Rock bottom U.S. bond yields and weaker US$ look set to remain in place through to mid-2013

By Mike Jones

NZD

The US Federal Reserve has reloaded its easing bazooka, slamming the USD and pitching the NZD/USD to a fresh 9-month high above 0.8440. The 2012 high of 0.8471 now looms as the next target for the NZD/USD.

The key take outs from the Fed Statement this morning are that 1) Operation Twist will be replaced with $US85b worth of monthly asset purchases (comprising $45b of longer-dated US government bonds and $40b of MBS), and 2) the Fed will maintain its aggressive easing policy until the US unemployment rate falls below 6.5%. While there will be plenty of debate about how long this will take, it’s probably not a story for 2013.

So extremely accommodative US monetary conditions (rock-bottom US bond yields and a weak USD) look set to remain in place at least through H1 2013. This fits with our forecasts for a gradual weakening in the USD over the coming six months. 

The Fed’s confirmation the monetary spigots will remain open simply reinforced the ‘risk-on’ bias prevailing overnight. US equity markets are higher, commodity prices have rallied, and ‘safe-haven’ currencies are underperforming.

The NZD/USD, AUD/USD, and EUR/USD all strapped on gains of just short of ½ cent in the wake of the Statement.

Looking ahead, with negative USD momentum now further entrenched, a further push higher in the NZD/USD towards the 0.8471 2012 high looks likely.

However, note that the local OIS curve now has now moved to completely price out any chance of RBNZ easing over coming 12 months.

This suggests that NZD/USD support from rising NZ-US interest rate differentials (a key factor behind the past week’s rally) may have run its course for now.

There is a slug of second tier local data lined up for release today. None of it is likely to be particularly market moving. The BNZ PMI (10am NZT) will be most keenly watched, in particular to see if last month’s tentative return to expansionary territory (50.5 from 48.5) was sustained in November. November job ads, food prices, and consumer confidence data for December will also be released.

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Majors

The Fed didn’t disappoint this morning. QE4 in disguise was duly delivered, with the amount of asset purchases towards the upper-end of market expectations. The USD has been sold as a result.

The Fed will replace Operation Twist with US$45n of outright Treasury purchases, in addition to ongoing monthly purchases of US$40b worth of MBS. While this was broadly expected, the size of Treasury purchases is at the upper end of analyst easing expectations.

This has produced the expected knee-jerk USD selling, but interestingly not driven by lower US yields (which are actually higher post-Statement). This suggests the USD’s losses are more a result of ‘risk-on’ positioning.

This would also explain why USD/JPY (being highly sensitive to US yields) has barely moved. The S&P500 has climbed a further 0.5% in the wake of the statement to be up 0.7% for the night.

The new asset purchase scheme aside, the bigger surprise for markets has been a change to the Fed’s forward guidance. The Fed will no longer keep its cash rate exceptionally low until “mid-2015”. A data-based target will now be used.

The Fed will maintain accommodative monetary policy for as long as a) the US unemployment rate remains above 6½%, b) inflation is projected to be close to its 2% target, and c) long-term inflation expectations well anchored. An announcement to this end was expected, but not until next year sometime.

It’s tempting to think this guidance change will result in a Fed policy reversal earlier than mid-2015. After all, the unemployment rate is currently only 1.2 percentage points above the new target.

However, PIMCO’s Gross has put paid to some of this speculation, suggesting it will take 4-5 years of 200k monthly US jobs gains to get the unemployment rate down to the Fed’s new 6.5% target.

Note also that in the FOMC’s last set of projections, the jobless rate was forecast to remain above 6.5% until late 2015. The Fed will release new projections at 8am this morning, with Bernanke’s press conference to follow.

Looking ahead, this morning’s Fed easing, alongside optimism Greece will soon receive its long-awaited €34.5b bailout tranche (European finance ministers meet tonight to discuss), an upbeat mood on the fiscal cliff negotiations, and signs that Germany may suffer a mere slowdown rather than recession should all act to keep risk appetite perky and the USD heavy.

This is very much in line with our own big picture view and a key factor behind our forecasts for a gradually weaker USD into the end of this year and H1, 2013.

Near-term, we look for the EUR/USD to explore the upper reaches of the 1.3000-1.3200 range.

Other News:

*Eurozone industrial production falls 1.4%m/m in October (flat expected).

*UK ILO unemployment rate prints bang on expectations at 7.8% in October. Employment +40k vs. +45k expected.

*German CPI falls 0.1%m/m (1.9%y/y), as expected.

Event Calendar:

13 December: NZ PMI; US PPIs; US retail sales; US jobless claims;

14 December: JN Tankan; CH HSBC flash PMI; EU PMIs; US CPI.

All its research is available here.