Dollar Tanks as Fed Buys Long-Term Treasuries

03/19/2009 10:33 am EST

Focus: FOREX

Kathy Lien

Managing Director and Co-Founder BKForex LLC, BK Asset Management

The Federal Reserve has previously promised to use all available tools to help the US economy recover, and they have followed through with that promise. The US central bank has officially cranked up the printing presses and will be flooding the financial markets with money. No one expected Bernanke to jump the gun and start buying US treasuries, but that is exactly what he announced Wednesday. In addition to expanding their purchases of mortgage-backed securities and agency debt significantly, the Fed will buy up to $300 billion in longer-term treasuries. This action puts them one step ahead of the market, which is exactly where they need to be if they want to gain control of market expectations. Their decision to print money and buy US treasuries has driven the US dollar lower across the board. We have previously mentioned that such a decision would be bearish for the US dollar and for bond yields, but bullish for equities. Interest rates were left unchanged at 0 to 0.25%.

The central bank did not need to start buying treasuries immediately because mortgage rates have fallen and equity prices have risen, but their decision to do so reflects Bernanke’s hand in the overall decision. In his infamous 2002 speech, Bernanke suggested that the US government could drop money from helicopters to fight deflation. The central bank head finally realizes that delaying the inevitable is not going to pay off and could instead lead to more uncertainty in the financial markets. The reward of announcing purchases of longer-term US treasuries outweighed the risks of not doing so. The Fed’s proactive actions will help restore confidence in the US government. There is still a lot of hope that the TALF program will work, and it is far too early to jump to any conclusions as the program’s rollout has just begun. Despite the recent improvements in economic data, the Fed remains very pessimistic, which contrasts sharply with Bernanke’s rosier outlook on “60 Minutes.” There is no question that the US economy is still very weak with more than five million Americans currently claiming unemployment benefits.

We expect President Obama and Treasury secretary Tim Geithner to reinforce the US government’s aggressive efforts to turn around the economy. Obama will be pitching his economic stimulus package on “The Tonight Show” with Jay Leno Thursday evening. We expect encouraging words from the President. Treasury secretary Tim Geithner could also release the details of the Obama administration’s public/private plan to take toxic assets off bank balance sheets as early as Thursday. The questions that remain unanswered include how the assets will be valued, how the losses will be shared between the private sector and taxpayers, and where the public sector money will come from.

By Kathy Lien, Director of Currency Research at GFTForex.com

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