US DOLLAR, FED, QE, STOCKS, CREDIT MARKETS, TED SPREAD – Talking Points:
- US Dollar pushed lower as the Fed makes QE open-ended
- TED spread warning that credit markets still under stress
- Markets seem vulnerable to another wave of liquidation
Financial markets breathed a sigh of relief as the Federal Reserve announced it will make its quantitative easing (QE) program open-ended, buying Treasuries and MBS securities in whatever amount is necessary to smooth the flow of credit. The central bank had previously committed to a fixed $700 billion in purchases, with $200 billion in MBS and $500 billion in Treasuries envisioned.
The announcement arrested panic cash hoarding triggered as credit markets locked up amid worries about the coronavirus outbreak. The US Dollar fell while gold prices rose, speaking to expectations of looser credit conditions that tarnished the appeal of cash while stoking anti-fiat demand. Stocks rose while the Japanese Yen backtracked as broader sentiment improved.
Chart created with TradingView
Interestingly, credit markets themselves do not seem to share such optimism. A gauge of credit stress called the TED spread – the difference between interest rates on 3-month Eurodollar deposits and Treasury bills – shows little sign of ebbing tension. This baseline for the market cost of near-term US Dollar liquidity remains near the highs set amid last week’s cash squeeze, suggesting problems with funding access continue.
Chart created with TradingView
The reticence on display here may reflect the limits that traders see in the capacity for stimulus to revive economic activity and relieve market stress while the coronavirus outbreak continues to rage, forcing entire nations to huddle behind closed doors. The incidence curve tracking new cases of infection continues to climb at breakneck speed, warning it will be some time before growth can be stoked in earnest.
Chart created with TradingView
With that in mind, the past week’s burst of optimism may not last long. The Fed seems to have becalmed investors for now, but a prolonged period of severe economic disruption layered atop a multitude of vulnerabilities building up before the coronavirus’ emergence seems likely to punch holes in financial stability as pockets of malinvestment are exposed and pressured.
That such pockets exist seems all but certain considering they’ve had fertile ground in which to sprout over the decade that global borrowing costs spent near historic lows after the 2008 financial crisis. A rupture in a corner of the market with scope for broader contagion – such as the CLO space – may yet test the limits of the Fed’s resolve and trigger another cash-starved wave of US Dollar buying.
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--- Written by Ilya Spivak, Currency Strategist for DailyFX.com
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