IB FX Brief: Investors misread the Fed
For hours and hours I scratched my head trying to understand what I might have missed in the FOMC statement that created an orgy of lust within the equity market. Minus a few hairs this morning, my conclusion remains the same: Nothing. The equity market’s strongest rally in several years is about as misplaced as had parents thrown a celebratory party for an eighth-grader after hearing their child would spend the next two years at the same grade level. The need to spell out the fact that interest rates have all but been abolished for a defined and prolonged period is worrisome at best and at worst speaks to the lack of demand that quantitative easing has delivered. Ahead, the central bank says it has an array of alternative policy tools and it’s not afraid to use them. Isn’t it a little late already?
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U.S. Dollar – Although its policy options are limited, the FOMC maintained that there were still tools left in the proverbial tool box. Low interest rates simply haven’t done the trick. Looking at the latest mortgage applications data from the MBA delivers that message in spades. While refinancing activity rose by 30% to its highest in two years inspired by a nine-month low for 30-year mortgage rates, the purchase index declined by 0.9%. The housing market remains in a very bad shape and as the Fed points out, activity is constrained by stubbornly high unemployment and a lack of consumer spending. Demand for new loans is paper-thin regardless of yields. Treasury prices faced a wild ride on the heels of the Fed’s announcement falling to the December 2008 low at 2.04%. That’s a pretty sad indictment over just how far policy responses have managed to aid the economy in almost three-years, and just for fun the Fed says the move is likely to remain intact for another two. So get used to it. The dollar rose in response on Wednesday as the mess became clearer. The initial response was to sell the dollar in anticipation of further quantitative easing. I maintain that the economy is in a better place than had the authorities not purchased $2.3 trillion of mortgage-backed and government securities. The economy’s hard fall was couched at the time. But the growing divide amongst FOMC members that became all too clear is only going to worsen if the suggestion of further bond purchases comes to the fore. Opponents only have to point to the lack of results to throw the ball back into Bernanke’s court. As dealers realize that the bind the Fed finds itself in won’t automatically deliver QE3, and as equity indices realize the perilous health of the world’s largest economy, the dollar index is tuning up for a safe haven rally once again.
Euro – The euro slumped as risk appetite fell through the floor. The dollar shrugged off its post-FOMC blues and made a beeline for gains on the day. The euro was weakened earlier by news that French industrial and manufacturing output was far worse in June than forecast. Industrial production declined by 1.6% on the month while manufacturers produced 1.9% less than in May. Both measures were massively out-of-line with estimates where analysts had vague notions of slim gains over the peak of the summer. The euro’s losses accelerated ahead of the opening of floor trading in New York and reaching its session low at $1.4224 recently.