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Global Briefing: Dollar Stabilizes as Bonds, Stocks Soften

Plus, a fond farewell to this column.

Global bond and stock markets are mostly lower in the aftermath of yesterday's slide in the U.S.

The dollar has stabilized after dropping sharply against the yen and moving to new highs against the euro.

The ostensible cause of added volatility wasn't simply hardening expectations of a rate cut following reports by some policy wonks and investment-bank economists. Rather, the more significant change was that many market participants are shifting their views and no longer simply expect the

Federal Reserve

to be satisfied with a one-off move.

At yesterday's close the July fed funds futures contract, the closest proxy for expectations for next month's FOMC meeting, 18 of a 25-basis-point hike has been discounted. Or to say the same thing, the collective wisdom of the market assesses a little more than a 70% chance of a hike. The market had assessed the chances at a little more than 55% as recently as Wednesday's close. A larger move was seen in the September contract, which offers the clearest insight into expectations for the mid-August FOMC meeting. At yesterday's settlement, not only had the market fully priced in a 25-basis-point hike, but also it was discounting by 7 basis points or more the 25% chance of a second hike as well.

If the Federal Reserve's new transparency means anything, announcing a tightening bias must mean that it is prepared to tighten, unlike in the past where a tightening bias meant very little and surely offered no reliable guide to Fed policy. If the Fed doesn't hike in June, it will lose some credibility -- not necessarily its anti-inflation credibility, though that could be part of it -- but credibility in clarity of policy, i.e., doing what it says it will.

Additional rate hikes, however, are not a done deal

and the Fed's hand could be constrained by three forces: 1) moderating pace of U.S. economic activity -- already interest rate sensitive sectors appear to be cooling off from a heady pace; 2) international fallout from higher U.S. rates and a sense that although the world economy has stabilized, it remains vulnerable, especially if economic growth does not improve significantly in Europe and Japan; and 3) the Y2K issues that the Fed would not want to exacerbate by doing anything that potentially would destabilize money markets near year-end.

Following the decline on Wall Street and the sharp appreciation of the yen

, the Nikkei tumbled 1.25% to its lowest level in two months. Companies that depend on the sales in the U.S., like







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led the move.

Foreigners turned net sellers of Japanese stocks in the week ended May 14

, for the first time in four months. Anecdotal evidence suggests they have continued to be net sellers since then as well. Japanese government bonds recouped their early losses, which had pushed the yield on the 10-year benchmark to 1.58%. Heavy buying in the futures market helped the cash bond close little changed with a 1.49% yield.

News that industrial output fell 2.7% in April, the first decline in three months, seemed to underscore the need for additional government stimulus and this seemed to weigh on Japanese bonds. The government also reported a 0.4% decline in Tokyo May consumer prices. A bright spot was news that household spending rose 1.5% in April, the second consecutive monthly increase. However, income continued to decline, falling 0.6% in April after 0.3% decline in March and a 0.9% fall in February. The weakness in income and poor labor market conditions are likely to cap spending going forward. But Japanese propensity to spend rose to 71% in April, the highest in four months.

Japanese importers were the featured dollar buyers in Tokyo

, according to market talk, taking advantage of the greenback's sharp drop in New York yesterday. The drop below 120 yen seemed to have been exacerbated by relatively thin market conditions, with many participants caught by surprise, triggering descending sell-stops. The dollar hit a similar but larger air pocket last October and this time players responded more quickly and were less leveraged than before. Yesterday's losses were excessive and most Japanese policymakers again beseeched the market for stability. Given the interest rate differentials, it is expensive to be long the yen unless it enjoys upside momentum. In a calm market, dealers will be quick to cut new long yen positions. A move above 120.80 would encourage position adjustments, but it will take a move above 121.50 yen to bring in new dollar buyers.

European officials have tried injecting their own note of stability in euro trading by playing up the future potential of the currency.

They have succeeded in slowing the sharp downside momentum that had built up over the last few days amid concerns about creeping fiscal laxity and official malign neglect stance toward the currency. Still, several officials have played down the effectiveness of intervention, which seemed to rule it out any time soon.

Of particular interest, the next Bundesbank president,

Ernst Welteke

, warned that a Fed rate hike could mark the end of the dollar's rally. Under different circumstances, which included the treasury secretary at the time talking using the foreign exchange market to pressure concessions from Japan, the dollar did slide in 1994 as the Fed was engaged in a sequence of tightening steps. Look for the euro to continue to consolidate. A new near-term range is likely to emerge between $1.04 and $1.0550.

I have enjoyed the opportunity of writing the Global Briefing and having a running dialog with many of you about the tumultuous world of high finance. But today's column concludes my daily commentary. I have accepted a challenging new post as chief currency strategist at

Mellon Bank

starting next month. I will continue to share my analysis and thoughts about the global political economy with readers of

on a weekly basis starting later this summer. Good luck to us all.

Marc Chandler is an independent global markets strategist who writes daily for At the time of publication, he held no positions in the stocks, currencies or instruments discussed in this column, although holdings can change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column at