Much of the financial media is hurriedly writing the obituary of the USD, with some declaring its reserve currency status as dead. In reality, though, the Fed has simply followed the lead of the BOE, BOJ, and SNB, all of which have already embarked on QE. For what it's worth, relative to GDP, the BOJ is pursuing an even larger program of government debt purchases than the Fed. And yet the USD weakened against these currencies. The relative value argument suggests that if all these countries are printing money to roughly the same extent, their relative exchange rates should not be severely affected. What of those currencies that have not embraced QE? Here the relative value argument might have some merit, except that those that have not yet done QE, namely the ECB, are likely to head down that road soon. Bundesbank Pres. Weber today said as much when he noted that interest rate cuts alone will not end the financial crisis, implicitly referring to 'unconventional easing', which is ECB-speak for QE. There appears to be a philosophical opposition within the ECB to cutting rates below 1%, suggesting their next rate cut to 1.00% on April 2 may be accompanied by a QE announcement.
On the relative growth outlook basis, the potential stimulatory effects of QE on the US housing sector and consumption in general point to an earlier US recovery than otherwise might happen. In comparison, the outlook for Europe, Japan and the UK continues to deteriorate. On the interest rate front, the Fed's QE easing announcement saw the yield differential to other government benchmark bonds move about 50 bps against the USD, equivalent to a surprise 50 bp rate cut, for example. Such a move in yield differentials roughly translates to about 4.5/5.5% move in currency values, which is how much the USD fell this week. But those yield differentials have already begun to narrow back in favor of the USD, and if markets begin pricing in QE in the Eurozone, the differential will narrow further in favor of the USD.
Lastly, the sharp drop in the USD sent commodity prices soaring. Extreme USD weakness can lead to runaway commodity prices, as we experienced in the 1H 2008. The net result of that was a sharp drop in personal consumption, which tipped the US into recession by 4Q 2008. Policymakers have hopefully learned that lesson, though you can never be sure. What I'm suggesting here is that the Treasury and Fed, having thrown everything they can at the current crisis, are very likely to intervene to prevent the USD from weakening significantly further. It would be pointless to provide so much economic stimulus only to have a falling USD drive up commodity prices and have food and energy inflation erase any boost to non-basic personal consumption. In addition, the ECB certainly does not want to see the EUR appreciate significantly, while the UK has lauded a weaker GBP, as have Australia and NZ with their currencies. And Japan never minds a weaker JPY. As such, a strong case exists for coordinated G7 intervention to support the USD. The trouble with intervention is that events usually have to reach an extreme before intervention happens, but I'm optimistic a new age of global coordination and policy pro-activeness may see a response sooner than later.
On balance, then, I do not expect to see the current USD slump continue and I remain exceptionally cautious on the commodity rally. The global recession is ongoing and commodity demand has not miraculously detached from the global outlook. In fact, the Baltic Dry Bulk index, a proxy for global trade, has fallen for the last seven sessions in a row, suggesting newfound pessimism on the global outlook, not the other way around.
Friday saw a number of significant short-term reversal patterns in many of the USD pairs. EUR/USD made a potential double top at 1.3730/40; GBP/USD made a similar double top at 1.4590/00; USD/JPY held key trend line support and the 100-day moving average at 93.40/50; USD/CHF made a possible double bottom at 1.1150/60. From the Ichimoku charts, the USD index tested below the bottom of its Ichimoku cloud, only to close above and bounce on Friday. EUR/USD made the equivalent test above its cloud, and even managed to close above it on Thursday, only to drop back into the cloud on Friday, a potential rejection signal. Having argued that the USD was set to weaken on improving risk sentiment since late February, I'm now prepared to reverse and look to use current extreme USD weakness to position for a rebound in the buck.
On the relative growth outlook basis, the potential stimulatory effects of QE on the US housing sector and consumption in general point to an earlier US recovery than otherwise might happen. In comparison, the outlook for Europe, Japan and the UK continues to deteriorate. On the interest rate front, the Fed's QE easing announcement saw the yield differential to other government benchmark bonds move about 50 bps against the USD, equivalent to a surprise 50 bp rate cut, for example. Such a move in yield differentials roughly translates to about 4.5/5.5% move in currency values, which is how much the USD fell this week. But those yield differentials have already begun to narrow back in favor of the USD, and if markets begin pricing in QE in the Eurozone, the differential will narrow further in favor of the USD.
Lastly, the sharp drop in the USD sent commodity prices soaring. Extreme USD weakness can lead to runaway commodity prices, as we experienced in the 1H 2008. The net result of that was a sharp drop in personal consumption, which tipped the US into recession by 4Q 2008. Policymakers have hopefully learned that lesson, though you can never be sure. What I'm suggesting here is that the Treasury and Fed, having thrown everything they can at the current crisis, are very likely to intervene to prevent the USD from weakening significantly further. It would be pointless to provide so much economic stimulus only to have a falling USD drive up commodity prices and have food and energy inflation erase any boost to non-basic personal consumption. In addition, the ECB certainly does not want to see the EUR appreciate significantly, while the UK has lauded a weaker GBP, as have Australia and NZ with their currencies. And Japan never minds a weaker JPY. As such, a strong case exists for coordinated G7 intervention to support the USD. The trouble with intervention is that events usually have to reach an extreme before intervention happens, but I'm optimistic a new age of global coordination and policy pro-activeness may see a response sooner than later.
On balance, then, I do not expect to see the current USD slump continue and I remain exceptionally cautious on the commodity rally. The global recession is ongoing and commodity demand has not miraculously detached from the global outlook. In fact, the Baltic Dry Bulk index, a proxy for global trade, has fallen for the last seven sessions in a row, suggesting newfound pessimism on the global outlook, not the other way around.
Friday saw a number of significant short-term reversal patterns in many of the USD pairs. EUR/USD made a potential double top at 1.3730/40; GBP/USD made a similar double top at 1.4590/00; USD/JPY held key trend line support and the 100-day moving average at 93.40/50; USD/CHF made a possible double bottom at 1.1150/60. From the Ichimoku charts, the USD index tested below the bottom of its Ichimoku cloud, only to close above and bounce on Friday. EUR/USD made the equivalent test above its cloud, and even managed to close above it on Thursday, only to drop back into the cloud on Friday, a potential rejection signal. Having argued that the USD was set to weaken on improving risk sentiment since late February, I'm now prepared to reverse and look to use current extreme USD weakness to position for a rebound in the buck.
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