Why Quantitative Easing May Not be So Bad for Dollar

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Daily FX Market Roundup 09-13-12

Why Quantitative Easing May Not be So Bad for the U.S. Dollar
EUR Soars, SNB Keeps EURCHF Peg
GBP: Struggles to Participate in the Rally
NZD: Star Performer, Rallies on Risk Appetite
CAD: Hits Fresh 1 Year High
AUD: Gold Up 2%, Oil Up 1%
JPY: When Will the BoJ Intervene?

Why Quantitative Easing May Not be So Bad for the U.S. Dollar

The U.S. dollar fell sharply today following the Federal Reserve’s announcement of an open ended Quantitative Easing program. We have written at length about our assessment of the Fed’s decision, in our piece titled Fed Hits it Big with Open Ended QE. In our end of day note however, we want to look at how the dollar could perform going forward based on its reaction to QE1 and QE2. Interestingly enough, Quantitative Easing may not be so bad for the dollar. While there have only been 2 cases of QE, making our statistical sample completely unreliable, it is nonetheless interesting to look at how the dollar performed against the euro and Japanese Yen in the days, weeks and months that followed QE1 and QE2. When the central bank took the monumental step of announcing the first round of Quantitative Easing on November 25, 2008, the U.S. dollar fell against the euro (or EUR/USD rallied) and the Japanese Yen. The next day however, the dollar recovered and rallied for 4 straight trading days before collapsing hard against the euro. USD/JPY on the other hand took a longer time to recover. The currency pair lost 1000 pips in the 3 weeks that followed (falling from 97.40 to 87.20) before stabilizing and recovering all of those losses. By March or April of that year, USDJPY was trading higher but as we know now, the gains did not last.

When the Fed announced its second round of Quantitative Easing on November 3, 2010, the dollar also fell against the euro the day of the announcement but recovered the day after and began an 8% rally that lasted for the next month. In other words, QE2 created a short-term bottom for the U.S. dollar against the euro. The same price action was seen in USD/JPY, which also bottomed after the Fed made its announcement, rising approximately 6% over the next month. The one consistent reaction to QE1 and QE2 was in stocks, which soared after both rounds of Quantitative Easing.

The reason why the EUR/USD reacted more significantly to quantitative easing than USD/JPY is because at the time, the monetary policies of the U.S. and Eurozone were more divergent than the monetary policies of the U.S. and Japan. If we look a year forward, in both cases, the dollar was lower than where it was before Quantitative Easing. The main reason why Quantitative easing isn’t always bad for the dollar is because often times investors are relieved to receive more support from the central bank. QE2 was far more beneficial for the U.S. dollar than QE1 because it wasn’t a surprise. The market had been talking about it for weeks and investors had plenty of time to position for the announcement – classic sell the rumor and buy the news. This is not to say that this time around the dollar won’t remain weak. If Europe doesn’t give investors a reason to seek safety in the U.S. dollar, the EUR/USD could extend its gains. However losses in USD/JPY could be limited to 76, as investors grow weary of Bank of Japan intervention.

Retail sales, consumer prices, industrial production and the University of Michigan Consumer Sentiment index are scheduled for release on Friday.

EUR Soars, SNB Keeps EURCHF Peg

The euro is closing in on 1.30 courtesy of the Federal Reserve’s monetary policy announcement. Between the bond purchase program announced by the European Central Bank last week and the Federal Reserve’s MBS program, cheap money is flooding into the markets and this is great news for EUR/USD. Despite Europe’s problems, at the end of the day, the EUR/USD is a risk currency and the cheap money is good for stocks and hence the EUR/USD, barring any surprise shock in the Eurozone of course. The decline in global bond yields and rise in global equities will ease the pressure on the ECB. While the EUR/USD enjoyed a very strong rally today, the move was driven entirely by dollar weakness and not euro strength. For this reason, we find the strong rally in EUR/CHF far more interesting. EUR/CHF has been frozen at 1.20 for the past 5 months with only a few temporary blips upward. Over the past 7 trading days, we have seen big moves in EUR/CHF, which had been linked to expectations for a higher EUR/CHF peg. However today, the Swiss National Bank left the EUR/CHF peg at 1.20 and yet rather than declining, EUR/CHF extended its gains. The SNB lowered its inflation and growth forecasts and pledged to continue defending the peg. According to SNB President Jordan, “at the moment, “there’s no reason to discuss any kind of exit.” The reaction in EUR/CHF could be credited to the central bank’s pessimism but also the shift in safe haven flows out of Francs and back into euros. We wrote about how this is happening in the British pound and there’s good reason to believe that it could be occurring in the Swiss Franc as well. Investors in Eurozone nations have sought shelter from the storm in other European currencies and with the strong rally in the EUR/USD in recent weeks, short covering and fresh long positions may have also encouraged investors to swap their francs for euros. Eurozone Finance Ministers begin their 2 day meeting tomorrow – no major headlines are expected on Friday but the ministers are working toward the leaders summit in October.

GBP: Struggles to Participate in the Rally

While the British pound also benefitted from broad based dollar weakness, the sell-off was moderate compared to the move in the EUR/USD and other major currencies. In fact, the GBP/USD had the smallest reaction to the FOMC. This is a bit surprising considering that we are coming off a series of better than anticipated U.K. economic data. Over the past 2 weeks alone, we have seen evidence of hotter inflation, narrower trade deficit and improved labor market conditions. We believe that the underperformance of the British pound has everything to do with flow of funds out of the British pound and into the euro. EUR/GBP extended its breakout today to rise to its highest level in 2 months. No economic data was released from the U.K. and it should be another quiet day for the British pound.

NZD: Star Performer, Rallies on Risk Appetite

The Canadian, Australian and New Zealand dollars soared against the greenback today. The Federal Reserve’s monetary policy announcement was not only good for stocks but also for commodities. Gold prices rose 2 percent while oil prices increased 1 percent. The rise in the price of commodities helped to propel commodity currencies higher. The CAD, AUD and NZD are also risk currencies and the hope is that more stimulus for the U.S. economy will stabilize global growth and lend support to export dependent nations such as Canada, Australia and New Zealand. The CAD rose to its highest level in more than a year against the U.S. dollar while the Australian dollar broke through 1.05. The New Zealand dollar was the star performer, rising 1.25% to its highest level in 5 months. Canadian economic data was right in line with expectations, which tells us the moves were fueled entirely by risk appetite. New Zealand consumer confidence and food prices are due for release this evening followed by Canadian manufacturing sales tomorrow.

JPY: When Will the BoJ Intervene?

The Federal Reserve’s monetary policy announcement drove the Japanese Yen to its highest level against the U.S. dollar since February. USD/JPY would have probably fallen further if not for the risk of intervention from the Bank of Japan. The last time the BoJ came into the market was last year when USD/JPY was trading around 76. We had said that we believe the central bank’s line in the sand is 75.50, but that does not mean they will not try to intervene above that level. Predicting Japanese intervention is tough because it’s a difficult decision for the Japanese as well. The Ministry of Finance knows that the only type of intervention that works for them is coordinated and at this point, other central banks have very little reason to strengthen their own currencies just to help the Japanese. The MoF could instruct the BoJ to go at it alone but this is an uphill battle because the pressure on the dollar stems from the U.S. and not Japan. This doesn’t mean that they will not try especially since they will be under heavy political pressure to do so. If USD/JPY breaks below 77.00, the risk of intervention increases significantly.

Kathy Lien
Managing Director

2 thoughts on “Why Quantitative Easing May Not be So Bad for Dollar”

  1. So in this imaginary world where Quantitative Easing causes no harm, will the US Credit Rating also stay where it is? If it doesn’t, and it hasn’t in the past with previous QE’s, do you consider that not so bad for the dollar? Have you looked at the real buying power of the dollar with food, fuel, and precious metals with the last QE’s? I’m all for being a devils advocate but really, there is no good side to QE. You understand that after the economy miraculously recovers, that the Fed intents to undo all the QE, potentially crashing the market. I’m sure there is much about the economy that I don’t know but to say QE3 might not be so bad for the dollar means you know even less. I hope your descendants don’t read this.

  2. In the short term, the QE3 may benefit the buck. Bernanke is playing with fire. I don’t see how this is going to benefit the USD long term like a year or even 5 years down the road. This will ultimately lead to higher commodity prices and higher interest rates.

    I am in the same camp as Marc Faber. Eventually, the FED will have to raise interest rates be able head off inflation. But, Helicopter Ben is too occupied with trying fight off deflation and is determined to create inflation. What will happen he won’t be able to control or contain it when it gets out of hand.

    Even Japan won’t prop up forever our debt. They are going say at some point we can’t do this forever and will demand payment on the bonds in their possession or dump altogether. Have you look at the interest rate on the 10 year note of late is pathetic.It is 1.68%. Generally, no sane person would want to be pay something where they are going to get rip offed. The Fed is going to run a negative interest program and will penalize savers down the road. Also, people want to be paid a higher rate of interest on their money. I I think the US is headed for European style crisis. Our situation is far worst than the Europeans.

    The other part is the events in the Middle East are going send oil prices higher.Also, I would look at copper prices to give direction for the commodity currencies. It is the best indicator of the health of the economy and has been the predictor for a long time.

    While the QE3 will work on a couple quarters or a year. It won’t work indefinitely. The roosters will come home to roost.

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