By Roger J Kerr
While the FX markets have instantaneously reflected a higher probability of QEIII by the US Federal Reserve following the weaker than expected employment number last Friday, it is instructive that the US sharemarket did not rally on the news and the US bond market also failed to attract new buyers to push the yields lower.
The weaker USD currency value against all the majors was to be expected with the prospect of additional supply of USD’s coming into the market, however it seems the equity and bond market are not so sure about another outright quantitative easing being necessary or desirable for the US economy.
Therefore, the jump up in the Kiwi dollar to 0.8140 from 0.8000 may be very short-lived if other forces overtake QEIII as the driver of NZD and AUD direction.
China is running into the problem some foresaw as occurring - that is, the economic slowdown is more rapid than expected, however monetary stimulus in response has to be measured as inflationary pressures are rearing their head again. Therefore, downward pressure on iron ore, steel and coal prices may continue for a while yet, which is very negative for the Australian economy and Aussie dollar.
My reading of recent developments is that the China/Australia/RBA nexus will outweigh the US QEIII factor as an influence on the AUD and NZD, therefore this spike up on Friday in both currencies will be short-lived.
Assisting the view that the latest AUD and NZD appreciation against the USD will not last long is the position of the EUR/USD exchange rate at $1.2800. While the financial and investment markets have been buoyed recently by the ECB’s plans to buy Spanish and Italian Government Bonds (sterilised buying which means they do not pump extra money into the system), Europe’s sovereign debt problems are by no means miraculously resolved.
Watch for developments this week from German judges on the ESM, Dutch voters, IMF inspectors and/or Brussels’ regulators to derail some of the market optimism Mario Draghi has stimulated over this last week. Thus, I expect the European euphoria around bond buying to dissipate this week and realities set in which will pull the EUR/USD rate back to $1.2500 at least.
As to how Ben Bernanke will play it on Friday morning with the FOMC monetary policy changes, while QEIII is now rated a 60% probability, he is more likely to have an open-ended stimulus programme of US$70 billion per month for as long as it is needed; that is, no expiry date, therefore it could end as quickly as it started if the US economic data improves.
The global FX markets appear to have priced-in far too much in respect to the size and term of QEIII, they may be disappointed at the Fed’s package on Thursday.
For this reason I am picking the Kiwi to reverse rapidly back to 0.8000/0.7900 in the short-term.
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* Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com
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