Forex Blog

February 1, 2012

Fed’s Near-Zero Interest Rate Policy a Failure?

The world’s largest central banks continue to follow a low interest rate policy first implemented to deal with the 2008 recession. The argument for adopting the record-low rate was that deep cuts to the lending rate would help ensure sufficient liquidity within the financial system and encourage spending and growth promotion.

In this regard, the U.S. Federal Reserve was the most aggressive of the major central banks. After a quick succession of rate cuts, the Fed took less than a year to chop the benchmark lending rate from 5.25 percent, to a maximum of 0.25 percent as of December, 2008. Now, more than three years later, the lending rate remains zero bound; a fact that has some critics suggesting the Fed’s policy has failed to accomplish its stated goals.

One of the most vocal opponent’s of the Fed’s approach is himself a Federal Reserve Bank President. Thomas Hoenig, President of the Federal Reserve Bank of Kansas City has, on several occasions now, spoken out against the continuation of near-zero interest rates.

Referring to the current Federal Funds rate as a “subsidy” for the banking industry, it is Hoenig’s assertion that while banks are indeed taking advantage of the “cheap” money available from the Fed, funds are not being made available for commercial and retail lending. The banks are instead simply investing the cash directly into higher yielding bonds including U.S. government treasuries. As of Wednesday morning, the benchmark 10-year yield on U.S. debt was 1.82 percent.

Using money from the Fed to buy higher yielding securities may make it possible for institutions to profit on the positive interest rate carry, but does little to help businesses acquire capital to expand and help get Americans back to work. It can also be argued that this policy has actually reduced liquidity.

With the ability to profit on higher-yielding bonds as described, banks have become even more selective to whom they provide loans. Banks can simply shun all but the top-tier ventures representing the least amount of risk. The result, according to Hoenig, is that rather than encourage lending to support growth, the Fed’s policy has actually made it more difficult for smaller companies and private individuals to gain access to the Fed’s liquidity.

April 27, 2011

Fed May Abandon “Extended Period” Phrase for Interest Rate Policy

Little in the way of change is expected in this morning’s FOMC statement with most economists suggesting the Fed will commit to the completion of the “QEII” round of stimulus ending in June as originally planned. No change is expected in the 0.25 percent Federal Funds cap but there is a growing belief that the Fed is ready to abandon its use of “extended period” when describing the long-term interest rate outlook.

Since late 2010, Fed Chairman Ben Bernanke has relied on the phrase whenever discussing how long we can expect interest rates to remain at the historical low. However, there is a growing sense that the Fed is about to lay the groundwork for its stimulus exit plan and interest rate increases will certainly be foremost on the agenda.

Source: Bloomberg

UK Economy Grows 0.5% in Q1

The latest growth figures show a reduced likelihood of the UK economy slipping back into recession with a weak but positive expansion of 0.5 percent for the first quarter of the year. This follows the contraction of half a percent in the second half of 2010.

Still, the UK is not out of the woods and with the impact of planned government spending cuts to reduce the deficit still to be accounted for, many questions remain.

“These figures were mixed and well below the Office for Budget Responsibility prediction that the economy would grow by 0.8% in the quarter,” noted David Kern, the chief economist at the British Chambers of Commerce. “Given the fragility of the recovery, it is vital for the government to persevere with policies that support growth, and remove the obstacles that prevent businesses from creating jobs and exporting.”

Source: BBC News

Focus on the releases not what Bernanke says in Q&A

The market is focused on what Ben is going to say, but they should be alert to the release of the forecasts which come first. The Fed’s projections of ‘central tendency’ for GDP, unemployment, and inflation will be released at the beginning of the press conference (2.15 EST) and could be the actual market mover rather than Ben’s performance during question and answers.

The recent rally in US Treasuries suggests that the market is priced for a dovish FOMC. The press conference is expected to touch upon several topics, including the timing of the withdrawal of liquidity and the impact of commodity prices on the FOMC’s economic outlook.

Elsewhere, Cable has found support after a solid UK GDP release this morning (+0.5%), even the Euro-zone’s industrial orders rising +0.9% on the month and +21.3% on the year is supporting the single currency short term as capital markets shift their attention to the FOMC.

The US$ is weaker in the O/N trading session. Currently, it is lower against 15 of the 16 most actively traded currencies in a ‘volatile’ session.

Forex heatmap

US data releases did little for the dollar yesterday, despite being somewhat more positive. Consumer’s current assessment of economic prosperity, fueled by job prospects, edged up +1.6 points this month to 65.4 from March’s unrevised print of 63.4. It failed to recapture all of last month’s loss which plummeted on consumer’s pessimism of the six-month outlook (-16.2 points). This month’s present expectations category was again outpaced by future-expectations. Digging deeper, the present situation rose +2.1 points to 39.6 on the belief ‘jobs were plentiful’, while the six-month outlook advanced +1.3 points to 82.6. It seems that higher energy prices are again weighing on expectations.

February’s S&P/Case-Shiller House Price Index printed a -3.3%, y/y, decline, meeting market expectations, deteriorating from a -3.1%, y/y, decline in January. On a monthly basis, the seasonally adjusted (10 and 20-city index’s) felly by -0.2%, compared to a -0.3% fall in January. It was the smallest seasonally adjusted monthly fall in over a year.

The USD is lower against the EUR +0.21%, GBP +0.51%, CHF +0.07% and higher against JPY -0.36%. The commodity currencies are mixed this morning, CAD +0.00% and AUD +0.39%.

Investors seem to collectively dislike the dollar, otherwise the loonie should have traded much lower yesterday as commodities came under pressure. It seems that the consumers ‘disgust for US monetary and fiscal policy’ had the ‘small’ positive CAD carry overcome this drop in commodity prices.

Fundamental reason have aided the CAD rise of late, but the speed of its rise has been somewhat over zealous, requiring a pull back from its four-year high print of last week that occurred after the stronger than expected domestic inflation data. The market has been pricing in a tightening bias for the July BoC meeting.

Expect investors to covet the loonie as an alternative to the EUR and the dollar, assuming risk appetite remains the same and Bernanke gives the market no more surprises (0.9525).

The AUD has rallied to a post-1983 float high above 1.08 overnight after higher-than-expected Australian CPI-inflation in the first quarter has increassed expectations of further RBA rate hikes. Inflation rose +1.6%, q/q, far higher than the consensus forecast of +1.2%, pushing the year-on-year rate to +3.3% from +2.7% in the fourth quarter. It seems that flood related food price spikes and higher oil prices drove the headline. However, the underlying inflation was also high, rising +0.9%, q/q to +2.3% from +2.2%, y/y in the fourth-quarter.

Currently, the RBA seem comfortable with interest rates as highlighted in the released minutes earlier this month. The Governor viewed his policy setting as appropriate, saying they will ‘look through’ higher inflation and slower growth stemming from natural disasters. It’s expected that Governor Stevens will want to see more data that’s not so distorted by weather, which may take some time to come through, before moving on rates again.

Australian yields are still the highest in the G10 and do look attractive. The expected mix of trade surpluses and rising capital inflows should provide support for the currency on any pullbacks as the currency marches towards 1.10 outright(1.0825).

Crude is little changed in the O/N session ($112.35 +14c). Oil prices remain range bound, despite the dollar underperforming and MENA unrest. Even comments from the Saudi’s about the impact of high oil prices on the global economy have been unable to provide sustainable pressure on the commodity just yet. Investors are waiting for the potential of ‘a signal of a change in monetary policy from the Fed’ this afternoon.

To a certain extent, last week’s EIA report has provided a level of support for crude. Supplies of commodity fell -2.32m barrels while the market had forecasted a stock increase of +1.3m. Gas inventories fared no better, falling -1.58m barrels. Stocks were expected to decline by -1.75m barrels. Year-to-date, crude has rallied +20%.

The IEA said it maintains its 2011 global oil demand growth forecast but noted that the high oil prices are beginning to dent demand growth based on its preliminary data for January and February. Both the IEA and IMF have said that prices above the $100 watermark are beginning to hurt the global economy.

Recent price movements are being dictated by the value of the dollar and on speculators pushing prices to extremes. Even OPEC sides with the other agencies and added that they are unlikely to alter output targets when it meets in June as there is ‘no shortage of oil anywhere in the world’ even after supply curtailments in MENA.

Gold came under pressure yesterday from investor uncertainty over the likely course of Bernanke and company’s monetary policy and tomorrows USD GDP release. Some investors were happy booking profits on event risk despite the dollar remaining under pressure.

It seems that gold’s usual inverse relation to the dollar has been weakening over the last few trading sessions. To date, the rally has been strong and it’s not surprising to see some profit-taking ahead of the FOMC meeting and Ben’s first public appearance post-rate announcement.

On these pullbacks, prices remain supported on speculation that record-low interest rates will encourage demand for an inflation hedge amid expectations that the Fed will maintain its accommodative monetary policy. Gold, as a non-yielding asset, has a higher opportunity cost when interest rates rise.

The precious metal has become the currency of choice, rallying +30.5% in the past year. At the moment, any price pullbacks are viewed as favorable opportunities for investors to continue to diversify into safe-haven assets, especially metal being used as a store-of-value ($1,508 +$4.70c).

The Nikkei closed at 9,691 up+133. The DAX index in Europe was at 7,399 up+43; the FTSE (UK) currently is 6,064 down-6. The early call for the open of key US indices is higher. The US 10-year eased 3bp yesterday (3.35%) and is little changed in the O/N session.

Ten year product yields have fallen to a new-month low on speculation that the Fed will keep overnight lending rates accommodative and consider steps to stop yields from rising as the end of QE2 approaches.

With the auctions also this week, it’s difficult for the market to set up to take down the product. That’s probably why, even with equities rallying, dealers are keeping things close to their chest.

Yesterday’s $35b 2-year auction was fair, printing a yield of +0.673% that was 3.06 times subscribed versus the four-auction average of 3.34. Indirect bidders took +37.9%, while direct took down +13.4%. Dealers will now change their focus to today’s $35b 5-years and tomorrows $29b 7’s. Now we wait for Ben’s first post-FOMC announcement appearance.

April 26, 2011

Dollar Weaker Ahead of FOMC Statement

The dollar continued its week-long slide against the euro just one day before the next Federal Open Market Committee statement and investors are strongly of the belief that the FOMC will maintain the current low interest rate policy capping the Federal Funds rate at just 0.25 percent.

A low interest rate tends to devalue a currency; this is because lower interest rates mean weaker yields for investors. As a result, investors will sell lower-yielding currencies for currencies providing higher returns and this exactly what has been happening with the dollar. Looking ahead, the dollar sell-off will likely increase as the interest rate gap between the U.S. and other countries continues to widen with rate increases in Australia, Canada, and most recently the Eurozone, taking the shine off the greenback.

Geithner Pledges Support for Strong Dollar

Regardless of the high probability that the Fed will maintain the historical low Federal Funds rate – an action that continues to encourage a weaker currency – U.S. Treasury Secretary Timothy Geithner today repeated his earlier mantra that the Treasury believes in promoting a strong U.S. dollar.

“Our policy has been and will always be, as long as I will be in office, that a strong dollar is in the interest of the country,” Geithner said at a New York conference earlier today. “ We will never embrace a strategy to weaken the dollar.”

Based on Geithner’s comments, it is clear that the Fed and the Treasury Department are not – publically at least – reading from the same playbook. In fairness, the Fed is “independent” of the government with a mandate to ensure full employment while promoting sustainable growth and it is the Fed’s ability to set interest rates that makes it possible for the Fed to achieve these goals.

Nowhere does it say that the Fed is responsible for maintaining the value of the dollar. In fact, considering its actions in the wake of the last recession, it appears a weaker dollar is exactly what the Fed is working towards.

Not that this is necessarily a bad thing at this time. A weaker dollar is beneficial for exporting companies as it helps make products made in America more affordable for foreign buyers. For example, recent earnings reports from large multinationals such as IBM and Intel were bolstered by surging global demand for their products. Certainly, these companies make good products, but so do other manufacturers but having a discounted dollar has helped foreign sales. If demand continues to grow, this could translate into employment gains for American workers.

So, while Geithner continues to pledge his allegiance to a strong dollar, look to Bernanke and tomorrow’s statement from the Fed for a realistic picture of America’s real fiscal policy. Also, keep in mind that Geithner is more politician than economist and it would not be very politically astute for him to announce publicly that a weak dollar is his objective. Bernanke has proven he has no such qualms.

January 26, 2010

Fed Weighs Interest on Reserves as New Benchmark Rate

Federal Reserve policy makers are considering adopting a new benchmark interest rate to replace the one they’ve used for the last two decades.

The central bank has been unable to control the federal funds rate since the September 2008 bankruptcy of Lehman Brothers Holdings Inc., when it began flooding financial markets with $1 trillion to prevent the economy from collapsing. Officials, who start a two-day meeting today, have said they may replace or supplement the fed funds rate with interest paid on excess bank reserves.

“One option you might want to consider is that our policy rate is the interest rate on excess reserves and we let the fed funds rate trade with some spread to that,” Richmond Fed President Jeffrey Lacker told reporters on Jan. 8 in Linthicum, Maryland.

Source: Bloomberg

October 29, 2009

Roubini Says Beware the Carry Trade Asset Bubble

Filed under: OANDA News — Tags: , , , , , , , , — admin @ 9:38 am

Dr. Doom – AKA New York University Professor Nouriel Roubini – is at it again. The man who is credited with being the first to point to the questionable lending practices that ultimately led to the housing bubble and the global recession, is now taking dead aim at what he believes is setting the stage for the next financial crisis – a US dollar asset bubble.

On Monday, Professor Roubini told CNBC that we are headed for the “mother of all carry trades” as interest rates widen amongst the major currencies. Roubini fears that now that US interest rates are zero-bound, investors will use the US dollar to fund the purchase of higher-yielding currencies – particularly those concentrated in several emerging nations presently benefitting from higher oil and commodity prices. This, according to Roubini, is a “dangerous” game.

Roubini does not believe US interest rates can remain at zero for the long term, and once the recovery is truly established, the Federal Reserve will be forced to fast-track interest rate hikes to fend off the threat of inflation. He also questions the sustainability of current commodity prices – especially oil – which he says is presently overvalued when economic realities are considered.

This warning should give pause to currency trade participants as a rapid US dollar appreciation, combined with a depreciation in the currencies on the other side of the carry trade, would quickly place these trades in a losing position. Obviously, this would lead to a sudden unwinding, sharply increasing demand for the dollar as traders scramble to buy enough dollars to cover their short positions.

The act of closing these carry trades would create the equivalent of a US dollar bubble supported not by economic fundamentals, but simply by the need to cover massive short positions. This bubble, like all asset bubbles, would inevitably collapse upon itself, but the damage could be so widespread that it would likely send the US economy back into recession in a scenario Roubini described earlier this year as a recession “double-dip”.

We need only look at our recent history to find an example of just how quickly carry trades can turn. During the mid 1990s, the Asian currency crisis weakened the yen against the major currencies, and the Bank of Japan responding by dropping interest rates to near zero in order to encourage spending and prop up the yen (sound familiar?). This gave rise to the yen-funded carry trade using very cheap yen to buy Australian and US dollars at a time when the US Federal Funds rate was 5.5 percent. So long as interest rates remained stable and the exchange rate between the two currencies continued to favor a long USD position, investors could profit on the interest rate carry.

Sadly, good things can’t last forever, and in October of 1998, the Bank of Japan implemented a plan to recapitalize the country’s banks boosting the yen by 12 percent – literally – overnight. Meanwhile, the US dollar suffered a significant drop during a stock market correction which caused the US bond market to fall on the same day that the Yen was appreciating. The cumulative effect of these events caused the exchange rate between the dollar and the yen to move so much, that most of the open carry trades were suddenly in a negative position.

This unexpected exchange rate reversal triggered a mad rush to unwind the off-side positions, and many large hedge funds and a handful of high-wealth individuals suffered very public losses. This led to a further sell-off, prompting US Federal Reserve Chairman Alan Greenspan to declare that the world was facing a credit crunch. The Fed responded by dropping the Federal Funds rate by 75 basis points over the span of the next three months, effectively closing the interest rate gap between the two currencies, further compounding carry trade losses. It is the potential for a repeat of this scenario that has Roubini once again taking on the role of Dr. Doom.

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