Weekly

Highlights
Week of September 26, 2010
Fed QE2 is far from a done deal
Is it Lose-Lose for the USD?
Precious metals shine
Stronger euro out of synch with fundamentals
Softening data & latest MPC Minutes suggests further easing ahead
Key data and events to watch next week

Commentary
Brian Dolan, Chief Currency Strategist

The Fed took another baby-step toward further unconventional easing, formally indicating it would provide additional accommodation to support the economic recovery if necessary. Previously, only comments by Fed Chair Bernanke had signaled such actions. The FOMC statement also noted low inflation levels and hinted at policy actions to restore inflation to normal levels over time. Markets reacted as though the Fed had actually changed policy, as opposed to sending signals, but the moves appear to have some force: the USD weakened, gold soared, stocks rallied and Treasury yields dropped around 20 bps.

We think it's important to note that the Fed statement does not mean that additional easing is necessarily forthcoming. For one, the US recovery will need to see further deterioration before the debate can be settled and additional easing agreed upon. In contrast, the most recent US data (e.g. housing and durable goods orders) suggests some stabilization after the weakness seen during the summer. Secondly, additional Fed action is unlikely before the Nov. 3 meeting, suggesting some of the recent moves may have been premature and/or excessive. Indeed, 10 year US Treasury yields recovered half of the post-Fed decline by the end of the week. Thirdly, additional unconventional easing takes the Fed into largely uncharted territory, not to mention effectively using up the last of the Fed's policy tools. Lastly, and perhaps most importantly, is that there are no guarantees additional easing from the Fed will actually succeed in boosting the US economy. High unemployment and weak final demand seem unlikely to be affected by lower interest rates, assuming any Fed actions actually result in lower market rates. We think the state of... Full text »

LAST WEEK
USD weakness looks suspect
JPY intervention may be the real deal
RMB strength unlikely to continue
Increased speculation on quantitative easing
Gold advances to new record levels
Key data and events to watch next week

Commentary
Brian Dolan, Chief Currency Strategist

The USD took a hit in the past week as better Chinese data supported global recovery prospects, weakening safe haven dollar demand, and markets responded to talk the Fed may undertake a second round of quantitative easing (QE). The greenback also likely weakened as the Chinese stepped back from dollar-buying intervention and allowed the RMB to strengthen. The Chinese data suggest a soft-landing has been achieved there and that is indeed supportive for the global outlook, and especially for commodity and regional currencies (e.g. AUD in particular) that benefit from Chinese growth. However, the other developments cited above are likely temporary in nature, suggesting potential for the USD to rebound in coming weeks. The talk of additional Fed QE seems premature given the split among FOMC members, with most content to maintain current policy and others openly questioning the effectiveness of QE. While US data has deteriorated, it does not yet reflect the 'appreciably' worse outlook Fed Chair Bernanke has indicated would be the trigger for additional unconventional policy measures. Judging by recent FOMC minutes, the subject of QE has barely been discussed, much less settled, so the prospect for additional asset purchases at this time seems highly remote. As such, USD weakness may dissipate following the FOMC meeting next Tuesday (Sept. 21). USD weakness emanating from China stepping back from managing the Yuan (RMB) seems similarly set to evaporate if they return to pattern (see more below).

To gauge the potential for a USD rebound, we will closely monitor the 1.2920/50 support level in EUR/USD, which was the recent range high and the break-level for recent EUR gains, and upside potential remains while price holds above. Keep in mind the German ZEW economic sentiment gauge has plunged from +53.0 in April to -4.3 in September, an indication of deteriorating 6-month outlooks. If EUR/USD does drop back below the range break at 1.2920/50, we would anticipate a test of prior range lows around 1.2590/2620 at the minimum, and... Full text »