Analyst Interview: Christopher Vecchio on Global QE, SNB's Floor
• The recent Fed decision triggered some changes in correlations, such as stocks and the dollar. Is this a long lasting change?
I think this is merely a temporary reprieve in the recent trend of “U.S. Dollar up, equities down” (and vice-versa). However, this is hardly a surprise. Although the recovery in the United States has been slow, the economy remains in a better position than other major economies. Relatively speaking, of course; the U.S. economy has a long way to go before anyone should consider the country recovered (housing, unemployment, wage growth, among a few glaring issues).
For now, we could see this trend stick around, but by the end of the year, I do believe that it will have reversed and the U.S. Dollar and equity markets will be negatively correlated. At the Federal Open Market Committee’s recent meeting, they decided that it was best to take a neutral policy stance. While more stimuli are an option, it is not currently on the table given the recent uptrend in economic data. This, however, is a stance that allows for more easing in the future.
By not announcing that more easing is in the foreseeable future, the Fed has lifted the backstop bond markets have had since 2008, if only temporarily. As a result, U.S. Treasuries have been falling, with the 30-year Bond moving from a 3.166 percent yield on March 13 to as high as a 3.490 percent yield on March 19. This is important because of the effect on mortgage rates for homeowners: higher long-term rates means that it will cost more to finance a house purchase. If it then becomes more costly for consumers to enter the housing market, house prices will need to correct lower. When this becomes a reality over the next few months, the economic conditions that would necessitate more mortgage backed security (MBS) purchases will exist, paving the way for the third iteration of quantitative easing. That will boost stocks and weaken the U.S. Dollar, breaking any short-term positive correlation that has developed.
• With the approval of the Greek bailout, do you think that the debt crisis will be less dominant for a while? Or is it just a temporary break until Greece misses targets or Portugal gets in trouble?
This is just a temporary reprieve in the crisis. I’ve long been an opponent to the measures taken to solve the crisis, and I remain bearish on the Euro-zone future prospects if they continue down the “implement austerity and hope for growth” path. Europe needs fiscal unity. That’s not a likely outcome in the near-term. Looking ahead, the ship on Greece has sailed – the market is well-aware of what’s happening, and now that a default is in the rear-view, attention turns to other Southern European nations. While I’m concerned about Italy, Portugal and Spain have my attention first.
Although Portuguese yields are down substantially from their 2012 highs (10-year bond hit 18.289 percent on January 31), they remain elevated and well-beyond a sustainable level (10-year bond traded as low as 12.506 percent today). This will be a serious concern in the future that will warrant a restructuring of Portuguese debt, ceteris paribus, of course. The same can be said for Spain: although yields are much lower now than they were a few weeks ago, economic conditions in the country are rapidly deteriorating – unemployment hovers a few ticks below 25 percent (!). If the European Central Bank’s spigot is closed (there are no plans for another long-term refinancing operation) and economic conditions across the continent continue to deteriorate, financial institutions will begin to panic as they did in the second half of 2011, LTRO be damned. The situation is very fragile in Europe and it will only take a few poor pieces of data to reignite contagion in the bond markets later this year.
• Do you think that QE in Britain has come to an end, and that the central bank will focus on inflation?
I don’t think QE is off the table anywhere, despite what policy officials have said recently. It is important to consider the longer-term macroeconomics in play: rates have been on hold near historic lows for three to four-years across the world’s largest economies yet economic conditions have just started to take a swing higher. We’re in the midst of a global easing cycle. The same can be said in Britain, where the Bank of England’s main rate has been on hold at 0.50 percent since March 2009. As per the BoE minutes that were released earlier today, two policymakers voted for an increase in their asset purchase program while the remaining seven voted to hold given the “substantial risks” to the medium-term inflation outlook. The writing is on the wall: if inflation risks subside, there is scope to ease further. The British economy isn’t out of the woods and although it may be in the clear for now, a dramatic downturn in Europe could provoke BoE policymakers to preemptively build a bigger safety net for the economy.
• Some Japanese firms were encouraged to perform M&A activity abroad. Is this a significant factor in the yen's weakness?
This could be hurting the Japanese Yen but I don’t think it’s the main catalyst behind the Yen’s rapid depreciation the past few weeks, in particular against the U.S. Dollar since earlier February. At the Bank of Japan’s February meeting, following a dismal fourth quarter growth print, policymakers announced a ¥10 trillion ($128 billion) stimulus package to help the economy. This dilutive effort was the first step towards a weaker Yen. More recently, I look to the bond market, where U.S. Treasuries have underperformed the past several weeks, but especially since March 10. With Japanese rates rather immobile, any upward trajectory in U.S. rates is going boost the USDJPY.
In what is perhaps confirmation of this move higher by the USDJPY that suggests the Yen may have topped (not just against the U.S. Dollar but across the board), our Quantitative Strategist David Rodriguez had this to say on March 14: “Our proprietary Speculative Sentiment Index (SSI) data has called for US Dollar losses against the Japanese Yen since it traded below ¥90, but a more recent shift says the opposite. The SSI measures retail forex trader sentiment as seen through FXCM Execution Desk data. Crowds have remained heavily net-long for nearly two years. As of today, crowds have moved net-short and provide strong contrarian signal that the pair could continue higher.” Indeed, I believe the recent Yen weakness is just the beginning of the Yen’s depreciation over the coming months.
• The SNB continues its successful protection of 1.20 in EUR/CHF, but they have raised growth forecasts. Do you the market might challenge this floor?
I would suggest that the market has been challenging the floor. The EURCHF moved as low as 1.2030 on February 1, but that’s been about it. Often we hear rumors of the Bank of Japan operating “stealthily” in the markets to boost USDJPY, so who’s to say that the Swiss National Bank hasn’t been either? In light of former President Philip Hildebrand’s resignation, Vice President Thomas Jordan, one of the architects of the 1.2000 floor, has been serving as the interim president. He has stated that the SNB will defend the floor at “all costs.” To me, letting the market push the EURCHF below 1.2000 would be a rather porous defense, and the SNB would lose credibility. I don’t see it happening in the near-term.
--- Answers provided by Christopher Vecchio, Currency Analyst for DailyFX for an interview with ForexCrunch.com
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