Friday November 5, 2010 - 15:40:22 GMT
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FX Briefing - Fed to buy Treasury bonds
FX Briefing 5 November 2010
ÔÉė Fed decision to purchase Treasury bonds weighs on dollar
ÔÉė BoE refrains from expanding asset purchase facility
ÔÉė ECB gradually becoming more optimistic, policy normalisation to proceed
Fed to buy Treasury bonds
The Fed‚Äôs decision to purchase $600bn in Treasury bonds by the middle of 2011 triggered a surge in demand for riskier assets. Against this backdrop, not only did equity and commodity markets post hefty gains, but most major non-US currencies rose significantly too, frequently breaking out above the trading ranges of the last few weeks. EUR-USD was no exception; during the course of the week, the euro gained almost 2% to 1.42.
The pound sterling‚Äôs rise was far more moderate than that of the euro. This was because, prior to the Monetary Policy Council‚Äôs meeting on Thursday at least, the market had been flirting with the idea that the BoE could expand its asset purchase facility. Conversely, the Swiss franc, which hardly falls into the category ‚Äúrisky assets‚ÄĚ, rose even more than the euro. EUR-CHF relinquished its gains from the past fortnight and is now trading at slightly above 1.35.
Some currencies, notably NZD and AUD, posted much higher gains than the euro. The Kiwi dollar‚Äôs appreciation was boosted by good labour market figures, triggering speculation on New
Zealand resuming its interest rate hike cycle again (rates are currently at 3%). The Aussie dollar benefited from the Reserve Bank of Australia‚Äôs rather unexpected interest rate rise to 4.75% last Tuesday. In the last few days, AUDUSD has settled above parity.
The impact on emerging market currencies was somewhat mixed. Whereas relatively flexible currencies, such as the rand and the Turkish lira, rose more than average, the reaction of Asian currencies, and also the real, was somewhat more subdued. The real is suffering a bit as a result of political uncertainty, which will continue to prevail, even though Dilma Rousseff, President Lula‚Äôs former cabinet chief, has won Brazil‚Äôs presidential election. Furthermore, the latest company surveys and the industrial production figures indicate that Brazil‚Äôs economy is taking a breather.
The impact on the Chinese yuan, which is more or less sealed off from the influence of international financial markets due to capital controls, also remained limited, of course. But even the yuan, which had depreciated slightly again after the G20 finance ministers meeting, rose during the course of the week by 0.3% ‚Äď quite substantially by Chinese standards. However, this might just have been the Chinese government‚Äôs typical political cooperation in the run-up to the G20 summit in Seoul which starts next Thursday.
Fed and ECB: moving in opposite directions
The Fed‚Äôs asset purchase programme envisages buying $600bn worth of Treasury bonds by the end of the second quarter of 2011, which equates to about $75bn a month. According to the New York Fed, the Fed receives around $35bn per month in re-payments on mortgage loans and MBS, thus a total of $110bn will flow into Treasury bonds. The purchases will cover the whole maturity segment; about 63% will be in the 2¬Ĺ to 7 year segment, a further 23% in the 7 to 10 year segment, and 9% in the over 10 year segment. The Fed reserves the right to review the pace of its security purchases and the overall size of the asset purchase programme in light of incoming information.
Whereas the effectiveness of the purchasing programme in terms of boosting employment still remains to be seen, it will without a doubt have a sweeping impact on financial markets. The envisaged expansion in liquidity supply will presumably keep the US yield curve flat and increase investors‚Äô risk appetite; risk premiums, in the form of credit spreads, for example, and riskrelated discounts (e.g. for shares, commodities, currencies) should go down. Risk appetite is set to grow even more, because the 8-month timescale of the programme offers an implied guarantee that exceptionally expansionary monetary policy will continue in the longer term; speculation on Q3 has already been voiced. Furthermore, the economic environment is relatively attractive: most recent US economic indicators ‚Äď including the latest labour market report ‚Äď are pointing upwards. There seems little danger of the US suffering an economic setback. Moreover, global economic growth is robust, particularly in the emerging markets, but also increasingly in industrialized countries. Even the eurozone is in good shape, despite the renowned weak spots on the periphery.
On Thursday, the ECB governing council confirmed for the most part its assessment of economic risks and monetary policy stance. The outlook is perhaps slightly more positive than in October, when the council was expecting growth to slow down in the second half of the year. Phrases such as ‚Äúrisks are ‚Ä¶still slightly tilted to the downside‚ÄĚ and ‚Äúsome concerns remain‚ÄĚ (‚Äústill‚ÄĚ and ‚Äúsome‚ÄĚ are new) suggest that the negative factors are losing significance. Much of the wording of the assessment of price risks is identical to that in October‚Äôs version; however, the reference to the dampening influence of low domestic price pressures in 2011 has now been omitted, and also the assessment of domestic price and cost developments as ‚Äústill expected to be contained‚ÄĚ sounds much more distanced than the ‚Äúare contained‚ÄĚ in October. In the monetary analysis, the indication that a turning point in loans to non-financial corporations might have been reached is also striking.
ECB president Jean-Claude Trichet has emphasized that the ECB governing council will continue to pave the way for money market controls in December. The new macroeconomic ECB staff projections will also be released in December. Bearing in mind that the growth projections will then probably have to be revised upwards, the ECB has begun to adjust the wording of its comments on the economic outlook. The ECB is thus moving step by step towards normalizing monetary policy, and even interest rate rises in the eurozone no longer seem so totally out of the question.
Stephan Rieke +49 69 718-4114
+49 69 718-3642
Foreign Exchange Trading
+49 69 718-2175
Matthias Grabbe / Klaus N√§fken
+49 69 718-2146 / -2683
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