Implications of the FOMC's Announcement for the Dollar

The FOMC's announcement today that it will purchase U.S. Treasury securities led to significant declines in Treasury yields that undermined support for the dollar. The greenback probably will weaken further, at least in the near term, versus most major currencies.

FOMC's Announcement Lead to Marked Decline in Treasury Yields

The Federal Open Market Committee (FOMC) announced its intention today "to purchase up to $300 billion of longer-term Treasury securities." In addition, the Fed will increase its purchases of mortgage-backed securities from $500 billion to $1.25 trillion. The FOMC's intent of its policy actions today was to reduce borrowing costs for businesses and consumers. Indeed, the Fed's announcement had a profound influence on the Treasury market, with the yield on the 10-year Treasury security plunging more than 50 bps (see top chart). With many private sector borrowing costs determined by a spread over U.S. Treasury securities, the Fed's actions should help to pull down interest rates for businesses and consumers.

Dollar Gets Whacked

The FOMC's action also caused the dollar to weaken versus most major currencies. As shown in the middle chart, the dollar dropped more than two percent versus the euro in immediate aftermath of the announcement. The greenback also weakened significantly versus the British pound (see bottom chart), the Canadian dollar and the Japanese yen among others. The dollar's depreciation makes sense because the sharp drop in Treasury rates will reduce the relative attractiveness of U.S. assets to foreign investors.

Dollar Weakness Probably Has Further to Run in Near Term

Looking forward, the greenback probably will weaken further, at least in the near term, versus most other major currencies. For example, the dollar/euro exchange rate probably will test technical resistance in the 1.38 to 1.39 range at some point over the next week or two. A near-term retracement of the dollar/British pound exchange rate also seems likely, with the 1.45 level in sight. The Canadian dollar/U.S. dollar exchange rate could make a stab at the low 1.20s in the near term.

Although the greenback will probably depreciate further in the near term, it is not entirely clear that the dollar longer-term trend is down. Much will depend on how other central banks respond. If the European Central Bank engages in its own version of "quantitative easing", then the euro could give up the gains it has racked up over the past few days. In addition, if the Fed's actions have the effect of hastening the day that the U.S. economy begins to recover, then the dollar should ultimately strengthen. While we acknowledge that the dollar should depreciate further in the near term, we are not inclined at this point to make any major changes to our longer-run dollar forecast. (See our Monthly Economic Outlook, which is posted at www.wachovia.com/economics )

Wachovia Corporation
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