Foreign Currency Exchange & UK Interest Rates

  • 17 years ago
  • Uncategorized
Moneycorp the foreign currency specialist report that he Dollar slammed the hammer down last Monday leaving Sterling and almost everything else eating its dust. Starting out from $2.02 Sterling had fallen to below $1.97 by Friday morning. Almost a three cent bounce was promptly followed by a two cent fall and Sterling opened this week just above $1.98.

As the US sub-prime securitised mortgage fiasco worked its evil way further through financial markets investors continued to run for cover. The US Dollar was a beneficiary for two reasons. First, investors had to buy Dollars to cover short positions created by losses on their asset-backed security positions. Second, the natural home for money in search of safety is the US treasury market; it is very big and very liquid. The synergy of threes two factors attracted speculative buying by other investors who simply wanted to get on the bandwagon and the Dollar went from strength to strength.

The party came to an end on Friday when the Federal Reserve cut its Discount Rate by half a percentage point to 5.75 per cent. The discount rate, at which the Fed supplies ’emergency’ liquidity to banks, is normally a full percentage point higher than the Federal Funds Rate. Friday’s cut recognised that there was a major emergency going on and that it would be unfair to penalise the market at large by overcharging for liquidity. The move also suggests that the fed funds rate itself could be lowered at the next scheduled FOMC meeting on 18 September.

So what to do?

Although the Bank of England did not join other central banks in flooding the money market with liquidity it does not mean that it will not now be having second thoughts about delivering another rate increase next month. Fortunately for Sterling the Euro, the Yen and the Swiss Franc are in the same boat and the prospect of a US rate cut has been heightened greatly. This ought to mean stability, at the least, for Sterling against the US Dollar but we have been reminded recently that interest rates do not count for a lot when there are much bigger fish to fry.

Buyers of the Dollar who followed Moneycorp advice last week will have been stopped into the balance of their purchases. Those new to the game should hedge half of their exposure at current levels and place protective stop orders in case of another major Dollar rally. Even though the main action has probably now been completed and a repeat of last week’s move is unlikely it would be unwise to ignore the possibility in markets like these.

Source: Moneycorp
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