A kommentárra figyelnek.
Trading
10 August 2010
FX Update: FOMC scenarios on this important day for markets
John J. Hardy, FX Consultant, Saxo Bank
Risk fell out of bed today in a bout of profit taking ahead of today's FOMC meeting. Now the question begs: to what degree does the Fed cooperate with the market's expectations that QE2 is on the way? Do we get a low- or no profile or a bold, if somewhat cryptic hint that the Fed is ready to get seriously unconventional down the road with new innovations in quantitative easing if deflation threatens? Bond purchases have not worked, mortgage purchases have not worked much either (though can we imagine where house prices would the government propping up the US domestic housing market?). Zero rates have certainly not worked.
It is clear that if we continue down the road we are on of increased risks of deflation and slack end demand in the economy, the Fed will want to circumvent the banking system entirely with new policies. The Fed's main challenge is that banks only want to hoard capital to bolster endlessly bleeding balance sheets while consumers are no longer interested in borrowing and spending as they did before because they are already overextended and because their confidence in their asset-base (equities and particularly their home values) has taken a seemingly permanent hit. Any such direct move would be highly controversial, to say the least, and would probably only be politically possible if the economy is in truly dire straits (and that assumes that the Fed isn't already in the hot seat as the risk increases in any renewed downturn that the Fed becomes one of the main scapegoats for the difficult economic circumstances.).
FOMC Scenarios
All of the above is grist for the longer term scenario. For the short term, of course, we have a FOMC statement later today that will exert strong pressure on all asset classes for the moment. Here we offer three scenarios
1) The "almost no change shocker". The Fed largely passes up the opportunity to suggest that it is cooking up plans for a renewed easing and only slightly upgrades its concern level from the June statement. Reasons for such a statement? Keeping a low profile until after the election, when Bernanke hopes he can get the support from the economic data, from within the Fed and from the Obama administration that will help Bernanke in the fight against deflation it seems he has been preparing his entire professional life. (The hard charging Tea Party/Republican opposition will loudly denounce any strong moves by the Fed between now and election day.) This could see an adjustment lower in fixed income (higher yields), a sharp rally in USDJPY and a sell-off in the commodity currencies as risk appetite also adjusts lower.
2) Hints but no details. This is perhaps the slightly higher odds scenario: the Fed downgrades its view of the economy and upgrades hints that is ready to move in new ways in the future due to deflation risks, but does not precisely identify the mechanisms it would use or provide many other details. Reaction: less downside for risk appetite and less upside for the greenback. (Similar to the reaction for the first scenario, but with less conviction)
3) Strong language that the Fed is ready to get unconventional if conditions deteriorate further. This is the lower odds scenario and what was priced in before the strong greenback rally ahead of the meeting today. If we get this outcome, then we would likely quickly erase the action from yesterday and today as risk appetite celebrates the liquidity implications and the greenback nosedives again.
Chart: USDJPY and rate spread
The fall in rates at the short end of the curve in the US as the market projects a renewed move into quantitative easing by the Fed has been a significant and provided the impetus for a weaker greenback. Below we see the 2-year US vs. Japan swap spread plotted against the USDJPY rate. Any further move in this spread is a move of diminishing returns, however, and if the market's QE2 expectations are dashed by today's FOMC monetary policy statement, we could see a rewidening of the spread that would likely see a reasonable consolidation higher in USDJPY. If the Fed follows through with strong language, however, then the downside pressure on the pair could remain in place.
