Fed (back) at the printing press

A basic law in economics says that for the thing to be valuable it needs to be rare. It applied especially to early-stage physical currencies. Now, George Washington and followers on the US dollar notes couldn’t be happy, as the notes they represent become less rare and – therefore, less valuable. The decision made by the Fed yesterday may put the dollar back on the slide vs. major currencies in a longer perspective.

Some try to picture it as a neutral, claiming that reinvesting proceeds from the Fed’s bond portfolio (and a decision to reinvest it instead of simply allowing a portfolio to shrink and thus reducing money supply is what it’s all about) will keep the portfolio roughly unchanged and therefore will not propel up the economy. One needs to disagree though. Ben Bernanke repeated numerously that the Fed at the very least would move away from the excess liquidity by letting the bonds to be paid back and at one point there even was a discussion about some buy-backs. So from this dynamic point of view, it’s a major move. The Fed not only shelved the exit strategy but indicated it would print as much as required. If that wasn’t enough it seems like the Fed couldn’t resist the market (and political?) pressure and moved somewhat nervously on the first signs of weakness in the recovery.

The move is clearly dollar negative, even if the current EURUSD situation could suggest otherwise. The euro gained right after the statement release but the pair reversed its course shortly and moved lower in Asian and early European trade. However, one needs to keep in mind that the pair was already somewhat overbought and deserved a correction. A move below 1,3120 yesterday before the Fed’s decision was a sign that more investors were going short and may eye a support at 1,2735. Nevertheless, in current circumstances, the move is even more likely to be nothing more than a profit-taking and a larger scale rise on the pair seems more likely in a longer perspective.

An initial reaction wasn’t negated on the USDJPY which once again returned close to the 2009 low of 84,85. Should had the Fed stayed cold blooded this support could have had spurred a reasonable upward movement as short term dollar market rates would have had ticked up. In current circumstances though, such a buying impulse doesn’t exists, rendering a test of 84,85 (and a new 15 years low!) more likely.  

Weaker data from China

While the consequences of the Fed’s decision will dominate the market talk, Chinese macroeconomic data shouldn’t be omitted as they represent an increasing part of the global picture. Especially, as that part of picture is getting darker. While a slight slowdown in output (13,4% y/y), sales (17,9% y/y) or investment outlays (24,9% y/y), shouldn’t rise concerns by itself, investors are looking at the Asian tigers to be the saviors as there is no evident growth engine in the US and a recovery in Europe is exclusively export driven.

Chinese figures add to the pressure on the equity markets. Stocks celebrated the Fed’s move yesterday for a short while, but futures for the key indices in the US didn’t manage to climb above the crucial resistances of 10680 pts. for the Dow and 1130 pts. for the S&P500, offering incentive to the bears. While the easier monetary stance can be a driver for equities, a more persistent bull market requires it to be coupled with improved macroeconomic picture.

Events to watch – UK’s inflation report, Australian employment

Investors will still mull the Fed’s decision over today, especially as the figures for today are second tier. In the US, the market expects the trade deficit to narrow down slightly (8.30 ET, 14.30 CET, -42 bln USD expected) but the figure has marginal to no impact on the market. Some impact of the calendar content might be felt on the GBP market with the claimant count (4.30 ET, 10.30 CET, exp. -17k) and the BoE’s inflation report (5.30 ET, 11.30 CET) on the agenda. The next Asian session will bring about employment figures in Australia (9.30 PM ET, 3.30 CET, exp. +20,1k). The employment surprised to the upside last month but with the RBA on the “wait-and-see” mode, the Aussie is looking mostly at the global markets for directions, and these are currently pushing it south.

Przemysław Kwiecień Chief Economist

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