Dollar: Should We Expect That Same Fed Turn As Post-QE3?

Equities rose and the dollar dropped against both the euro and Australian dollar Wednesday after the Fed announced that it was wading deeper into the stimulus pool. Yet, we saw the same reaction after the induction of the QE3 mortgage-backed securities purchases program back on September 13.

Looking back to that historical example, though, the equities markets leveled off immediately after the last-gasp advance and the greenback triggered an abrupt reversal not a day later. So, the question going forward is whether the good will for risk was already fully priced in.

First we need to get the lay of the land for this monetary policy outcome from the Federal Reserve. The FOMC announced a monthly purchase of $45 billion in longer-dated Treasuries would replace the expiring Operation Twist extension program at the start of next year. For all intents and purposes, this is as close to meeting expectations as the central bank could have gotten. This will certainly have the benefit of forcibly keeping Treasury yields down - which translates into lower loans for homes, vehicles, small businesses, education, etc; and thereby encourages growth to the best of the Fed’s ability.

That said, the market impact depends on how much of this outcome was priced in (for the short-term) and to what degree it can offset larger headwinds like slowing growth, the exit of speculative capital and financial uncertainties (for the long-term). On both accounts, this policy decision will struggle to bolster risk taking and/or drive the dollar down.

There are two threats to the dollar from additional stimulus: the removal of risk drives speculative appetites higher (negating the need for a safe haven like the dollar), and an increase to the money supply can structurally devalue the currency. In the latter function, a monthly increase of $45 billion to the Fed balance sheet and money supply can easily be absorbed. Risk sentiment is the more critical factor.

The promise to keep rates low is an invitation to take on more risk (though volatility levels are already at a 5-year low) in order to draw more returns (though yields are so low that capital has to be distributed to far risky assets). Given the four-week rally into this decision, the short-term risk expectations are likely played out. Now, the reality of thin speculative participation (season and structural) and the lingering Fiscal Cliff will really start to weigh in.

Euro Faces 1.3100 and a Greek Aid Payment that is Priced In
The euro has climbed rapidly this week – against safe haven and investment currency alike. That is a critical point to make as it speaks to strength inherent to the shared currency. This may be another key example of expending buying interest between the fundamentals are fully confirmed. For the euro, the fundamental focus is on the eurozone Finance Ministers’ decision on whether to pay out Greece’s next round of aid.

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Through the past week, we have the stages of progress to bring the country closer to relief. The bond buyback program was a big stepping stone and arrangements for €11.3 billion in EFSF bonds in exchange for €31.8 billion in Greek debt comes close to meeting requirements. Though, technically, the amount spent was more than was earmarked and the projected debt-to-GDP ratio for 2020 of 128 percent is lower than the IMF’s level of sustainability. Be prepared for a deferment (an immediate selling event). An approval is best case, and may be fully priced.

British Pound Mixed Between Big Drop in Jobless, Fears of BoE Stimulus
The sterling was torn between two very different fundamental developments this past session. On the positive side, jobless claims for November unexpectedly dropped by 3000-positons. The real stats come from the ILO figures though which reported the biggest drop in unemployment since 2001 – though the jobless rate held steady.

On the negative side, future BoE Governor Carney hinted that he could take a very dovish tack in the UK. This offset could have been the source of the pound’s drift or the currency may still be disconnected from its own fundamentals.

Swiss Franc Traders Tune in to SNB for Follow Up to Negative Bank Rates
The Swiss franc was the only currency that outpaced the euro – which was itself exceptionally strong. That speaks to the currency’s performance. Against most counterparts, the franc is a stand in for the euro; so much of that strength is likely borrowed. However, the slip for the EUR/CHF speaks to lingering safe haven demands for euro-area funds.

The SNB should be concerned. We will see if they are in the upcoming London session as the SNB will deliberate on monetary policy. The central bank has maintained a floor on EUR/CHF and Swiss banks have started to charge for holding franc-based accounts, yet the currency stubbornly holds on. Further stimulus would help, but it is unlikely.

Australian Dollar: Inflation Expectations Plunge, Currency Exposed to Risk
There are two things that typically define the Australian dollar: risk trends and interest rate expectations. The two are interconnected. This morning, we saw inflation expectations (a factor in policy setting) dropped to the lowest level since 1997 – boosting rate cut potential. That sets the tone for the aussie and leaves it exposed to selling. Yet, to turn the high-yielder, risk trends needs to collapse.

Japanese Yen: Be Careful of Jumping on This Fast-Moving Plunge
The Japanese yen is on fire. The currency has plummeted against every one of its counterparts this week and finds itself at multi-month (and in some cases, multi-year) lows. We have seen heavy runs like this happen in the past and history shows they can be hearty trends.

However, there are two reasons for concern for jumping in now this late in the game. First the threat of risk aversion (detailed above) means carry trade unwinding drives the yen higher. The other issue is the Japanese election this weekend. Stimulus fears may have already played out.

Written By: Dailyfx