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US Dollar Rally Likely to Accelerate as Federal Reserve Witholds QE3

US Dollar Rally Likely to Accelerate as Federal Reserve Witholds QE3

2011-09-19 11:07:00
Ilya Spivak, Sr. Currency Strategist
Share:

Major Currencies vs. US Dollar (% change)

12 Sep 201116 Sep 2011

US_Dollar_Rally_Likely_to_Accelerate_as_Federal_Reserve_Witholds_QE3_body_Picture_5.png, US Dollar Rally Likely to Accelerate as Federal Reserve Witholds QE3

Talking Points

  • EUR: Debt Crisis Compounds Sensitivity to Risk Trends Ahead of FOMC
  • GBP: Bank of England Minutes in Focus, Traders Look for QE Guidance
  • JPY: Currency Intervention Risk Keeps Prices Locked in Narrow Ranges
  • CAD, AUD, NZD: All Eyes on Fed Meeting as Stocks Set Direction Cues

Most major currencies continue to show a strong relationship with the S&P 500, suggesting risk sentiment trends remain the core driver of price action. In the week ahead, this puts the spotlight squarely on the outcome of the Federal Reserve monetary policy announcement due on Wednesday. Needless to say, the evolution of the Euro Zone debt crisis also remains an important background factor as markets enter the week on the defensive after EU policymakers failed to produce any concrete steps to slow the relentless march toward a Greek default at a summit in Poland over the weekend.

Sizing up expectations for the Fed, it seems increasingly likely that Ben Bernanke and company will not unveil another round of quantitative easing (so-called “QE3”). It appears that the decision in August to establish a firm time frame qualifying the familiar pledge to keep interest rates low for an “extended period” as being at least through mid-2013 was a deliberate chance in strategy away from unconventional policy tools such as asset purchases.

Indeed, a compelling explanation for the failure of the two previous QE efforts to trickle down past the financial markets and into the broad economy is the scheme’s novelty. Businesses didn’t have a good bearing on the policy’s implications and so shaping expectations about the near- to medium-term credit environment – an absolute essential for firms making plans at least several years forward – became very difficult and undermined QE’s transmission mechanism. The new approach aims to resolve this issue by offering fixed parameters for a familiar variable (the benchmark interest rate) with a long-enough window of opportunity to relieve uncertainty and give corporate America a chance to plan and capitalize.

While the approach is sensible and ought to prove reasonably helpful for the overall economy, the financial markets that had so relished QE as a source of cheap funding for speculative bets across the asset classes will be disappointed. Until the new policy begins to prove itself, a lack of aggressive action from the Fed is likely to stoke risk aversion as it becomes increasingly apparent that the central bank will not do materially more through bond purchases. This is likely to stoke selling across the spectrum of sentiment-sensitive assets, sending most major currencies lower against the safe-haven US Dollar.

On the Euro Zone debt crisis front, the focus is likely to be on Finland. The country has been a poster-child for the euro-skeptic bloc that has argued against ever-growing bailouts of profligate countries at the expense of prudent ones. The country will begin debating the ratification of the expanded powers granted to the EFSF bailout fund in late July on Wednesday, and while no vote is expected until next week, traders will keep a close eye on commentary from the sidelines of the proceedings to get a reading on the state of the discussion.

The British Pound and Japanese Yen stand notably apart from this dynamic, with weak links to stock prices hinting that other factors are likely to be at work. For the former currency, the release of minutes from September’s Bank of England policy meeting will prove critical, with traders eager to gauge the evolution of the dovish lean on the rate-setting MPC committee to see if perhaps further asset purchases are on the horizon. For the latter, lingering FX intervention risk continues to force price action into a narrow range, with traders seemingly unwilling to challenge authorities for now.

EUR/USD

US_Dollar_Rally_Likely_to_Accelerate_as_Federal_Reserve_Witholds_QE3_body_Picture_6.png, US Dollar Rally Likely to Accelerate as Federal Reserve Witholds QE3

Source: Bloomberg

Key Upcoming Events

DAY

GMT

EVENT

EXP

PREV

IMPACT

20 SEP

9:00

German ZEW Survey (Econ. Sentiment) (SEP)

-45

-37.6

High

20 SEP

9:00

German ZEW Survey (Curr. Situation) (SEP)

45

53.5

Medium

22 SEP

7:30

Germany PMI Manufacturing (SEP A)

50.5

50.9

High

22 SEP

7:30

Germany PMI Services (SEP A)

50.5

51.1

Medium

22 SEP

8:00

Euro Zone PMI Composite (SEP A)

49.8

50.4

Medium

22 SEP

8:00

Euro Zone PMI Manufacturing (SEP A)

48.5

49.0

Medium

22 SEP

8:00

Euro Zone PMI Services (SEP A)

51.0

51.5

Medium

GBP/USD

US_Dollar_Rally_Likely_to_Accelerate_as_Federal_Reserve_Witholds_QE3_body_Picture_7.png, US Dollar Rally Likely to Accelerate as Federal Reserve Witholds QE3

Source: Bloomberg

Key Upcoming Events

DAY

GMT

EVENT

EXP

PREV

IMPACT

21 SEP

8:30

Bank of England Minutes Published

-

-

High

USD/JPY

US_Dollar_Rally_Likely_to_Accelerate_as_Federal_Reserve_Witholds_QE3_body_Picture_8.png, US Dollar Rally Likely to Accelerate as Federal Reserve Witholds QE3

Source: Bloomberg

Key Upcoming Events

DAY

GMT

EVENT

EXP

PREV

IMPACT

20 SEP

23:50

Merchandise Trade Balance Total (¥) (AUG)

300B

70B

Medium

21 SEP

4:30

All Activity Index (MoM) (JUL)

0.5%

2.3%

Medium

USD/CAD

US_Dollar_Rally_Likely_to_Accelerate_as_Federal_Reserve_Witholds_QE3_body_Picture_9.png, US Dollar Rally Likely to Accelerate as Federal Reserve Witholds QE3

Source: Bloomberg

Key Upcoming Events

DAY

GMT

EVENT

EXP

PREV

IMPACT

21 SEP

11:00

Consumer Price Index (YoY) (AUG)

2.9%

2.7%

High

22 SEP

12:30

Retail Sales (MoM) (JUL)

-0.3%

0.7%

Medium

AUD/USD

US_Dollar_Rally_Likely_to_Accelerate_as_Federal_Reserve_Witholds_QE3_body_Picture_10.png, US Dollar Rally Likely to Accelerate as Federal Reserve Witholds QE3

Source: Bloomberg

Key Upcoming Events

DAY

GMT

EXP

PREV

IMPACT

20 SEP

1:30

RBA Board Meeting Minutes (SEP)

-

-

Medium

NZD/USD

US_Dollar_Rally_Likely_to_Accelerate_as_Federal_Reserve_Witholds_QE3_body_Picture_11.png, US Dollar Rally Likely to Accelerate as Federal Reserve Witholds QE3

Source: Bloomberg

Key Upcoming Events

DAY

GMT

EVENT

EXP

PREV

IMPACT

20 SEP

22:45

Current Account Balance (2Q)

-0.671B

-0.097B

Medium

21 SEP

22:45

Gross Domestic Product (QoQ) (2Q)

0.5%

0.8%

High

21 SEP

22:45

Gross Domestic Product (YoY) (2Q)

1.7%

1.4%

High

For real time news and analysis, please visit http://www.dailyfx.com/real_time_news

To receive future articles by email, please contact Ilya at ispivak@dailyfx.com

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