Forex Investment and Currency Trading

The Fed and the Bank of Canada appear to have shifted into data-watching mode following the 25 basis-point ease in the United States and the Bank of Canada’s 50 basis-point slice to the overnight rate in April. The Fed’s policy statement suggested that committee members view the cumulative 325 basis points of easing plus non rate-related liquidity measures as providing the foundation for financial markets to function and the economy to recover. The statement did not signal a definitive end to rate cuts but more of a switch to a “wait and see” stance.
While no significant pick-up in growth is expected in the near-term, the statement sets the Fed up to ride out this period with the policy rate steady at the current 2% in the near-term. Risks that the economy will falter again late in the year following the tax rebate-induced spurt expected in the third quarter will likely see the Fed restart its rate cut program. Market looks for 50 basis points of easing in the fourth quarter and the funds rate at a cyclical low of 1.5%. The year-end Fed funds target is unchanged from previous forecast, but market has adjusted the timing of the Fed’s actions to reflect their updated stance.
The Bank of Canada’s statement also maintained an easing bias, but there was a softened tone about the timing and necessity of future rate cuts. Market forecasts that the Bank of Canada will hold the overnight rate steady at 3% at the June fixed action date but that it will make a final 25 basis-point insurance cut in July in the face of indications of declining U.S. economic activity in order to prevent this weakness from spilling over to the Canadian economy.

Central bank near-term bias

The Bank of Canada sliced 50 basis points from the policy rate in April and will finish the easing cycle off with a 25 basis-point cut in July against a backdrop of an expected decline in U.S. economic growth but
calmer financial markets.
The Fed signalled less urgency to ease policy further, hoping that the combination of 325 basis points in rate cuts and the fiscal stimulus package will be enough to support stronger growth in the second half.

The Bank of England joined the group of central banks using alternative tools to stem financial market tightening, making a rate cut in May less likely. However, with the economy slowing and housing under downward pressure, more rate hikes are in the pipeline.
The ECB’s concerns on the inflation front look set to continue to outweigh its growth fears with the result that the central bank looks unlikely to hint at an easier policy stance any time soon.
The RBA faces intensifying price pressures and signs of a very soft print on first-quarter growth and will likely keep policy steady for now.
New Zealand’s central bank will keep policy tight in the face of elevated price pressures. However increasing downside risks to the growth outlook will likely yield rate cuts later in the year.
Market expectations shifting as market turmoil eases
Market expectations for future central bank policy have shifted significantly in the United States where the combination of the Fed’s liquidity-enhancing measures and rate cuts have alleviated some pressure in financial markets. The Fed funds futures market now gives limited odds that the Fed will cut the policy rate again, signalling a shift from a sustained period when markets expected the Fed to continue to ease the policy rate throughout 2008. In the middle of March, just prior to the Fed’s actions giving direct support to the brokerage industry and the increasing access to the discount window, the Dec08 Fed funds futures contract was priced for a 1.5% funds rate; today that contract is priced to a steady 2% rate. In Canada, markets are now priced for one more 25 basis-point rate cut to 2.75% over the next 12 months. With growth and inflation unfolding generally in line with the Bank’s forecasts, market expectations have been more stable and only limited easing is expected going forward.

Signs emerging that financial markets are stabilizing
There are signs that financial markets are relaxing a bit from the frenzied pace of recen months, supporting the view that the credit crunch may be easing and that limited, if any, additional rate cuts are in the pipeline. Swap spreads narrowed relative to the mid-March highs with the greatest easing in longer end of the market. Equity markets look like they are finding firmer ground with the financial indices in Canada and the United States posting a solid 12% gain since the Fed’s actions mid-March. Financial companies have also been able to raise funds in both bond and equity markets, albeit at more expensive levels. As investor funds flowed into other products and rate cut expectations filtered out of the market, government bond yields moved higher in April, with the two-year U.S. Treasury bond rate rising a whopping 67 basis points and the 10-year rate up a more moderate 32 basis points. Canadian government bond yields drifted higher as well, with
both the two-year and 10-year bond yield rising 15 basis points last month.