A group from the FOMC
Gave speeches to help us to see
They all talked about
Their bond buying doubts
While ending it they could foresee
Clearly the biggest events yesterday were the speeches from regional Fed presidents Lacker, Plosser, Fisher and Williams, who all discussed the ending of the Fed’s $85 billion monthly bond purchases. While it was no surprise to hear this from the first three, who are confirmed hawks, Williams has been amongst the most dovish members of the Fed since his appointment, and this was really something quite new. The dollar’s response to this was to shake off the weak data from yesterday (something I clearly didn’t foresee) and end the day stronger, or at least at the top of its recent trading ranges. And the dollar’s strength continues unabated this morning, trading to new 11 month highs vs. the AUD, and pushing at those same trading range highs vs. the G3 currencies.
I believe the market is currently anticipating QE in the US to continue on toward the end of 2013 if not further. And in fairness, we have not heard an indication from Bernanke, Yellen or Dudley that they think the time for ending purchases is drawing near, but it is obviously the topic du jour at the Fed. And the market, rightly in my view, is reevaluating the dollar weakness story on the basis of a premature end to QE. Will they end it early? I have my doubts. After all, they have been quite explicit about achieving 6.5% unemployment before doing so, and despite recent gains there, we remain a long way away from that level. But the dollar will continue to benefit from these discussions, at least for a while longer. At some point, the market will expect action, otherwise, it will devalue the Fed speeches on the topic and diminish their ability to communicate their message effectively.
The overnight story was of PM Abe’s ‘Third Arrow’ speech, where he outlined further plans that his government plans to enact or encourage in order to keep Japan’s economy on the right track. These included fostering private domestic investment of ¥70 Trillion ($687 billion), a 10% increase on this year; tripling infrastructure exports by 2020; and doubling agricultural exports by 2020. Certainly, all those things would be of great value for the economy and help it on its way toward breaking the deflationary cycle in which it has been mired for more than a decade, but can the government do that? The first two arrows in Abe’s quiver were government actions, QE and fiscal expansion, and he has delivered as he said he would. Q1 GDP of 3.5% was proof positive that things were going in the right direction. But this is a much tougher process for the government to foster, given it is relying on private actors to achieve its stated goals. I hope he can do it, but it remains to be seen just how effective this part of the strategy will be. In the meantime, nothing has changed my view of a significantly weaker yen, especially given the prospects for the Fed ending QE sooner than previously expected. We are still heading to 105 in the summer, 110 by year end and perhaps further than that. Over time, achieving 125 is not an unreasonable target.
As I mentioned above, AUD continues to fall, as we see medium term holders of the currency unwind positions amidst the ongoing dovishness from the RBA and the modestly softer outlook for Chinese growth. CAD continues to lag in this process and I expect that this relationship will continue. Aussie has further to go, CAD less so.
In the emerging markets, we continue to see the story dominated by the USD price action, which means that the dollar keeps rallying against pretty much all of these currencies. There was precious little to drive things overnight, and movements here have all been quite modest, mostly in the direction of USD strength. This is likely to be the reality going forward.