Fed panics: dollar bears the brunt

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Panic is a bad advisor in the financial world. Still, the US central bank has let itself be guided by its fears in its surprising decision to cut the interest rates. It looks like there are hard times ahead, particularly for the dollar.

Sunday 1st March, President Donald Trump told us that just over twenty people in the United States were infected with the corona virus. That same day, the first corona-related death in the country was mourned. By then, the disease had already claimed more than 3,000 victims worldwide, while more than 85,000 infections had been diagnosed. Nevertheless, the US Federal Reserve acted much faster and fiercer than other central banks. On Tuesday 3rd March, the main interest rate was lowered by no less than half a percentage point. It was the first time in more than a decade that the Fed cut interest rates outside official meetings.

What prompted the Fed to make this decision?

The bank’s foremost reason for the interest cut is to give the American economy a boost. The direct impact of the coronavirus on the population is much smaller than in China or Italy, for example, but its indirect impact is nevertheless considerable. Several American companies are struggling with a shortage of parts due to temporary shutdowns in the Chinese manufacturing industry. In addition, the corona outbreak is causing a lot of unrest; not only among the population but especially in the investment world. US stock market indices fell by 10% in the last week of February and the first days of March. However, the Fed’s surprising decision did not produce the desired effect.

Panic outbreak

The fall in interest rates caused investors to become even more nervous instead of alleviating their concerns. American stock market prices went down by an average of almost 3% on Tuesday after the interest rate adjustment. The dollar was also hard hit on the forex markets. The dollar index – which compares the value of the US dollar to six other major currencies – fell to its lowest level in six weeks. Not only that: the dollar was under a lot of pressure even before last Tuesday. Currency traders were already counting on the US central bank to intervene more vigorously than other banks. That’s not bewildering, because the Federal Reserve had a lot more autonomy even before then. Before the interest rate cut, the American interest rate stood at 1.75%. In Japan it is -0.1% and in Europe as much as -0.5%.

Dollar’s problems not over yet

Eventually, the American stock market prices recovered on Wednesday. This was partly due to the surprisingly strong performance of moderate Joe Biden in the Democratic primaries. As a result, the chance that Bernie Sanders will compete against Trump in the fight for the presidency is much smaller. Sanders’ plans do not spare the business community, which worries investors. However, a real recovery for the dollar seems a long way off. The risk of a recession in the United States is gradually increasing. Chances are considerable that the even more interest drops will occur in the course of this year. If you are looking for a safe haven on the forex market, your best bet is currently the Swiss franc.

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the forex world. This column reflects his personal opinion and is not intended as professional investment advice.