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Fed Tapers QE3 to $75B/Month - US Dollar Volatile, Slightly Higher

Fed Tapers QE3 to $75B/Month - US Dollar Volatile, Slightly Higher

Christopher Vecchio, CFA, Senior Strategist

Talking Points:

- Federal Reserve cuts MBS, Treasury purchases by $5B each; QE3 now $75B/month.

- Further cuts to QE3 data dependent, but FOMC believes economy moving in right direction.

- AUDUSD and EURUSD big swings, slightly lower; USDJPY slightly higher.

The Federal Reserve ‘surprised’ market participants by cutting its QE3 stimulus program by $10B beginning in January 2014. After several better than expected Nonfarm Payrolls reports and consumption and housing data that showed the economy weathered the government shutown, the Fed’s decision comes as consensus forecasts, compiled by Bloomberg News, showed that market participants were widely expecting the Fed to keep QE3 on hold. Here are the main points:

- Main Refinancing Rate: on hold at 0.25% as expected.

- Treasury Purchases: -$5B to $40B/month.

- MBS Purchases: -$5B to $35B/month.

= Total QE3= -$10B to $75M/month.

It might be best to clarify the Fed’s policy decision as a dovish taper. Although QE3 has been cut down, the tone used in the Fed’s policy statement was very much inclined towards a low interest rate environment for the foreseeable future. The Fed enhanced its forward guidance, by indicating that low rates should continue well-beyond the Unemployment Rate falling below 6.5%.

Fed_Tapers_QE3_to_75BMonth__US_Dollar_Volatile_Slightly_Higher_body_Chart_1.png, Fed Tapers QE3 to $75B/Month - US Dollar Volatile, Slightly Higher

Market participants have taken the taper and ensuing policy statement in a mixed fashion. Initially, the US Dollar was exceptionally strong across the board, as US yields surged. The 10-year note yield hit a high of 2.923% after the data, after opening the day at 2.838%. However, within a few minutes, any ‘pro-taper’ moves were erased – as if the market believed this taper was a one-off event.

In fact, a look at the chart above shows that yields are relatively flat on the day. At the time of writing, the 10-year note yield was 2.878%. Note that the short-end of the yield curve – 1M to 3M bills – is seeing lower rates, a sign that “tapering does not equal tightening,” in the chairman’s words.

USDJPY 1-minute Chart: December 18, 2013 Intraday

Fed_Tapers_QE3_to_75BMonth__US_Dollar_Volatile_Slightly_Higher_body_x0000_i1028.png, Fed Tapers QE3 to $75B/Month - US Dollar Volatile, Slightly Higher

Charts Created using Marketscopeprepared by Christopher Vecchio

The volatility in underlying yields was evident given the sporadic price action of various US Dollar pairs after the report. The USDJPY, for one, remained elevated, trading from a low of ¥102.66 to as high as 103.64, where it was trading at the time this report was written.

EURUSD 1-minute Chart: December 18, 2013 Intraday

Fed_Tapers_QE3_to_75BMonth__US_Dollar_Volatile_Slightly_Higher_body_x0000_i1029.png, Fed Tapers QE3 to $75B/Month - US Dollar Volatile, Slightly Higher

Charts Created using Marketscopeprepared by Christopher Vecchio

The EURUSD, only the other hand, traded in a more volatile, approximate 120-pip range. After opening at $1.3760, the pair dropped to a session low of 1.3697, before ripping to a fresh session high of 1.3810. At the time this report was written, the pair was trading slightly lower at 1.3747.

--- Written by Christopher Vecchio, Currency Analyst

To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com

Follow him on Twitter at @CVecchioFX

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