Ever since the Sept. 21 Fed press statement warning that the FOMC wasn’t all that excited by the prospect of a general drop in the aggregate level of prices, the dollar and equity prices have moved in opposite directions. Today the greenback reached an eight-month low against a basket of currencies. Investors are ignoring the path of easing taken by other central banks because those are tiny measures in comparison to the likely size of anything the Fed is likely to announce in the weeks ahead. The world’s number one economy is likely to need more than the rest of the world put together to fight the deflationary war. At least that’s the fear the dollar is suffering from.
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U.S. Dollar – The dollar changed hands at levels not seen since January against the euro and it slipped to its lowest since the Bank of Japan intervened three weeks ago. But there’s something of a disconnect in what investors seem determined to project. The initial phase of quantitative easing saw the Fed purchase $1.75 trillion in mortgage and government securities before prematurely figuring a way to reduce its balance sheet. The measure did, however, work and resulted in a burst of growth that couched business and consumer confidence and quelled fears of a precipitous drop into the abyss. After all, this economic momentum is insufficient to generate a decline in unemployment nor will it prevent a worrisome dip in the price level and one which if begun would prove hard to contain.
The prospect of retracing the same steps it took in 2009 has investors running scared from the dollar. Yet the equity markets are discounting a boom. Some say that the Fed’s liquidity boost will end up creating more asset price bubbles, which is why stock indices are surging. That would mean that there would be unwanted results feeding rallies in certain asset classes. Rather than rising on the prospect for a surge in consumption leading to higher economic activity, equity markets could be accused of rallying precisely because there’s a wall of cheap money coming our way and it’s undoubtedly heading for stocks as buyers compete with buyers in search of higher yields than the cost of borrowing. That’s another so-called “carry-trade” in the making.
New York Fed Chief William Dudley believes, however, that the authorities have a cheap call option to play with. He says that the Fed has “tools that can provide additional stimulus at costs that do not appear to be prohibitive.” Yet the market is behaving as though the result will be an unwarranted boom for equities with the hangover cost of still sliding prices. And if prices aren’t sliding, they’ll be surging.
The reality is that the Fed is evaluating the way in which to improve the current trajectory for growth, which would inherently avoid deflation. Yet it won’t act to over stimulate the economy in such a way that would generate rising prices. People used to say that the Fed was printing money and that the unavoidable consequence had to be a rise in the price level. People are wrong about that and now the Fed’s balance sheet is becoming better understood as a monetary tool.
The market’s view of raging equity prices, if predicated on healthier prospects for consumption, do not jive with the sliding dollar. A rosier outlook for corporate output is the solution for a stronger dollar. If you believe deflation is dead ahead, you don’t believe that Fed’s QEII plans will work, in which case the equity market rally is misplaced. If you believe that the Fed’s plans will deliver stronger growth to the extent that they justify the equity market’s rally, it’s hard to argue that the dollar’s slide will persist.
Euro – The euro earlier reached $1.3881 according to Interactive Brokers data as the assault on the dollar continued. Not only does it appear that the Eurozone as a whole will not need a further quantitative ease, but data has also shown an extension of the rude health first spotted at the end of the second quarter. That doesn’t mean to say that no single European member will need further assistance. In fact that’s a distinct possibility. But for now the choice facing investors is one of choosing a currency with QE dead ahead in the crosshairs or one that’s not. For now the euro’s rally is sustainable in the mind of the market, until investors hear more from the Fed.
British pound – The British pound has fared extremely well against the dollar of late. Indeed, you’d hardly know that the pound is about to receive a further round of asset purchase by the Bank of England, if not tomorrow, then in November. MPC member Adam Posen cracked open the arguments for dealing a further round of bond purchases in recent weeks. Tomorrow’s debate at the central bank will focus on the risks of acting versus the risks of inaction and Mr. Posen goes in to the meeting with the subsequent backing of the British Chambers of Commerce and the Institute of Directors. The Bank knows the Fed is on the verge of further action and should not wait for any further signs from the U.S., especially when you consider the impact on British growth as a result of stringent spending cuts in coming quarters. The pound pared its advance against the greenback and buys $1.5845 while it slid against the euro, which buys 87.35 and close to a four-month high.
Japanese yen –The Bank of Japan may well be sidelined from further intervention ahead of this weekend’s G7 meeting of finance ministers. At least that appears to be the motive behind dealers pushing the yen higher against the dollar midweek. The yen just leapt ahead once again to reach ¥82.77 according to Interactive Brokers data before slipping to ¥83.06. However, one shouldn’t rule out intervention ahead of the weekend and one certainly shouldn’t rule it out during non-Tokyo hours. Intervention during New York hours while Japanese markets are asleep would be a strong sign of the central bank’s commitment to frustrate yen bulls.
Aussie dollar – The Aussie reached 97.81 U.S. cents this morning and is closing in on that 98.50 all-time high of July 2008. The rising tide of risk appetite saw an across the board advance in Asian equities, while regional currencies strengthened against the greenback. The Aussie has since slipped in New York to stand at 97.35 cents a day after the Reserve Bank left interest rates alone, surprising most analysts who fully expecting further monetary tightening.
Canadian dollar – The Canadian dollar reached a one-month peak at 98.67 U.S. cents this morning as the dollar’s slippery slide continued. The Canadian unit continues to flourish on two fronts. The rising appeal of risk means that investors are discounting better economic activity ahead and that QEII from the Fed would revive demand in Canada’s major export market. Second, the declining greenback has sent commodity prices lurching forward meaning better things for Canada’s natural resource industry. The unit currently stands at 98.47 cents according to Interactive Brokers data.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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