Dollar falls sharply in wake of Fed move

The dollar plunged and government bond yields in the US and Europe fell to multi-decade lows as investors tried to digest the implications of the Federal Reserve’s new near-zero interest rate policy.

The US currency suffered its biggest one-day slide against the euro since the birth of the single European currency in January 1999 as the euro jumped from under $1.40 to above $1.44.

The yen powered higher, dragging the dollar to a 13-year low of nearly Y87 despite speculation that Tokyo might intervene to limit the rise in its currency and calls for the Bank of Japan to act more aggressively.

Following the Fed meeting on Tuesday, which reduced interest rates to a range of zero per cent to 0.25 per cent, US rates are lower than those in Japan for the first time since 1993.

The US currency has now given up a significant chunk of the gains it made as the credit crisis escalated and there was a global surge in demand for dollar liquidity.

Expectations that the Bank of England would cut rates more aggressively than the European Central Bank and could even follow the Fed into unorthodox territory sent the pound tumbling nearly 4 per cent to £0.9325 against the euro, a record low.

In the US, investors flocked to longer dated bonds, buoyed by the Fed statement that it was evaluating plans to buy Treasuries. The yield on the 10-year Treasury touched 2.08 per cent, below all monthly levels recorded by the Fed since 1954.

The Fed also said it stood ready to increase plans for hefty purchases of mortgage debt. In response, the interest rate on 30-year mortgages fell to 5.06 per cent, the lowest level since the early 1960s, according to HSH Associates.

The fall in US bond yields triggered by the Fed rate cut came even though the Treasury could issue as much as $2,000bn in debt during the current financial year. Foreign investors hold more than half of Treasury debt.

European bond yields also plumbed record lows. “We are in a world where central banks are converging towards zero,” said Alan Ruskin, RBS Greenwich Capital strategist.

The Fed on Tuesday said it expected to keep rates at ultra low levels for “some time” – further undermining the prospective yield on the dollar. It laid out a framework for creating reserves and expanding the US money supply to fund bigger credit programmes aimed at driving down borrowing costs. But it did not provide details for its unorthodox operations, making it difficult for investors to calibrate what they mean for the supply of dollars.