Trade Team Update

As expected, Bernanke and the FOMC gave the markets an additional 50bps cut, dropping the Fed's key interest rate to a paltry 3.00%...

The market's first-wave, initial response was to drive the euro up 100 pips against the dollar, but as we indicated in our chat this afternoon, we'd then see a pullback and retracement of at least 50 pips, which has since materialized as we're sitting comfortably at the 1.4830 level...

There's just a few points I want to cover in today's update... some food for thought going forward...

Today's Fed action, in my opinion, will keep the USD under pressure in the near-term. In yesterday's update we discussed each possible scenario that could play out today and I won't take the time to re-hash as you can read yesterday's update if you like...

In addition, Fed Funds Futures is pricing in additional rate cuts in March,
possibly bringing the Fed's key interest rate as low as 2.25%!

So, what does this mean for the dollar? I'd like to use the CHF as an example of something I believe could play out should the Fed decide to keep cutting and cutting and cutting all the way down to 2.25% or lower...

For the past few years the Swiss have kept their key interest rate at or below the 2.50% level -- it was only last year that the SNB finally moved rates to where they currently sit at 2.75%, which is a major factor why the CHF has gained against the USD...

Now, when the Swiss kept rates hovering around the 2.00% to 2.50% levels, the markets beatup the CHF by using it as a funding currency and as a carry trade currency... the crazy thing about that is, Switzerland has always been a very fundamentally sound economy and very prosperous, with solid GDP and low unemployment rates, however, their artificially low interest rates took a damaging toll on the CHF... banks, investors, and traders used the CHF as a funding currency because Swiss rates were so low and it was cheap to borrow and cheap to repay...

These banks and investors would use cheap francs to invest in either higher yielding currencies and or higher yielding investments like equities, commodities, etc... you get the idea...

What I'm getting at is this -- should the Fed keep hacking interest rates, keep price fixing, and keep devaluing the dollar, I believe the USD could go the way the CHF went for the past few years, which is the USD being used as a funding or carry trade currency...

Think about it... these are some scary and current interest rate differentials:

USD and AUD -- 375bps in favor of the AUD
USD and NZD -- 525bps in favor of the NZD
USD and EUR -- 100bps in favor of the EUR
USD and GBP -- 250bps in favor of the GBP
USD and CHF -- 25bps in favor of the USD

In this market, the money flows to where there is a higher rate of return and right now, there are many other places to get a higher rate of return...

Now, I'm not making any predictions that the dollar is going to turn into a carry traded currency, but I truly believe this is a real potential should the Fed keep on this super rate cut cycle... with those interest rate differentials as they are presently, why would the banks buy up dollars, especially if the Fed is just going to keep going lower with rates? Maybe I'm thinking too logically here, but it just wouldn't make any sense to say buy dollars and sell-off Aussies when there's a 375bps interest rate differential...

Moving on...

Today's action left some traders scratching their heads, wondering why the euro couldn't sustain a break above the 1.4900 level... well, please keep in mind we have a mega fundamental release -- NFP.

Now that the banks have gotten today's FOMC out of the way, the next hurdle before we make any bigger, extended moves is Friday's NFP... I believe the banks are formulating a gameplan and are likely saving their heaviest firepower for Friday... in addition to NFP, there's likely an option expiry on Friday morning, after NFP, at the option barrier of 1.5000...

We'll talk more about NFP tomorrow and as we run-up to the data release... but as far as trading goes, it's the same old story I've been saying for the past two weeks... I'm staying euro long at this point -- cautiously long -- playing the market tight on the intraday, and keeping my best euro longs from the 4385 to 4658 level open at this point on a swing basis...

We could certainly see some more retracement between the 0300 and 0700 EST timeframes as the market may want to allow the euro to correct a bit, then buyers will re-emerge to pickup better entries...

Can we go to 1.5000? At this point, I believe it's possible... I have to imagine there are some big stop sets between 1.5000 and 1.5020, and experience tells me the banks and brokers will do what they can to run stops and trigger stops... that being said, let me repeat that I'm playing the intraday cautiosly long and certainly not loading the boat and blindly expecting 1.5000 to show up on our doorsteps by Friday...

As always, please practice smart and strict risk/money management the rest of this week... keep your margin in check...

Today's price action for the euro was correlated to the Dow, gold, and oil, so let's keep our eyes on those market correlated variables as we trade tomorrow... fundamentally, we have another huge day tomorrow, so please prepare accordingly... bear in mind, as we said, the market may be holding it's heaviest fire power for Friday...

Lastly, if you're a yen trader, stay strapped in because your rollercoaster ride from hell could just be getting warmed up in the near-term...