Greenback Pares Gains as Fed Takes Small Step to Ease Monetary Policy

The U.S. Dollar gave back much of its earlier gains Tuesdayafternoon after the central bank’s Federal Open Market Committee revealed adisappointing outlook for the U.S. economy.

The U.S. Dollar gave back much of its earlier gains Tuesdayafternoon after the central bank’s Federal Open Market Committee revealed adisappointing outlook for the U.S. economy.

The Federal Open Market Committee left interest ratesunchanged as expected as well as a majority of its policy statement fromprevious sessions although it kept the language stating that inflation is“subdued” without specifically mentioning any issues with deflation. It alsoadded that interest rates would remain low for “an extended period”.

The Dollar declined from its pre-report high as the Fed keptits balance sheet intact while changing the composition of said balance sheetby moving out of mortgages and into long-term Treasuries.

The FOMC vote was not unanimous, as Kansas City Federal BankPresident Thomas Hoenig once again remained the lone hawk. The vote was not“bookended” by any doves as some had anticipated.

Before the release of the report that was much speculationas to how the Fed would address the issue of deflation. Concerns were beingraised because if allowed to spiral out of control, deflation would be verydifficult to contain, unlike inflation which the Fed usually battles with manyof its monetary policy weapons.

The move by the Fed was enough to keep the pressure oninterest rates while implying that the outlook for the economy remains rocky.Some analysts felt the move by the Fed was merely symbolic, but did send astrong signal that it was not going to stand on the sidelines doing nothing.Moving principal payments from the mortgage market to long-term Treasuriesleaves the door open for the central bank to make more aggressive balance sheetmoves at its next meeting on November 3 should the economy fail to improve.

While not actually disappointing investors with its actions,the Dollar did decline after an early morning surge triggered by speculationthe Fed would act move aggressively to loosen monetary policy because of aslowing economy. Instead, the Fed may have acted more prudently with its actionrather than create an aura of pessimism with unnecessary aggressive action.

Traders shouldn’t get too comfortable with the short-side ofthe Dollar despite the initial reaction because trading conditions suggest theGreenback is ripe for a rally due to increasing interest in safe haven assets.The next few days will give more clues as to whether the Dollar will rally orresume its recent decline. The first sign of weakness will be new highs inmarkets that have corrected the past two days, namely the Euro and the BritishPound. The Euro and the Sterlingboth bounced back following earlier weakness, but not enough to reverse thedeveloping downtrend.

Overnight a softer U.K. housing report overshadowedthis afternoon’s U.S. Federal Open Market Committee announcement as fallinghouse prices increased jitters in an already fragile economy.

Early in the trading session, a report from the RoyalInstitution of Chartered Surveyors said July house prices turned negative forthe first time since July 2009. This report echoes earlier reports that showeda rising supply of houses for sale and decreased buyer interest. The return ofa buyers market indicates the strong possibility of a softer housing marketthrough at least the end of the year, leading to speculation of a double-diprecession.

Technically, after failing to follow-through to the upsidefollowing the penetration of a major Fibonacci retracement level at 1.5967 intwo out of the last three trading session, the British Pound took out a mainswing bottom at 1.5819. This move turned the main trend down on the dailychart. The chart pattern suggests that 1.5633 is the next likely downsidetarget, followed by an uptrending Gann angle at 1.5400.

Concern about a slow down in the global recovery alsopressured the Euro. Before the New York session opening, the Euro was trading on itslow, threatening to turn the main trend to down on the daily chart on a movethrough the last swing bottom at 1.3119, a move which took place shortly afterthe NY opening.

Based on the range of 1.1876 to 1.3334, the chart indicatesthat this current break could turn into something substantial if investorsdecide to begin shedding risky assets. If this current break turns into a hardcorrection, the daily chart indicates that 1.2605 would be the minimum downsidetarget. This price represents a 50% correction of the June to August rally.

Besides the start of downtrends in the Euro and BritishPound, the shedding of risky assets such as gold and crude oil could be anothersign that the Dollar is getting set to rally. Falling commodity and equitymarkets are likely to pressure the commodity-linked currencies.