The Fed & US $$$

The Federal Reserve opted to keep US interest rates on hold for the fourth meeting running, fretting about inflation but also warning that a housing downturn is now substantial. The Federal Open Market Committee (FOMC) decided to keep its key fed funds interest rate pegged at 5.25 percent.

My guess is that if the US dollar did not weaken so much over the last 2-3 weeks, the Fed WOULD HAVE LOWERED INTREST RATES BY 0.25 percentage points. However, the dollar weakness basically left the Fed with little choice but to maintain rates in order to maintain some stabilising platform for the dollar to stand on. A drop in rates by the Fed could very well send the US dollar down another 2%-3%. That would have been two uppercuts to the jawbone of the US domestic economy - a risk not many are willing to stomach.

The Fed has held interest rates steady for four meetings since it halted a run of 17 quarter-point increases in August. The Fed acknowledged that the downturn in the US' housing market had become more significant of late. But with the world's biggest economy showing signs of slowing, some experts say the Fed must consider the downside risks, and consider cutting rates in 2007 to avert a serious downturn. It appears that the Fed only have two options going ahead for the next 6 months, stay put or lower. The way housing is going, a lot will ride on the year end retail sales and unemployment figures. If both sets of figures showed weakness then the Fed will ease, with or without a weak dollar. It is pointless to protect the US dollar at the expense of a recession in the US. Having said that, I think the US economy is a lot more stronger than what the housing figures are showing. Bearing in mind that the US housing boom have basically been on a tear for the longest time, an easing in housing is largely anticipated, in particular when you consider that the US equity markets have been booming as well for the last 12 months, thus taking away some of the limelight and attention from property.

The strong undertone will be reflected in good bonuses in US companies and the good employment figures. Too many experts have been overhyping the slight weakness in housing and extrapolating it to other areas of the economy.

The weaker US dollar is about time. It brings more benefits than risks to the US and world economy - the reasons will be too long to elucidate here, but its all over my historical blogs. Hence we are actually at the crossroads, chances are rates will stay put for the next 2 sessions by the Fed as economic figures to be announced over the next 2 months will show underlying strength, still good for the US equity markets either way actually because we are not looking at a recession , and also not at an overheated or overvalued equity market anyway.

The FOMC voted 10-1 to keep rates steady, with Richmond Fed chief Jeffrey Lacker again dissenting in arguing for another quarter-point rate hike. The one person arguing for a rate hike is a major pointer - he could be asking for a hike based on underlying strength of the US economy or to protect the downward spiral by the US dollar. Methinks its both.

No matter how you cut it, 99% of economists and experts think that the US dollar is overvalued. But why the sudden downshift in the dollar. In my past blogs on US dollar, the recycling of dollars is holding up the dollar. The biggest cohorts are the world's central banks and OPEC nations. These buggers keep holding trade surpluses largely in dollars thus keeping the dollar overvalued and basically financing American's insatiable consumption.

In the latest quarterly report just released by Bank of International Settlements (BIS), the truth came out on explaining why the dollar fell.Many oil producing nations held much less US dollars inpreference for the Euro and yen in particular. Russia and OPE increased their holdings of Euros from 20% to 22%. The other notable insights was that Qatar and Iraq have cut their US dolar holdings by US$2.4bn and US$4bn respectively. Even Ecuador and Indonesia have cut their US dollar holdings by US$2.3bn and US$1.9bn respectively. Surprisingly, one of the strongest ally of the Americans, Saudi Arabia, also cut its holdings of US dollar by US$3bn. While these are minor adjustments, it is nonetheless very significant and these small moves would reverberate worldwide and prompt even more central bankers to reweight their currency portfolio.

Overall, this is a very good move for the global economy, and would actually reduce the risk of imploding of the US economy. It is better to have 2 or 3 minor corrections a year in US dollar than a 25% devaluation in one whack. At least some air has been released from the balloon.