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Zero interest rate policy?

Written by A Forex View From Afar on Monday, March 17, 2008

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A few weeks back I wrote that a 75 points rate cut is just too much, but Friday's events made me change my view. These markets showed that they are in deep turmoil and are unable to stop the bleeding themselves. Now I see 75 points as the lowest possible cut, close to nothing for markets. If the FOMC members only cut 75 points or less, they will probably make the Markets test 10 years lows. Will the Fed want to carry such a weight? I doubt it very much.

The Markets are now pricing a 100 points rate cut, taking the Federal Funds Rate to 2%, and even with such a cut, they still have no idea how soon investors will start buying again, they look a little frightened. Add to this that a 2% interest rate coupled with over 4% annualized CPI, does not look to good for investors either. But I'm probably one of the few who has inflation on their minds right now, unfortunately.

I wonder how bad the situation can really be, if the Fed needed to cut the Discount Window Rate 24 hours earlier then they should normally, in an emergency meeting and extend the maturity to 90 days. Since The Fed couldn't wait a couple more hours for that move it is likely that they will give the markets what they want; a 1% cut. The sub-prime issues should be seen as an ill, coming back from time to time, requesting more and more drugs to temporarily heal it. At first, in August, it just needed a 25 points cut in the discount rate, reaching 1 full point in the Fed Funds now, in March.

The big problem is that the Fed does not have unlimited ammunition to fire at this. If the FOMC cuts 100 points, to 2%, how much can they cut at the next meeting; 2% is already very low. Are markets asking the Fed to have a Zero Interest Rate Policy? We can only hope not, because Japan still has not recovered from the '90's assets bubbles.

In the last two decades we never had a 1% cut, not had an Emergency Cut on a weekend in 3 decades, and never had an Emergency Overnight cut of 0.75%. Is it a worrying precedent, or a breath of air for the Wall Street Bulls and Bears?

Time will tell, and the reaction the Dollar will be really interesting to watch; 2% Rates and a rallying Equity Market will push Trade Desks out of Bonds, increase Risk Tolerance, instigate buying of Higher Yielder's (Pound, Aussie, Kiwi), send Swissy to 0.9500 and the Dollar Index towards 70.00. The Dollar may however make ground on the Yen, to the delight of the Japanese Finance Ministry.

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There is a constant question from some traders as to why anybody would ever need to consider the ‘F’ word when trading. Fundamentals: what is so damaging at looking at both Technical charts and having a Fundamental filter to gauge how many Lots to put on? Why is it that accepting that Technicals give us price points to trade, but Fundamentals determine the direction that we travel is so difficult for some traders to accept? Without a Fundamental Filter very few pure Technical traders would have seen this Dollar move coming today.

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