Dollar compromised as Fed polls bond dealers


A solid trading day for the buck on Wednesday is being compromised in Thursday trade thus far, with the greenback well offered ahead of the North American open. The pound and kiwi are the biggest gainers on the day, with UK currency already recovering all of its losses from the previous day. Meanwhile, all other major currencies are also tracking higher against the US dollar. Economic data released in Europe produced some stronger than expect Eurozone confidence numbers, while a weaker UK Nationwide house price print was offset by the better than expected CBI reported sales. Kiwi is showing some relative strength after the RBNZ left rates on hold at 3.00% but left the door open for additional hikes.

Relative Performance vs. USD Thursday (As of 11:10GMT)

1. STERLING+0.70%
2. KIWI +0.64%
3. AUSSIE+0.59%
4. EURO+0.58%
5. YEN+0.58%
6. SWISSIE+0.53%
7. CAD+0.32%

But we look no further than a Bloomberg article entitled “Fed Asks Dealers to Estimate Size, Impact of Debt Purchases” for what we believe to be the clear driver of this latest price action. We are somewhat surprised with the publicity of such actions as they clearly call into question a certain degree of confidence and independence that the Fed has in making its decisions. The article also helps to sway confidence back in favor of QE bulls that had been more uncertain of the outcome for such measures over the past few days.

Clearly a poll conducted by the Fed on how much QE markets are expecting evokes some uncertainty from Fed officials and also sends a message that the Fed and Treasury might be very concerned with letting market expectations down. Investors have been buying equities and feeling better about the economy largely on the expectations for additional accommodative measures, and the Fed could be worried that if they let the markets down with a small injection of QE2, that it will open a major sell-off in the equity markets and seriously damage confidence.

However, we do not believe this to be good reason to pump more money into the system, and remain highly skeptical of the effectiveness of additional easing measures. It is our opinion that the Fed should not be pressured by the markets at this point and should instead continue to focus on the fact that the economy has indeed stabilized and that attention must now be given to the longer-term impacts of the current ultra-accommodative policy. To us the longer-term implications could be disastrous for the US economy with a severe threat of hyperinflation should the Fed inject too much additional stimulus into the system. Instead, the strategy should be to continue to buy time and offer as little as possible in the form of additional stimulus, while continuing to monitor economic data, hoping that additional easing measures are not “necessary.”

Right now, we believe it is very much about good public relations. At present, investor confidence is directly correlated to expectations for QE2. Market participants have grown to believe that QE2 is a good thing and have therefore been buying equities on the back of this expectation. In our opinion, all that needs to be done is to show investors that QE2 is not necessary (and could even be a bad thing) and that a move to actually reverse monetary policy and begin to raise rates is a positive, as it sends a message that the economy can stand on its own two feet and no longer needs to rely on the Federal Reserve to support it. It sends a message that the US economy is on the path of recovery and prosperity. To us, it is simply maddening to think that US equities have been rallying because the US economy needs more stimulus. How counterintuitive is that? Hey…let’s buy equities because we need to be supported some more from collapsing. Does this make sense?

We feel that the Fed needs to step up at this point and attempt to bolster confidence by sending a message that the economy does not need another round of quantitative easing and that this is a good thing. Bernanke needs to tell investors that the economy is showing signs of stabilization and even moderate signs of growth, and while it may take some time, we are finally on the path to recovery and can now finally begin to start thinking about reversing monetary policy.

We would analogize the current situation to a patient who has suffered a severe accident and is in the process of recovering. At some point, the crutches need to be put away and the patient needs to begin a very tough and difficult rehabilitation process that he/she may initially be reluctant to embark upon. The patient however is motivated by the fact that they know full well that if the timing of rehabilitation is delayed then there is a serious risk of not being able to make the full recovery (this should be the focus of the Fed right now). While the process of recovery and rehabilitation is indeed quite difficult, it is also a very healthy, positive and necessary step in order to ensure that the patient is able to make the full recovery. At the same time, once the patient starts to fight through the pain and realize that he/she is making progress, it motivates them to work harder so that they can recover as fast as possible.

As such, we remain highly critical of those who continue to influence market perception, conveying a message that additional quantitative easing measures are market positive. Here the analogy is more likened to a drug addict-dealer relationship, and what better analogy when talking about the need to “inject” more liquidity into the markets. Furthermore, are we really then expected to rely upon the results of a poll which asks the junkie if they need more drugs? We would stress that we are not adamantly opposed to the need for additional stimulus “if necessary,” but at present we seriously question whether in fact additional measures are really “necessary.”

Looking ahead, US initial jobless claims (455k expected) and continuing claims (4430k expected) are the only economic releases scheduled in North American trade, while the market will take some time to also digest the latest earnings reports. US equity futures are mildly bid, while commodities are also tracking higher into North American trade.

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