US dollar sinks to record lows as Fed fights credit market turmoil

The Federal Reserve made a surprise cut in its discount rate yesterday and introduced a new lending facility. However, despite determined efforts by the Federal Reserve to contain the impact of the credit crunch, markets had not been able to avoid further turmoil last week, with the greenback bearing the brunt of the fallout. It remains to be seen whether the latest moves will help.

Yesterday, the Federal Reserve announced that it was lowering the discount rate by 25 basis points to 3.25 percent. It also announced the creation of a new lending facility to allow credit to be extended to primary dealers in government securities at the discount rate against eligible collateral.

These moves were the latest in a series of initiatives by the Federal Reserve over the past week or so to tame the persistent turmoil in credit markets that is threatening a financial meltdown in the United States.

On 7 March, the Federal Reserve had announced an increase in the size of its auctions under the Term Auction Facility, its programme for providing funds to markets to boost liquidity.

It followed up the following Tuesday by announcing the introduction of a new programme called the Term Securities Lending Facility. This facility is designed to provide primary dealers with liquid securities in exchange for collateral, which may include mortgage-backed securities. Again aimed at boosting market liquidity, this move sparked a 3.7 percent rally in the Standard & Poor's Index on the same day.

Then on Friday, it provided Bear Stearns with emergency financing through JPMorgan Chase. This was to help Bear Stearns prop up its operations after the investment bank reported that its liquidity position had deteriorated sharply.

Unfortunately, the crisis at Bear Stearns undid most of the Fed's earlier efforts to boost the market. The S&P 500 fell 2.1 percent on Friday on fears that the credit market turmoil will pull down more victims in its wake. The fall on Friday left the S&P 500 down 0.4 percent for the week.

European stock markets also fell on Friday, dragging key indices into the red for the week. The FTSE 100 slumped 1.2 percent, the DAX dropped 1.0 percent and the CAC 40 lost 0.6 percent.

The worst-hit among the world's largest stock markets last week was Japan's, where the Nikkei 225 lost 4.2 percent. And it had not even had time to react to the news on Bear Stearns yet.

I think it is fair to say that markets have generally been unimpressed by the Federal Reserve's efforts to ease the credit crunch. The latest initiatives announced yesterday are likely to meet with similar reception.

Meanwhile, further aggressive rate cuts by the Federal Reserve are now widely expected. Interest-rate futures on the Chicago Board of Trade show that traders are now betting that the Federal Reserve will cut interest rates at its rate-setting meeting on 18 March by either 75 basis points or a full percentage point.

US economic data last week supported such aggressive rate-cut expectations. US retail sales fell 0.6 percent in February while consumer prices were unchanged from January.

The expectation for more rate-slashing by the Federal Reserve is making itself felt in foreign exchange markets. The past week has seen the fall in the US dollar accelerate.

The US dollar fell below 100 yen last week, touching 98.90 yen on Friday and closing for the week at 99.09 yen for a loss of 3.5 percent.

Against the euro, the US dollar fell 2 percent last week to US$1.5674 per euro after touching US$1.5688 on Friday, its weakest ever level against the euro.

The US dollar fell below parity against the Swiss franc last week, falling to an all-time low of 0.9988 francs on Friday.

The US dollar also fell to a record low against the Singapore dollar. The Singapore currency gained 0.3 percent from a week ago and one US dollar now buys S$1.3827.

The Dollar Index, which tracks the currency against six major counterparts, fell to 71.58 on Friday, also an all-time low.

As the US dollar fell, commodities priced in the currency rose. Gold surged to a record US$1,009 an ounce while crude oil touched a record high of US$111 a barrel. This rise in commodity prices could boost inflation in the US.

However, there is a silver lining to all this for the US economy. The weaker US dollar makes US goods and services cheaper for foreigners, making the economy more competitive in global markets.

And unlike most economies, where a weaker currency can increase the foreign debt burden -- as happened to many Asian economies ten years ago -- for the US, most of whose liabilities are denominated in US dollars, a fall in the currency value reduces real US liabilities.

Then again, maybe the US dollar will not fall for much longer. If US economic weakness spreads globally, as many economists now expect, the US currency would no longer look so bad in comparison to others.