Is the Fed Running Chinese Monetary Policy?

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Market Drivers Mar. 30, 2016

Dollar destroyed in Asia EU trade
ADP on tap
Nikkei -1.31% Dax 1.55%
Oil $38/bbl
Gold $1240/oz.

Europe and Asia:
CHF KOF 102.5 vs. 102.2

North America:
USD ADP 08:15

Janet Yellen couldn’t have hurt the dollar more if she tried as her dovish comments continued to reverberate through the markets one day after her speech taking the buck to fresh session lows against all of the major trading partners.

Ms. Yellen’s comments which suggested that the FOMC is far more concerned about the global economic slowdown rather than the generally steady state of US growth made it very clear that the Fed is unlikely to hike rates in the foreseeable future. In fact the Fed funds futures are only pricing a 100% chance of rate hike in December of this year, indicating that markets no longer believe with great certainty that the Fed will do anything at the June meeting.

Carry trade currencies were the immediate beneficiaries of the this change in sentiment as both Aussie and kiwi continued to soar in Asian and European dealing with the latter racking up as many as 150 points before finally running into profit taking at 6960 level. Both NZD/USD and AUD/USD now find themselves at multi-month highs despite the fact the RBA and RBNZ have consistently tried to jawbone the currencies in an attempt to keep the exchange rate competitive. Although neither of the central banks have yet to resort to intervention, that scenario is not out of the realm of possibility if the carry trade flows push Aussie through the key 80 cent level and if kiwi pops above 70 cents.

Both central banks could also resort to further rate cuts, eliminating the carry premium but monetary authorities are loathe to make any dramatic moves for fear of destabilizing the housing and credit markets. Still, recent market moves have completely upended central bank policies and authorities will be forced to act if this trend continues.

Ms. Yellen uber dovish stance has taken the market by surprise, but perhaps it makes more sense when looked through the prism of the yuan rather the dollar. Indeed Fed’s recent moves look more like a rescue line to the PBOC rather than a concerted effort to manage domestic policy. By maintaining a weak dollar stance, the Fed has taken enormous pressure of the yuan, allowing the PBOC to maintain a loose monetary policy and reliquify its damaged banking sector.

The key question going forward is whether the present posture will provide enough time for Chinese authorities to reorganize the bad debts of the financial sector and contain the capital outflows. If Chinese demand could stabilize and resume growth, the Fed would have dodged another bullet and rebalanced the global economy without the need for a severe correction. However, it remains to been seen if such a rosy scenario could take place given the pressure still existent in the system. For now the risk on appetite clearly has control of the market but buck’s weakness is sure to evoke reactions elsewhere if it continue unabated.

Boris Schlossberg
Managing Director

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