Greenback stabilizes as QE2 is confirmed

Tom Tong18/Oct/2010Currency Updates

US dollar appears to stabilize as Bernanke confirms QE2 is on its way. Forex trading last week was once again dominated by the looming prospect of additional quantitative easing from the Federal Reserve. The price action was quite interesting, however. On the one hand, nearly all G10 currencies moved in lockstep against the dollar. This increased correlation is by now a well establish feature of most financial markets. On the other hand, even though speeches by Ben Bernanke and other voting members of the Federal Reserve Open Market Committee appeared to confirm that the Fed is indeed poised to ease, the US dollar appear to stabilize later in the week and even bounced back somewhat from its lows. While there can be little doubt that the Fed is, overall, genuinely concerned about the subpar recovery and enormous labour market slack in the US, the unprecedented level of consensus that the only way for the dollar is down appears to be providing at least a temporary floor for the greenback relative to other developed market currencies.

Away from forex markets, the increased certainty that QE2 is on its way continues to buoy asset and commodities markets. The S&P500 rallied over 1% for the week and gold broke through to record highs again, inching closer to the $1,400 level on Thursday before pulling back somewhat on Friday.


Last week was very positive for euro fundamentals. Industrial production surprised somewhat to the upside, with solid news from Germany outweighing (again) weaker results from the peripheral countries. Peripheral spreads responded very positively to the news that, outside of Ireland, peripheral dependence on ECB funding came down significantly in August. And finally, ECB officials confirmed again that European monetary authorities have no intention of following the Fed’s lead in providing further easing in monetary conditions in the Eurozone.

All of the above should have fuelled yet another massive rally in the common currency against the dollar. However, it only managed to eke out a 0.2% gain – a clear indication that the unprecedented level of consensus on a weaker dollar is making it difficult for euro to break consistently above the 1.40 level. We are almost alone now in maintaining a bearish medium-term stance on the euro.


All eyes last week were on the Federal Reserve and the potential for a new round of quantitative easing (QE2) to be announced as early as the next Fed meeting in the first week of November. The Fed did not disappoint. Ben Bernanke and a few other voting members gave speeches last week in which they made it clear that the current pace of economic recovery in the US is unacceptably slow, and that the steady trend downwards in most inflation measures is worrying them. While there were also some notes of dissent from this view, they came primarily from non-voting governors of regional reserve banks and are not expected to sway the consensus of the FOMC. Therefore, it seems that an announcement of QE2 of some sort at the next Fed meeting is a certainty.

In this context it is somewhat surprising that the trade-weighted dollar actually dropped less than 0.5% for the week, and in fact posted a spirited rally on Friday after Bernanke’s speech. This looks like a textbook case of ‘buy the rumour – sell the news’. The extremely heavy positioning against the USD in forex markets appears to be providing a floor for the greenback. Further, the uncertainty over the size and manner of QE2, together with the possibility that they will disappoint the very aggressive interventions the market is pricing in, may make it difficult for the USD to sell off further in the near term – at least against other G10 currencies.


UK inflation came in more or less as expected, as the headline number remains stubbornly above 3% at 3.1% YoY while the core eases a bit to 2.7% YoY. However, the Bank of England (with the exception of Mr. Sentance) appears to be looking past these near-term inflation numbers, very confident that inflation is only temporarily higher due to one-off effects from VAT increases and previous sterling devaluation. While it awaits further news on the size and timing of BoE’s QE2, GBP is happy to trade almost in lockstep with the euro, ending the week nearly unchanged against both the common currency and the greenback.

Other G10

The Japanese yen moved much as the rest of the G10 currencies did against the US dollar. ‘Buy the rumour – sell the news’ was in full effect in JPY trading, as the markets pushed the currency up to 15-year record highs just below 81 to the USD on Thursday, only to pull back sharply on Friday after Bernanke all but confirmed that QE2 will be forthcoming at the next Fed meeting. Meanwhile, the market ignored completely the increasingly frantic warnings from Ministry of Finance officials that the Japanese Government is unhappy with current JPY strength and will not hesitate to intervene again. After a fairly volatile week, the JPY eked out a gain of just under 0.5% against the USD.

The increasing correlation among G10 currencies was on dramatic display among the 3 dollar bloc currencies last week. All three moved essentially as one against the USD, a trend that was reinforced by the relatively light news flow out of Canada, New Zealand and Australia last week. Nevertheless, the level of correlation was astonishing, and all three ended the week up about 0.5% against the greenback.

The increased correlation story also made for a fairly dull trading week in the Scandinavian currencies. Neither the Norges Bank nor the Riskbank met last week, and both currencies traded in an extremely narrow range to end up essentially unchanged against the euro. Pretty much the same can be said of the Swiss franc, which barely moved at all during last week trading against the common currency.


Written by Tom Tong

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