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Though the Federal Reserve was already considered dovish, the minutes from the March 18th decision to cut rates by three-quarters of a percent proved the policy group has grown far more pessimistic about the outlook for the world’s largest economy recently. In the statement, the Board made sure to note deterioration in most of the major components of growth in recent data.

Starting with the business sector, officials noted a cooling in industrial production through February and an outlook for weak captial spending through the first quarter on the basis of sentiment reports. The housing market - the catalyst for the economy’s recent downturn - recieved a similar bill of health, with the Fed seeing "little indication" that housing has begun to stabalize. The Fed reported demand for housing "continued to be restrained by tight financing conditions" leading to faltering sales and ballooning inventories. Far more concerning for dollar traders who have grown used to the crumbling fundamentals though was the wrap up for the consumer. The report touched upon "widespread" declines in hiring, cooler wage growth and depressed consumer sentiment, which in turn "stalled" real consuemr spending in recent months.

And, while these reflections were well known from the data that has crossed the wires over the past few weeks, the opinions and forecasts from the policy statement stood as confirmation to policy actions and individual policy members’ speeches to the public. Overall, the Fed officials said their outlook for the economy had "weakened considerably." In fact, "many" members saw a contraction in GDP as "likely;" while a number of officials saw risk for a "prolonged and severe" downturn ahead. What’s more, the statement had also made room for concerns surrounding the health of the financial market. The TSLF and Bear Stearns were mentioned, though not treated as efforst to avert impending market collapses as many analysts and traders felt they were. Furthermore, dampening confidence in the Fed’s ability to cure the ails of the economy, they went on to acknowledge that monetary policy alone wouldn’t address the problem in the housing and financial markets.

Despite all the dollar gloom in this summary and outlook though, there was a silver lining. For the policy group, the outlook for inflation to moderate over coming quarters offered some level of relief and confidence in pursuing a easing monetary policy. For traders on the other hand, optimism was born in Fed Presidents Fisher and Plosser’s vote for a less aggressive shift in the benchmark lending rate. They felt the Board should throttle back the size of the rate cuts as the previous 225 basis points of easing had yet to show its full effect on the economy. Mr. Fisher further stated a belief that focusing on "measures targeted at relieving liquidity strains would improve economic prosepcts mroe quickly and lastingly" than further Fed Funds rate cuts. What’s more, both raised concerns over inflation potentially coming unhinged as rates are lowered. Mr. Plosser specifically remarked that acting on inflation pressures when it was clear expectations were no longer anchored would be too late. And so, the Federal Reserve’s difficult balance for monetary policy continues.

Click here to read the Federal Reserve’s full report.

What are other FOMC members saying? Find out in Central Bank Speak.

Written by: John Kicklighter, Currency Analyst for DailyFX.com

To contact John about this or other articles he has authored, you can email him at jkicklighter@dailyfx.com.

The Great Britain pound fell sharply today against dollar, euro and yen as the house prices fell in March by 2.5%, indicating that the country’s mortgage market slump is not over yet.

Halifax House Price Index — a housing report of HBOSplc — showed a 2.5% decline in prices for March with the annual growth (March 2008 to March 2007) at as little as 1.1%, significantly below the overall CPI level in the United Kingdom (2.5%).

HBOSplc expects that there will "modest (low single digit) decline" in the U.K. house prices annually for 2008.

Markets reacted with a very strong movements on this report, as the traders became more insured that the Bank of England will cut interest rate to 5.00% on the 10th of April.

Pound was losing against other currencies today during the Asian trading session, before this housing report came out, but it started an even faster decline after its release.

GBP/USD fell from 1.9883 to 1.9778 (as of 8:07 GMT) today, GBP/JPY dropped from 203.67 to 201.44 and EUR/GBP almost reached its new absolute maximum going up from 0.7898 to 0.7970.

The US dollar kicked off this week on a better note as rising risk appetite strengthened the US dollar against most of the major currencies - helping to consolidate last Friday’s losses. As a result, the US dollar picked up the biggest gains against the lower yielding Yen ahead of the BoJ rate decision tomorrow, and was closely followed by the Swiss franc as the currency climbed above 1.01. Versus the European currencies, the US dollar appreciated against the British pound due to the mounting bets of a 25 - 50bp rate cut by the Bank of England, while the euro held near 1.57. The US dollar took the biggest hit against the New Zealand dollar as investors moved into higher yielding assets, with the Australian dollar following behind as commodity prices accelerated. However, the Canadian dollar came out as the sole loser among the commodity currencies as the struggling US economy persists to hamper the outlook for Canada.

Fresh economic data portrayed greater downside risks for the US economy as tightening credit conditions pushed consumers to hold back on spending. As a result, the Consumer Credit index plunged to $5.2B from a revised $10.3B, with both revolving and non-revolving debts declining. Amid the pessimistic outlook for the economy, investors are showing surprising resilience against the financial turmoil as Treasury yields showed to be increasing in March by Bloomberg. On average, Treasury yields rose 0.33 percent from March 17 to April 4th - reflecting investors’ increased willingness to diversify out of risk free investments.

The securities market advanced as Washington Mutual came closer in reaching a $5B infusion from investors, but failed to hold onto the gains as investors rushed to cash-in their profits on energy and tech stocks. As a result, the DJIA finished the session 3.01 points higher at 12,612.43 points, with AIG and Merck picking up the biggest gains. Among the broader indices, the S&P500 rose 2.14 points to 1,372.54 points, with 137 shares hitting a new 52 week high.

US Treasury demands faltered as investors raised their risk appetite - leading many to leave the safe haven of risk free bonds. Consequently, the benchmark 10-Year yield jumped to 3.556 percent from 3.470, while the 2-Year yield surged to 1.948 percent from 1.827.

Looking ahead, all eyes will be focused on the Bank of Japan’s rate decision tomorrow - with most market participants expecting the central bank to hold key rates at 0.50 percent. Following the rate decision, our focus will be turned to the Minutes of the FOMC Meeting for March 18 at 18:00 GMT, and will look for clear signs of what the central bank will do next to fight off the downside risks to the economy.

DailyFX

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Halifax Bank in the UK have announced the largest drop in house prices for the last 15 years for last month. HBOS PLC reported a drop of 2.5% which is much greater than the predicted 0.4% fall expected by financial experts.

The quartely results showed little encouragement for the economy with prices falling by 1%. This is one of the largest house price falls since 1995.

Japanese economic data is beginning to improve, but this is having a minimal impact of the Japanese Yen.

Leading indicators rose from 36.4 percent to 50 percent and we expect this strength to pass over to the Eco Watchers Survey, which is due for release this evening. Labor cash earnings have been on the rise, which should help to boost consumer confidence. Meanwhile the Japanese government is coming closer to announcing a new Bank of Japan Governor. The latest nominee is Shirakawa, the current acting Governor. There is a decent chance that he will be approved by the Liberal Democratic Party and the Democratic Party of Japan. In the past Shirakawa has been seen as a hawk on monetary policy, but economic conditions have changed significantly and as a result, it is not clear whether he will be willing to cut interest rates.

EUR/USD is grossly over-valued, according to our valuation model and common sense. There are many reasons that have been offered to help explain this rising trend in EUR/USD in the past six years. But none of these factors convincingly explains why the EUR is so over-valued, i.e., why its level is so extraordinarily high. In this note, we propose a new hypothesis.

In recent years, US real money investors have aggressively diversified out of USD assets. Most of the rest of the world have also been reducing their financial ‘home bias’ by diversifying out of their own domestic asset markets. However, European investment funds (IFs) have diversified more within the Eurozone than outside the Eurozone, i.e., they diversified out of their own
countries but into other EMU member countries, and not out of the Eurozone. The EUR, therefore, should be strong if everyone else in the world is diversifying while the Europeans are not.

Stephen Roach, Head Economist, Morgan Stanley

Weekly Bank Research Center 04-07-08

Why Is the EUR So Strong: A New Hypothesis

Stephen Roach, Head Economist, Morgan Stanley

EUR/USD is grossly over-valued, according to our valuation model and common sense. There are many reasons that have been offered to help explain this rising trend in EUR/USD in the past six years. But none of these factors convincingly explains why the EUR is so over-valued, i.e., why its level is so extraordinarily high. In this note, we propose a new hypothesis. In recent years, US real money investors have aggressively diversified out of USD assets. Most of the rest of the world have also been reducing their financial ‘home bias’ by diversifying out of their own domestic asset markets. However, European investment funds (IFs) have diversified more within the Eurozone than outside the Eurozone, i.e., they diversified out of their own countries but into other EMU member countries, and not out of the Eurozone. The EUR, therefore, should be strong if everyone else in the world is diversifying while the Europeans are not.

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Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank

In the past week Fed chairman Ben Bernanke presented his semi-annual testimony to Congress. Generally, the testimony did not uncork any surprises. Still there was a bit of new information, which may provide some indications about the minutes from the FOMC meeting in March due to be released in the coming week. First of all, Bernanke acknowledged that growth prospects had deteriorated further since the January meeting when the FOMC members expected growth of 1.3-2.0% Q4/Q4 in 2008 and 2.1-2.7% Q4/Q4 in 2009. Moreover, Ben Bernanke for the first time mentioned the possibility that the US economy is recession-bound in H1 08. Overall, he painted a bleaker picture of the economy on the back of the financial problems, the continued downturn in the housing market, the high food and energy prices and the tight credit conditions. Thus, there are prospects of a downward revision of the growth estimates for 2008 and possibly also for 2009 when the new estimates from the FOMC members are in connection with minutes from the April FOMC meeting.

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E. Silvia, Ph.D. Chief Economist, Wachovia

Expectations of economic growth and inflation suggest another Fed ease later this month as well as continued low long-term interest rates this year. This week we received indications that the overall real economic growth should remain below trend over the next two quarters with slower consumer spending and continuation of the housing market correction. Job losses in recent months are consistent with our expectation of slower income growth and consumer spending in the first half of the year. Second, inflation remains slightly above the Fed’s target range with the trend in food and commodity prices being an issue. Based upon our expectations for growth and inflation, we expect the Fed will retain a bias to ease another 25 bp at the April 29/30 meeting.

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Global Risks From U.S. Consumer Mounting

Steve Chan, Economist, TD Bank Financial Group

In our latest TD Economics’ Quarterly Forecast, we discuss the importance of the U.S. consumer to the health of the global economy. In recent years, the GDP share of U.S. consumer spending has surged from 67% to 72%, fuelling rapid growth in imports from across the globe. It is very unlikely that ongoing rapid expansion of domestic spending in countries such as China and India will be able to fully offset the headwinds from a weakening U.S. consumer appetite, leading to a substantial slowing in world GDP expansion. This message was echoed in the latest IMF world forecast, which won’t be formally released until next week but was leaked to investors on Wednesday. The IMF marked down its U.S. growth forecast by a full percentage point in 2008, to only 0.5%, and scaled back its view for next year to only 0.6%. The global pace of expansion was also pared back substantially – to under 4% – with the organization citing a 25% risk of a world recession. Meanwhile, another high-profile economic assessment was delivered by Fed Chairman Bernanke in his usual testimony before Congress. He was quiet on any guidance on interest rates, but noted that real GDP is not expected to grow much, “if at all, over the first half of 2008 and could even contract slightly”.

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Tighter Credit Conditions Will Weaken UK Economy and Raise Default Rates

Trevor Williams, Chief Economist at Lloyds TSB Financial Markets

The latest UK credit conditions survey from the Bank of England made grim reading. It suggested that credit conditions will tighten even further for UK households and companies in the next three months, after a pronounced tightening in the three months to March 2008, which itself was more than was expected at the end of 2007. At the same time, the survey reported that lenders also intended to widen spreads, effectively raising the cost of borrowing to households and companies. Thus it was no surprise that the report also showed that a greater number of lenders expected default rates on loans in the UK to rise, after been higher than expected in the previous three month period.

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