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Michael Jordan was a phenomenal basketball player in the 1980’s and 1990’s. Many consider him the greatest of all time. And he’s probably best remembered for winning championships and uncannily hanging in mid air.
However, I remember Jordan for something else — his head fakes. Never before had one player made entire teams look so foolish. A mere turn or bob of his head would send his opponents tripping over their own feet.
In fact, the only other place I’ve seen such effective head fakes is in the currency markets. For example, take the U.S. dollar’s moves this week, which left traders dizzy and confused.
Today, I want to tell you what I make of the action, and what it means for the dollar’s future …
First, the hype-meter was off the charts leading up to Wednesday’s Fed decision.
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| Federal Reserve Chairman Ben Bernanke wants the financial markets to stop looking to him for cryptic clues about interest rates. Many say he’ll be disappointed. |
Wednesday marked the culmination of the most recent Federal Open Market Committee meeting where officials discuss their forecast for prices and growth in the U.S.
And as always, the high priests of finance come down from the temple to issue a brief announcement summarizing their meeting. This is when we learn what direction the Federal Reserve plans to guide the nation’s economy. In other words, find out what they going to do with interest rates.
I probably don’t have to tell you that these FOMC meetings are a big deal. That’s partly because these decisions will impact the economy, but mostly because of the hype that’s built up by analysts and investors ahead of each meeting.
Considering the ongoing evolution of economic and inflation conditions, it seems that every new meeting carries more significance than the last.
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Let me show you what I mean. The chart below is an inverted shot of the September Fed Funds futures. In short, the red shaded area shows the changing expectations for the Fed Funds rate in the two weeks leading up to Wednesday’s FOMC announcement.
As you can see, at the beginning of that period, the market expected the Fed Funds rate would eventually be dropped to about 1.75% — the equivalent of a 50-basis point cut. But as the meeting grew closer, expectations tightened up and more traders began counting on just a 25-basis-point cut (or nothing at all).
These Over-the-top Expectations Are
A Good Recipe for Disappointment!
When the Fed shifts its stance, markets will react. So as rate cut expectations changed ahead of Wednesday, so did the outlook on the markets likely to be impacted by a changing Fed policy.
Conversation regarding a potential dollar bottom swept through pages of market analysis. Of course, this idea should be nothing new to you — I’ve been telling you about this possibility for quite some time.
Lo and behold, the possibility that the Federal Reserve would turn hawkish, and focus their attention more on rising prices and less on the anemic growth, gave the buck an opportunity to post some gains.
Apparently, the Fed’s decision didn’t jibe with expectations. And the dollar’s knee-jerk reaction didn’t exactly jibe with the dollar-bottom scenario all that well, either. The greenback was smacked down sharply in the hours following the announcement.
Game over? No. In fact, the buck came roaring back on Thursday. After traders took some time to digest the Fed’s decision, they began to feel better about it. So the dollar had thrown a major head fake!
I pin this on one fundamental reason: With that last 25-point cut out of the way, the market is now expecting the Fed to stop cutting and turn relatively hawkish.
So despite the quick moves back and forth, it’s beginning to look like the greenback might finally be hitting a bottom. Take a look at this chart …
Even though we’re still dealing with the market’s expectations, price action is supporting the dollar-bottom scenario. And I’m certainly not going to argue against a dollar rally when the dollar is rallying. After all, I’d say this bounce is overdue.
The Fed may have needed another rate cut before it could comfortably switch its weight to the other foot. But there’s a good chance the markets can now see where the ball is going next.
Best wishes,
Jack
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