Today we are seeing US dollar strength as risk aversion has picked up due to mildly hawkish comments yesterday from various Fed officials. This has induced some short-covering ahead of today’s FOMC meeting as QE2 may not be the slam dunk that everyone has been anticipating.
I mentioned last week that the Fed may have accomplished it’s job of lowering the value of the Dollar with the threat of QE2 which may buy them some more time before it becomes necessary (in their minds) again. After all, it would seem highly hypocritical to condemn China for currency manipulation and then go ahead and ease further. Yes, quantitative easing is a form of currency manipulation.
In the EU, German CPI figures came in as expected which means that the ECB is likely on the sidelines for the rest of the year as no change to rate policy will be necessary.
In the UK, CPI came in as expected slightly higher than the BOE target band and core CPI figures are declining which is as the BOE had hoped, leaving the door open for a more dovish stance if economic data continues to weaken.
But today, all eyes are on the Fed as risk aversion has started the morning as the QE2 expectation has lessened going into today’s session. Equity indices are lower, as are commodity prices and the commodity currencies, except the Kiwi, which is showing unusual strength so far.
If the Fed backs away from QE2 than we could see a major short-covering rally, with stocks and commodities selling off as the recent moves higher may have moved too far, too fast. However, overall I do not think that this would necessarily be a negative, though the markets will perceive it that way because of the tsunami of liquidity they were expecting has gone away. Expect major volatility either way.
In the forex market:
Aussie (AUD): The Aussie I slower this morning as risk aversion is ruling the session ahead of today’s FOMC meeting. Business confidence figures slipped slightly, though have remained near a 4-month high.
Kiwi (NZD): I have been searching high and low to figure out why the Kiwi is higher this morning despite the risk aversion in the market. I don’t have any specific news not have I seen any commentary which would explain this market anomaly. When in doubt, blame China. (Click chart to enlarge)
Loonie (CAD): The Loonie is also showing some strength as it is mixed this morning as well. Though oil prices are marginally lower, the market is betting that the BOC will stop raising rates at its next meeting as declines in housing and jobs growth may induce caution.
Euro (EUR): The Euro is lower as CPI figures in Germany came in as expected which will allow the ECB to maintain interest rates at current levels. In addition, strikes in France have disrupted commerce as labor unions are not in favor of the pension overhaul proposals. (Click chart to enlarge)
Pound (GBP): The Pound is also lower as speculation of further asset purchases picks up due to declining house price figures. CPI data came in as expected and as the BOE had hoped, showing gradual declines. A BOE policy-maker stated that they may have to ignore their sub 3% inflation mandate as a removal of stimulus could halt the recovery.
Dollar (USD): The Dollar is showing some strength today as yesterday’s hawkish comments may have tipped off the markets that the Fed is going to back away from QE2. Recent Dollar weakness and the correlative effects it has had on other markets may reverse some, or the Fed could announce further easing which would send the Dollar lower. Stay tuned at 2:15 EST!
Yen (JPY): The Yen is showing some strength today as the Nikkei sold off 2% last night. In addition, consumer confidence fell for the third straight month, yet the Japanese PM stated that they are ready to take “bold action” if the Yen reaches a new 15-year high, though his idle threats may be falling on deaf ears.
So what will the Fed do? My initial gut feeling is that they will back away from further QE and will make no changes to policy. We may hear some dovish comments, but the market may cover positions as it is looking for action NOW. This could send stocks and commodities lower as the recent moves have induced both over-bought and over-sold conditions.
The problem in the US isn’t that there isn’t enough liquidity; the problem is that people and business don’t want to borrow money as they fear that current government policy is not good for economic growth. Would you expand your balance sheet if you didn’t know what the future held? Neither would I.
The negative effects of QE2 in the long run far outweigh the short-term gains, and I don’t think even Bernanke will cave in to political pressure to pump markets higher going into the elections. Yesterday’s hawkish tone from Fed officials may confirm this.
So keep an eye out for the FOMC meeting as volatility is sure to ensue, and remember to trade what you see and not what you think should happen!
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