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Forex Market Extreme Volatility to Continue

May 20, 2008
Forex traders have plenty of volatility to work with this year as the Fed continues to try to postpone the inevitable. By acting so aggressively to prevent a recession and Wall Street stock market sell off rather than to defend the US currency the Fed has placed itself in an uncomfortable position. Whatever action it takes from here forward will likely be harmful to the US economy.

For the short term the US Dollar continues to rebound against the Euro and to act like the Federal Reserve's interest rate cutting spree is over, at least for now. With the actual inflation rate soaring the Fed is being forced to pay some attention to the inflation outlook for this year and next.

Against the Euro the dollar hit a low of just over 1.6000, then made a V reversal that quickly carried it to about 1.5350. Forex market traders noticed that at the May 28-29 FOMC meeting FOMC members expressed more concern about the inflation rate and came to the conclusion that further interest rate cuts, if any, would be quite small.

Of course with the Fed funds rate now at 2% the Fed has already used quite a lot of its interest rate cutting ammunition.

A bounce from the 1.5300 handle to just above 1.5500 was short lived and we are again trading in the 1.5300's this morning. Against the Yen the dollar has made a similar comeback. From recent lows below 100.00 Dollar/Yen quotes are now above 105.00.

With many soft commodity prices and energy prices making record highs the Fed has to be concerned about the inflation rate getting totally out of control. I don't think that oil above $120.00 a barrel was in any one's playbook for the first half of 2008. With oil, wheat, corn , rice, and soybeans all at record or near record levels the two most sensitive inflation indicators for the public, food and gasoline, are racing to the upside.

While a dishonest government may exclude food and energy from its inflation index the public is not fooled with such visible pocketbook benchmarks being excluded from official statistics. But what a fix the Fed has placed itself in. To reduce rates further to continue to help out its undeserving rich whining Wall Street friends runs the risk of tanking the dollar and further accelerating the dollars long term decline. The stock market may benefit from such action but inflation would be further accelerated to truly dangerous levels.

However, to start increasing rates to fight inflation will likely tank the stock market and more than a few stock brokerage firms and banks that the Fed has been pulling out all of the stops to throw a lifeline to.

The most likely scenario is that the Fed will "pause" for awhile while inflationary events spiral further out of control. This would likely mean that for the short term the dollar will further gain strength, perhaps back to 1.5000 Euros, but will set the stage for a high powered Euro and Yen rally later this year as the US economy sinks further into recession.

It is highly likely that due to the uncertainly surrounding the US recession and the worldwide financial crisis that extreme volatility in the forex market will continue for a long, long, time.

Yes, yes, I know. The US government says that in official terms no recession exists but what does it feel like to you?
About the Author
Gerald "Taipan" Greene is a retired forex trader and portfolio manager who worked in Asia for over 20 years. The nickname was acquired in Hong Kong and is now used for a number of financial, political, and Internet business related blogs. One of them is at Forex Trading Guru
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