on it, the futures market is even betting on it; but what happens? Nothing. Same thing that will happen this time.

[User 118015]

Inflation can be stopped if money drys up...real fast...higher interest rates will do the trick...if the economy is negative as a result it means that people just have to learn to stop living on borrowed money!!!

[buyitcheap]

I find the author's as well as bearfund's comments viable. I'd like to see a small increase in the fed funds, but can't deny the high probability of NO action as bearfund posits. In fact, the play here may be to short the dollar going into the next meeting on the basis that no action will be taken and it will sell off a bit after having strengthened prior to the meeting.

Perhaps 2009 for the hikes is going to be the timeframe as the probability for 2008 hikes seems to be slouching toward less than 50% imho. Good post bearfund.

[OldLimey]

Done deal - up 50bp by November. November - that rings a bell.

[phinsuntanning]

you know what a rate hike means? R word 1930 style, no way, these guys just inflate their way out of the mess. More FXE and FXA to me please !

[EUARTE]

As usual the Brasilian Real R$ is a better bell weather. It went up against the dollar again (again and again and again). They know the dollar is no asset and is heading to Banana Republic land.