QE, or not QE, that is the question:
Whether Bernanke will see fit to continue
Buying all the Treasury has to offer,
Or whether the Fed will not merely stop
But actually sell that which they already own
And by so doing, change the fortunes of both men and nations.
William Shakespeare could not have written a story with more drama than what is currently ongoing in the markets.
There once was a bearded old man
Of whom I was never a fan
In Congress today
What he seemed to say
Was QE has been a great plan
But then what he told every nation
Was QE might soon need cessation
The bond market tumbled
The dollar was given salvation
It has been a hectic twenty-four hours in the FX markets, and in markets in general, ever since Chairman Ben started his testimony before Congress. Leading up to that, the equity rally continued, the dollar was strong and bond’s had found stability. But the contrast between his written testimony, that it would be a while before there were any changes to Fed policy, and the Q&A responses that the FOMC has considered reducing the amount of QE within the next several meetings was too much for the market. Equities reversed course in the US, closing lower on the day, and bonds sold off pretty extensively as the prospect for a less aggressive Fed meant that investors would have to absorb all the Treasury issuance. The dollar rallied on this activity, especially against the yen, as the prospect of higher Treasury yields attracted Japanese investors.
And then Tokyo walked in. Things started quietly in Asia, right up until the release of the HSBC PMI numbers for Chinese Manufacturing, which at 49.6 were lower than expected and below the critical 50 boom-bust line. Signs of unexpected weakness in China were too much for the Asian markets to accept, and the Nikkei wound up falling 7.3% last night; USDJPY declined 1.6% and US 10yr yields fell about 10bps. Fear was suddenly back in vogue and with positions overextended, a sharp reversal in markets was the outcome. But remember this, in the broad scheme of things, Japanese equities have rallied 48% over the past 6 months and the yen has declined 22%, so this correction is just that, and likely nothing more. Is it painful? Clearly, for short term traders it has been difficult. But does it signal the end of the current trends? I firmly believe that the longer term trends remain intact, and that a weaker yen and stronger overall dollar will continue to be the way of the future.
Did anything else of note go on in the markets? Well, the EU leadership had a meeting yesterday in Brussels where they discussed the state of their Union. The outcome was that the austerity measures that have driven policy for the past 3 years seem to have lost favor almost universally, and now policymakers are looking for ways to get the economy growing again. Currently, the European Commission is forecasting a continuation of the current recession for 2013, with area growth to decline 0.4% on the year. The EU leadership seems to be shifting its collective focus on the rising unemployment situation, especially amongst the youth in Europe, and are now tasked with developing plans to help mitigate this problem. I have an idea, scale back employee union strength and allow companies to hire and fire as they need rather than have the government dictate the terms of all employment. I bet that would help solve some of their problems! But of course, that is not the European way, and so I expect we will see more government funded schemes to encourage the hiring of youth a la the Italian job sharing idea that was proffered yesterday. It is this type of regulatory nightmare that feeds the idea the euro cannot be successful as a currency in the long run. This morning, it has rallied marginally, but given the dollar’s general strength elsewhere (JPY excepted), I feel this gain will be forfeited soon enough. A lower euro is in our future.
The Swiss franc is weaker this morning as SNB President Jordan remains committed to weakening it further, and a growing number of market players believe that they will soon move the EURCHF floor up to 1.25 from its current level of 1.20. If I were the SNB, I would look to raise that floor to 1.30 since the market is clearly in the mood for a weaker CHF. But right now all remains speculation. I expect that the CHF will remain weak for now.
Finally, AUD suffered last night as well, at least initially, which should be no surprise given the weak Chinese data. However, in the intervening hours, we have seen the Aussie rally back to 0.97 and it is actually marginally higher than yesterday’s close. This has the feel of position unwinding rather than confidence in the Australian dollar, and I expect that AUD will continue its recent declining trend going forward. After all, if China is slowing to 7.0% growth, rather than the 7.5-8.0% that had been expected, will they continue to import quite as much coal and iron ore?
The thing to remember in markets as volatile as we are currently seeing is that this price action will stabilize again, probably pretty soon. So orders at your levels are better than trying to pick a top or bottom, as they are less stressful and easier to work with. I expect that today will remain pretty volatile, but that as we head into the Memorial Day holiday weekend, things will be much calmer by tomorrow.