Asset markets embrace QEII

'It does no good at all to just throw dollars from a helicopter,' says Brazilian finance minister

5th Nov 10, 10:12am by bnzeconomists

By Mike Jones

The NZD has been the strongest performing currency over the past 24 hours, for the second day running. From around 0.7800 this time yesterday, NZD/USD rocketed to within spitting distance of 0.8000 overnight.

Even on a trade-weighted basis, the currency is sitting around 29-month highs.

Yesterday’s FOMC decision got the ball rolling for the NZD/USD. Confirmation the Fed is restarting quantitative easing (QE) reinforced the downward pressure on the USD, sending most of the major currencies rollicking higher. Soon after, a surprisingly strong set of HLFS labour market figures lit a rocket under the currency. The 1.0% lift in employment in the quarter was double the 0.5% jobs growth expected by the market.

This pushed the unemployment rate down to 6.4%, lower than our (6.6%) and market (6.7%) expectations. In response, interest rate markets brought forward the timing of the next RBNZ interest rate hike to March (thereby siding with our expectations) further enhancing the yield advantage of the NZD. Indeed, NZ-US 3-year swap spreads jumped from 350bps to 26-month highs around 365bps.

Overnight, the NZD/USD continued on its path northwards as surging risk appetite bolstered demand for “growth-sensitive” currencies like the NZD and AUD.

Stock markets and commodity prices soared as investors bathed in the afterglow of the Fed’s US$600b QE policy. Global equity indices jumped 1.6-2.0%, oil prices rose 2.3%, and our risk appetite index (which has a scale of 0-100%) leapt to 71.7% – the highest since April 2010. Whether or not the NZD/USD can hold onto its recent gains will depend on how USD sentiment fares in the wake of tonight’s US non-farm payrolls report.

We suspect an undershoot of the market’s +60k jobs expectations would see a weaker USD propel the NZD/USD above 0.8000. Short-term support is eyed on dips towards 0.7890.

Majors

The USD plunged overnight, caught between the twin headwinds of sliding US bond yields and rising risk appetite, after the Fed pulled the trigger on “QE2” yesterday. Market sentiment has been cheered over the past 24 hours by yesterday’s Fed decision to buy an extra US$600b in long-term Treasury bonds in an attempt to stimulate the US economy.

Just about every asset market revelled in the promise of additional US stimulus. Stock markets soared, in many cases to flirt with 2-year highs. The FTSE, CAC 40 and DAX increased 1.8-2.0%, while US stock indices are up 1.3-1.7%. In commodity markets, oil prices jumped around 2% to 6-month highs around US$86.5/barrel, while the broader CRB commodity price index was up just over 2%. The VIX index (a proxy for risk aversion based on volatility of the S&P500) dipped from 22% to around 18.5%.

Global growth sentiment was further bolstered by more good news on the global economy. The JP Morgan Global Manufacturing PMI showed global manufacturing activity accelerating to 53.7 in October, from 52.5 in September. Buoyant risk appetite and surging equity markets encouraged investors to trim positions in “safe-haven” currencies like the JPY and USD, in favour of EUR, CHF, GBP, and AUD. USD sentiment was further knocked by another slide in US bond yields. 10-year Treasury yields fell around 8bps to below 2.5% after a surprise increase in US jobless claims (457k vs. 442k expected).

There were relatively few surprises from last night’s ECB and Bank of England meetings. Both left their key policy rates unchanged, with the BoE also leaving untouched its £200b asset purchase scheme. The confirmation of no extra QE measures from the BoE saw GBP/USD surge from around 1.6150 to nearly 1.6300. It’s worth noting, the Fed’s extra easing measures drew criticism from several quarters overnight.

This mostly reflects the likelihood the globe will now have to deal with a weak USD for longer. The Brazilian finance minister said “it does no good at all to just throw dollars from a helicopter" while an advisor to the PBOC said “the occurrence of another crisis is inevitable”.

The German and French economy ministers didn’t sound too impressed either. Looking ahead, whether or not the USD continues its slide will depend on the strength of tonight’s non-farm payrolls employment report. We suspect a weaker number than the 60,000 gain expected will see markets speculate on QE3, dragging the USD lower.

* Mike Jones is part of the BNZ research team.

All its research is available here.

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12 Comments

by Steptoe | 5th Nov 10, 11:04am 1288908294

The US, as they have done on previous occasions over the last 100 odd yrs, do what is in their interest with no concern to the rest of the world.

In the past they have created mass inflation around the world, the rear depression with their protectionist policies....imported NZ hi inflation in the Muldoon yrs (Muldoon wasnt perfect either)

Once again the US is taking a huge gamble with the international community....and I do not see it being pulled off once counties seriously start to look out for number one only.

Lets not forget China and their long term agenda to be a leading trading currency, they will not be sitting back quiet.

So watching oil prices, and bank lending rates, these will be the 1st 'public' signs of heading back in to an inflationary period similar to the late 70s early 80s...The only real question is if the US will pull it off and how serious the inflationary presures will be....will we see 8% to 10% mortgage rates or 20% to 30% again.???

by Nicholas Arrand | 5th Nov 10, 11:11am 1288908678

Eloquently put ..

"..all of the capital flows seeking to arbitrage this pricing volatility are still mediated by the same broken, ill-disciplined, risk-mad, sentiment-driven global market, which is itself beholden to the same global banks and other players that very nearly destroyed the world in the last cycle. (We don't) know how long the reflation will last. It could be killed by US housing, a sovereign default in Europe or a full-blown trade war any minute. It can only observe that we have learned nothing."

http://housesandholes.blogspot.com/

by Mark Thomson | 5th Nov 10, 11:53am 1288911216

As far as analyis goes, not a great deal here to take home. A nice summary of what has just happened in the last couple of days and a few sentences on propects for the next 24 hours, but no indication of any insight into more substantive and systemic issues that will drive currency market behavior in the medium to long term.

If QE2 really is inflationary as the weak USD seems to imply, what will the Fed do to US interest rates when that inflation actually shows up. What impact will that have on the NZ dollar and when?

Maybe bnzeconomists save the good stuff for their clients.

markmthomson.net

by wtf | 5th Nov 10, 12:22pm 1288912931

The Chinese have those supersonic Sunburn missles for dealing to US navy carriers. Surely there would be a temptation to put a couple into the side of the "QE2" if it wasn't for the financial MAD pact the major players seem to have created.

But if we don't now have trade and currency wars, it will be because the ruling elite in each country, and the bankers who underwrite them, are only acting in their own self interest and really are trying to screw the other 99% of us. How else can you explain the lack of action against those who caused the mess, who were bailed out and now get to start it all over again. It's like the Twilight Zone.

If you keep the peasants in a constant state of fear and anxiety, not to mention indebtedness, they have to work so hard to keep their heads above water, they have no time or energy to resist. None of it bodes well for the middle class.

by steven | 5th Nov 10, 12:38pm 1288913918

hmm...."none of it bodes well for the middle class", no indeed it does not....indebtness is to a degree of course voluntary....ie private debt.....now we are paying that down so instead that swapped to public debt that we cant avoid paying down as easily unless we vote in a Govn that defaults.....which I suspect is where we will go....the debt is owed overseas, once overseas doesnt matter, neither does the debt...coming round to the sooner the better....

regards

by powerdownkiwi | 5th Nov 10, 1:08pm 1288915698

Not surprising - the 'middle class' have been the most confident, uninformed mass for a long while. Pity that the media come by and large from that middle class - Joanne Black on yesterdays Panel being yet another example.

Debt-forgiveness en masse was first raised as an inevitability back about 2004-5 in the Peak Oil fraternity - what it does to relative values doesn't bear thinking about.

If there is a new Bretton Woods, and debt is wiped/parked, the environment would essentially be the underwriter. Of course, you don't need to eat, drink or breathe if you're wealthy enough....

I keep forgetting that....

by Nicholas Arrand | 5th Nov 10, 1:04pm 1288915442

"STIGLITZ: We Have To Throw Bankers In Jail Or The Economy Won't Recover"

by powerdownkiwi | 5th Nov 10, 1:21pm 1288916484

NA- perhaps we can cut them some slack? They were part of a system which has to grow, or die, It needed to consume resources at a growing rate to grow, and was always going to hit the wall.

It is entirely understandable that they tried to continue it, much as folk facing the receivers wait in hope just that bit too long. 'Tis human nature, and they - to be fair - had no training in alternatives.

Blame-shifting, witch-hunting, while satisfying on an animal level, don't and won't change the situation.

May you debt-free be.... :)

by steven | 5th Nov 10, 3:10pm 1288923011

Agree, it's more than just a banking problem.....multiple facets....while I see some comments on peak oil and its "a few years off yet" no one is as yet connecting the dots or publically admiting they have...once they do I wonder just how fast the protectionalism shutters come down.....mighty fast me thinks.....

for instance,

" We are already starting to see the same sort of rush into oil and resources that played such havoc in mid-2008, and may have been a key trigger for the Great Recession. There is a risk that this commodity shock will hit before QE stimulus filters through. "

So it was a financial crisis and not an energy one.....personally I think they have it backwards....but that seems to be a minority view....

regards

by steven | 5th Nov 10, 3:00pm 1288922448

"The atomic bomb, of course, is quantitative easing by the Federal Reserve. America has in effect issued an ultimatum to China and G20: either you stop this predatory behaviour and agree to some formula for global rebalancing, or we will deploy QE2 `a l’outrance’ to flood your economies with excess liquidity. We will cause you to overheat and drive up your wage costs. We will impose a de facto currency revaluation by more brutal and disruptive means, and there is little you can do to stop it. Pick your poison.

This is what QE2 means, though Fed officials prefer to talk of their “mandate” of supporting employment. It is nothing like QE1, which was emergency action to halt the economic free-fall of late 2008 and early 2009. This time the Fed is using QE as a long-term tool to manage America’s chronic ailments."

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/80540…

by powerdownkiwi | 5th Nov 10, 3:54pm 1288925665

Makes sense. They're down a couple of tricks, short-suited, leading the joker.

Big game, but....

by neco | 5th Nov 10, 6:12pm 1288933959

Here's one to watch. The Fed's worst nightmare... Ron Paul to chair Monetary Policy Subcommittee

http://www.examiner.com/finance-examiner-in-national/the-fed-s-worst-nightmare-ron-paul-to-chair-monetary-policy-subcommittee

Ron Paul in charge of Federal Reserve oversight?

http://www.politico.com/blogs/glennthrush/1110/Ron_Paul_in_charge_of_Federal_Reserve_oversight.html