Fed’s move to lift the discount rate by 25 bp last Thursday was a shock to the markets. It didn’t matter much that the rate is not the key one – actually the discount window is the last thing banks want to touch. However, the psychological meaning was obvious. Investors were right to ask why the Fed decided to act at that point? Why not during the scheduled meeting? If the discount window didn’t matter that much, why to touch it at all? There are two options. The first one is that the Fed officials really didn’t intend to send a signal and attaching a comment (that the move shouldn’t be interpreted as a tightening) naively expected the markets to shrug it off. Alternatively, they made a fake shot to test the market reaction to any signs of the tightening. They could see a reaction and easily explain that they didn’t mean it. It wouldn’t be possible with a removal of the “extended period” phrase or some asset selling. With a nearly meaningless discount window it was.

In either case, the market was calmed by January inflation figures. Core inflation was at -0,1% m/m . The prices didn’t fall so much since the second dip of recession in 1982. So even if some Fed members considered some initial tightening, they might think twice now. Nevertheless the Fed disappointed investors in terms of transparency and Bernanke will be pressed for explanations during his speeches to the Congress scheduled for Wednesday and Thursday.

If the Fed really didn’t intend to tighten and if Bernanke is able to give convincing arguments, the EURUSD may see some room for a rebound. After six weeks of consecutive declines the pair touched 1,3440 last week (shortly after Fed’s announcement) but the sellers face more obstacles down the road. First of all the pair reached roughly a 61,8% retracement of 2009’s increases (slightly more when measured from March 09 to Dec 09, slightly less when measured from Oct 08 to Dec 09). Secondly the momentum is clearly gone which is reflected in two spin weekly candles. The bulls on the pair shouldn’t party yet though. The real test of their power will come at 1,3850.

Meanwhile, stock markets continue to recover, confirming buying signals which we mentioned last week. As the 1103 pts. resistance on the S&P500 futures is conquered, bulls paved the path back to maximums recorded in January. They expected to get some extra ammo from US macroeconomic reports this week including Conference Board sentiment index (Tuesday), home sales (Wednesday and Friday), durable orders (Thursday) and Chicago PMI (Friday). A hurdle may be set by another high reading of initial claims (Thursday), stacking fears of a stall in a labor market recovery.

Przemysław Kwiecień Chief Economist

Disclaimer, investment risk warning
X-Trade Brokers Dom Maklerski S.A. does not take responsibility for investment decisions made under the influence of the information published on this website. more