USD rally not looking so solid as QE tapering story

USD rally not looking so solid as QE tapering story

Traders expect and welcome volatile forex markets, but not volatile communications from policy makers, though the latter certainly helps create market action. Ben Bernanke, chairman of the US Federal Reserve is quite visibly cooling expectations this week that monetary policy isn’t going to be tightening any time soon. A cue to sell USD?

This is in contrast to the general impression he’s been creating for most of this year, which is that the tapering of the Fed’s quantitative easing programme is due shortly as the economy is recovering. This was rightly taken as a buy signal for the USD and as a hint to bail out of risk currencies and the forex markets duly obliged.

By Justin Pugsley, Markets Analyst MahiFX Follow MahiFX on twitter at:

Bernanke provided a list of reasons why US monetary policy should remain accommodative and none of them are particularly new: US inflation is around 1% (below Fed’s 2% target), US fiscal policy is “quite restrictive” (citing potential to remove the equivalent of 1.5% from US growth) and unemployment is 7.6% (masks under-employment and well above the Fed’s 6.5% target).

It’s a little like the host was starting to walk out of the room with the punch bowl only to put it back on the table by popular demand from the guests, so the party can go on a little longer than anticipated.

EUR/USD – Probably short-term pull back as Eurozone still far gloomier than US

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Fed spooked by real interest rates?

What is very likely to be worrying the Fed is the rise in interest rates for corporate and consumer debt and fears that when combined with cuts in government spending and tax rises will simply snuff out economic growth. Talk of tapering off QE was enough to send the cost of credit to the economy rising suggesting it would increase even more once stopped.

Another issue is that bank balance sheets are stuffed with US Treasuries at the behest of regulators to make them sounder. The withdrawal of QE could see some banks take big paper losses and could respond by restricting lending to businesses and households or at the very least charge higher rates of interest.

It’s very likely the Fed does want to exit unconventional monetary policies such as quantitative easing. It would at least signal an improvement in the economy and there must be concerns it will fuel dangerous speculative bubbles in the financial sector if QE carries on year after year.

The big dilemma for the Fed is how to withdraw QE whilst keeping the cost of credit low for the real economy and not tanking asset markets and reversing the fabled wealth effect. The problem is that QE has so distorted asset markets that its unwinding is bound to create volatility and uncertainty leaving the Fed with a real headache.

For the short-term at least that suggests a USD sell-off, which is happening at least until the next mis-communication from the Fed or a surprisingly strong US economic number emerges.

Justin Pugsley

Justin Pugsley

MahiFX is headed by David Cooney, former global co-head of currency options and e-FX trading at Barclays Capital and responsible for the award winning e-commerce platform BARX and Susan Cooney, former head of e-FX Institutional Sales in Europe for Barclays Capital. Operating as a market maker, MahiFX provides traders direct access to institutional level execution speeds and spreads through its proprietary-built fully automated pricing and risk management technology, lowering the cost of retail forex trading. MahiFX global operations are headquartered in Christchurch, New Zealand with offices in London, UK with development and support teams in both locations for 24 hour service. The company is regulated by The Australian Securities and Investments Commission (ASIC), Australia’s corporate, markets and financial services regulator. Article by Justin Pugsley, Markets Analyst MahiFX  Follow MahiFX on twitter and on facebook  Disclaimer: This material is considered a public relations communication for general information purposes and does not contain, and should not be construed as containing, investment advice or an investment recommendation, or an offer of or solicitation for any transactions in financial instruments. MahiFX makes no representation and assumes no liability as to the accuracy or completeness of the information provided. The use of MahiFX’s services must be based on your own research and advice, and no reliance should be placed on any information provided or comment made by any director, officer or employee of MahiFX. Any opinions expressed may be personal to the author, and may not reflect the opinions of MahiFX, and are subject to change without notice