Downbeat Fed introduces 'QE II lite'

Downbeat Fed introduces 'QE II lite'

By Mike Jones

It’s been a wild ride in the NZD over the past 24 hours. Having hit a three week low below 0.7200 at one point during the night, a late plunge in the USD saw NZD/USD rebound to around 0.7250.

The first part of the night was all about rising risk aversion. A sea of red in Asian equity markets yesterday set the scene. Yesterday’s Chinese trade balance data failed to impress, and there was little to get excited about from the Bank of Japan’s interest rate announcement. No new stimulus measures were announced, despite the worsening deflation outlook. Asian stocks slipped 0.5-2.9%, with the negative sentiment dragging European and US stocks lower in tandem.

Against a backdrop of weak equities and subdued risk appetite, investors shunned ‘growth-sensitive’ currencies like the NZD, and NZD/USD was dragged from 0.7290 to below 0.7200.

All eyes this morning were on the US Federal Reserve, and whether additional measures to prop up the ailing US economy would be announced. The Fed indeed delivered, announcing quantitative easing ‘light’ – a scheme whereby maturing Fed bond purchases will be reinvested. It’s not an easing in monetary policy per se, more of a ‘top-up’. After a decidedly downbeat night, the Fed’s announcement provided some welcome cheer for financial markets.

US equities pared earlier losses (the S&P500 is currently down 0.4%) and risk aversion eased. This, combined with a slide in the USD in the wake of the Fed’s announcement, saw NZD/USD recover to almost 0.7250. Looking ahead, while the outlook for the US economy has clearly worsened of late, we don’t think a ‘double-dip’ recession is likely at this stage.

As such, a repeat of the kind of USD weakness seen through 2009 looks unlikely, and our view the peak in NZD/USD is behind us remains in tact. In the short-term, market attention will shift to today’s plethora of Chinese data. Initial support on NZD/USD is seen towards 0.7200, with resistance at 0.7340.

Majors

The Federal Reserve struck a much more downbeat tone in this morning’s FOMC policy statement. The cautiously optimistic tone of previous statements was gone, replaced with “the pace of recovery in output and employment has slowed in recent months”. Not surprisingly, the Fed retained its view zero interest rates are warranted for an “extended period”. But the real focus for markets was on the Fed’s introduction of quantitative easing ‘light’.

The Fed agreed to begin re-investing proceeds from maturing mortgage-backed securities in Treasury bonds. So not an easing in monetary policy per se – more of a stimulus ‘top up’. Indeed, the scheme avoids the alternative of a mild contractionary force on the US economy from a natural shrinking in the Fed’s balance sheet. Given earlier speculation about the introduction of QE ‘light’, the market reaction was not as wild as it might have been. 10-year US Treasury yields slipped around 4bps, while 2-year yields ended the night broadly unchanged.

The USD index dipped around 0.8%, but it’s notable that this only got the USD back to where it started the night. Indeed, the post FOMC gains in EUR/USD, GBP/USD, AUD/USD simply returned them to levels prevailing this time yesterday. The only exception was USD/JPY, which finished the night down 0.7% around 85.20. Prior to the FOMC meeting, the USD had been on the ascendancy.

Rising risk aversion encouraged demand for “safe-haven” currencies like the USD and JPY, amid escalating worries about slowing momentum in the global economy. A near 3% slump in the Shanghai Composite index dragged Asian equity markets lower yesterday after a disappointing read on China’s trade balance (Chinese imports increased 22.7%, compared to the 30% expected).

The negative sentiment soon flowed through to European and US equity markets. European bourses dived 0.9-1.2%, unwinding part of yesterday’s gains and US stocks opened down roughly 1.5%. However, the announcement of more support for the economy from the Fed saw the S&P500 pare its losses to around -0.3% late in the session.

Looking ahead, we suspect this morning’s more dovish Fed statement will keep the USD on the defensive in the short-term, as markets push back the timing of eventual Fed tightening. Resistance on the USD index will be found towards 81.40, with initial support at 80.25.

* Mike Jones is part of the BNZ research team. 

All its research is available here.

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