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The QE3 camp seems to be missing a simple reality – Treasury yields sit near record lows, says Ilya Spivak of DailyFX. A severe credit crunch could ignite Fed action though.

In the interview below, Spivak discusses Europe, QE3, the impact of North Dakotan oil and more topics. The interview was conducted before the ECB press conference. Note that the potential of disappointment expressed here eventually materialized.

Ilya Spivak is a currency strategist with DailyFX, whose expertise is in fundamental analysis, economic and market themes. Ilya Spivak applies a top-down global macro approach to longer-term investing in the G10 currencies.  Ilya has headlined seminars on FX trading around the world and is regularly cited in leading publications including the Wall Street Journal, the Daily Telegraph, CNBC, CNN Money and Reuters.Ilya Spivak

Draghi and other leaders made very strong declarations: What will please the markets? Is Thursday’s rate decision a “make or break” moment? Or could we see something in the middle?

Markets have been pricing the probability of a 25bps ECB rate cut at over 80 percent since the last rate decision but Draghi upped the ante last week by hinting a re-launch of the SMP bond-buying scheme is also in the cards. At this point, both are effectively status-quo expectations and anything shy of that is likely to carry very negative implications for risk appetite. To mollify investors, the ECB will need added firepower, perhaps announcing another round of 1-3 year LTRO operations and/or a further relaxation of collateral rules to expand banks’ access to central bank funds.


Could the Federal Reserve surprise with new moves in its upcoming meeting? Or is the QE3 camp set for another disappointment?  

The QE3 camp seems to be missing a simple reality – Treasury yields sit near record lows having arrived there since the Fed stopped expanding asset purchases over a year ago. With that in mind, it seems unreasonable to think that more asset purchases are needed to keep credit costs capped or that marginally cheaper funding will bring a significant number of would-be borrowers off the sidelines. On balance, the core benefit of a QE3 program would be psychological, marking it as a tool the Fed is likely to reserve to use in the event that the Eurozone debt crisis breeds a 2008-style credit crunch.

There has been a suggestion in the UK to raise the inflation target to 4-5% as a way to battle the debt instead of the current course of austerity. Are higher inflation targets possible as a new global tactic? Or are policymakers too afraid of letting the inflation genie out of the bottle?

The Bank of England allowed above-target inflation for over two years without raising interest rates starting in January 2010 while clearly communicating its intention to do so, so formally raising the target level is not something that is likely to have a material impact by itself. Inflation is also dropping as the UK economy is battered by recession, so achieving the new target would imply aggressive BOE stimulus, a policy already being pursued in any case. On balance, raising the target seems largely moot for now.

Oil production in North Dakota is gaining traction. If this continues and the US imports much less oil, how could this impact the dollar in the long term?

 Most obviously, securing cheap domestic oil supplies is likely to be a boon for economic growth, which ultimately translates into inflation and interest rate hikes. Needless to say that bodes well for the US Dollar over the longer term.

Japanese officials recently expressed worries of the yen’s strength against the euro. Could they intervene to weaken the yen against the euro? Could they join the efforts of the SNB?  

Japanese authorities talk tough a lot more than they actually intervene, but they have certainly stepped into markets before and may certainly do so again. With that in mind, Japan has clearly seen that below-the-radar management of the exchange rate (like what policymakers were able to do in late 2011) works much better than big-splash interventions. That means an aggressive one-off EURJPY spike courtesy of Japanese officials is relatively unlikely. As for the SNB, their one-sided intervention strategy has been rather successful so far, but attempting something similar with the Yen seems unlikely considering the Japanese currency is far more liquid than the Franc.