Federal Reserve Bank’s role as a market stabilizing force has been taken to new highs over last few months. In the aftermath of the “housing market bubble” and “credit crunch”, popular media and Wall Street executives were pleading, well, demanding, forceful action by the FED. It was suggested that rates should be cut and liquidity “injected” into the financial systems. Surprisingly to some, our Central Bank did all that and more, saving Bear Sterns from certain demise.
Some might see it as FED simply doing its job, promoting psychological stability and diluting market pessimism. Others argue that they are way too responsive to Wall Street wishes, bailing out individuals and companies from their greed induced troubles. Whatever the reason, recent FED’s activism in equity and debt markets has been way above normal. Will this spread into currency markets as well?
Over last few weeks following headlines have been seen on front pages of important newspapers: ” Oil up on another dollar slump”, “Dollar weakness causes yet another oil jump”. And many similar ones. Slowly but surely general public makes a connection between the two. Soon enough there will be a prevailing belief that stronger dollar should bring oil prices down. Can FED do anything about it? Over next few weeks we expect to see more and more talk about an all out INTERVENTION. Our fiscal authorities, being so helpful in one crisis, surely should accommodate our wishes in another.
If this actually happens, does FED have enough muscle for a successful intervention? Currency markets being the largest financial markets on earth, surely would require massive amount of money in order to change major trends. Most likely this kind of action would need a coordinated effort by a number of central banks, with a commitment to do it for weeks if necessary. The good news is, just about every major economy on earth would like to see some strength in USD, so other central banks would be likely more than happy to help.
Many market observers claim that interventions are a waste of time and money, and in the long term markets will do what they intended to do in the first place. As an example they often point out Japanese Central Bank prolonged intervention in Yen in 2004. Bank of Japan was publicly unhappy with USD-JPY rate falling under 115.00 level. In spite of continues BOJ actions the market slowly but surely, went to as low 102.00 before rallying for next couple of years. What we don’t know, and never will, is how low the rate would have gotten without BOJ stepping in. For what we know, price could have fallen to 90.00 or maybe 80.00. Who knows?
This kind of market actions don’t happen often enough to have a statistically valid evidence of outcomes. In 1980’s central banks were obligated to maintain exchange rates within certain boundaries. Once prices reached specified levels, intervention could be expected and even guaranteed. That is not the case these days. Central banks will not advertise their actions, they will simply step in.
There is no guarantee that an intervention will happen, but the probabilities of this taking place are growing with every week. It doesn’t mean that one should start piling up dollars. Traders ought to stick to their systems and methods, even if they call for shorting USD. They just don’t want to leave their positions unprotected. Stop/loss is a MUST , because if the intervention comes, it will mean hundreds of pips within hours. S/L on every trade is a cheap insurance policy.
Mike P. Kulej is a Chief Forex Strategist for Spectrum Forex LLC. He specializes in mechanical trading systems as explained on http://www.spectrumforex.com - Spectrum Forex LLC offers numerous services to individual traders. With questions and comments e-mail him at kulej@spectrumforex.com