We’re Not Gonna Stop With QE

Bernanke said, “Listen to me
We’re not gonna stop with QE”
I don’t understand
Why traders demand
More proof than they already see

While I grant that I am paraphrasing the Chairman’s words, I think that is the message he is trying to get across. Of course, once again I ask, how is it that tapering QE is not considered tightening, when increasing QE was considered easing of policy? If anyone can answer that question for me I would be most appreciative.

At any rate, as has been the case for the past many months, markets have responded aggressively to the latest words from Bernanke, this time accepting that there is no tightening of policy coming and so QE∞ remains infinite. The predictable results were for the Treasury market to rally, equities to rally and the dollar to fall. Perhaps surprisingly, the dollar seems to have been the biggest mover of the bunch, falling more than 1% vs. most of its major counterparts. So the euro is back above 1.30, the pound above 1.51 and USDJPY back below 100.

The euro is an interesting test case because at the same time that we have Chairman Ben saying the Fed is not about to start easing, we have Signor Draghi saying that ECB policy will be accommodative for “an extended period of time” (haven’t we heard that language before from the Fed?). So, who’s easy money is more important? Yesterday it was the Fed, the day before it was the ECB. And this, my friends, is why markets are so volatile. Central bankers around the world are going through a period of one-upmanship, and each time they speak, the market reacts to the latest comments. What we do know is that economic growth in the Eurozone continues to flounder amid an ongoing recession that shows no signs of ending. We also know that the picture in the US, while uneven, is much more encouraging. This is especially true in the Housing sector and in the recent employment data. So based on the old-fashioned idea of economic fundamentals driving things over time, I maintain my view that the dollar will outperform as the Fed will be tightening policy in some form far before the ECB. Does that mean the euro will tumble soon? Clearly not. But I maintain my view of 1.20 within a year.

Looking at the pound, we have a slightly different situation. BOE Governor Carney is clearly anxious to show that he can be creative and flexible when it comes to supporting the economy, and sounds almost anxious to ease policy further. But the improvement in UK data, which has been much better than expected, is preventing him from acting without tossing away any credibility he may have coming into the role. Over the course of the past month, all the PMI data was better than expected, Retail Sales were higher than expected as was IP. The employment data is improving and home prices are rising. Perhaps the only serious negative is that wage growth has been stagnant. Inflation remains above target but Carney has already indicated he is unconcerned with that for now. All of this leads me to believe that the BOE will not be easing policy further, but what Carney did say last week was that he was not going to tighten anytime soon, similarly to Draghi. So despite a more positive fundamental outlook, we have an essential promise from the BOE that they will not be tightening policy for a long time. Again, this contrasts with the Fed, which while not seeming to tighten immediately, is clearly past the inflection point from easing to tightening. Ultimately, the pound will continue its decline, perhaps slowly, but a move toward 1.45 seems reasonable over the next months, with an outside chance of going even lower.

Finally lets look at the yen. My gut about further action last night was wrong (although I ascribed only a 25% probability) and in fact comments were indicative that they BOJ is likely to stand pat at current policy settings for a while. They seem happy with the results so far as inflation expectations are picking up and their economic assessment has improved. It can be no surprise that USDJPY fell back below 100 after the meeting since there was no immediate impetus for either a stronger USD (based on Bernanke) nor a weaker JPY (based on Kuroda). As such, long USDJPY positions were unwound. Once again, lets look into the future and see what fundamentals indicate. On the US side, as already discussed, monetary policy is heading toward tighter not looser. On the Japanese side, while economic growth has been showing signs of picking up, the inflation expectations remain below their target of 2.0%, and the question is will they be able to achieve their aims in the stated timeframe of 2 years (probably about 21 months left). If anything, I expect that the BOJ will be forced to be more aggressive than they have already been as inflation continues to lag their target. So the long-term view remains for a weaker yen. I still like the election next week as the starting point for the next leg in yen weakness, but in any case, the yen has further to decline.

What I think we can look forward to over the coming months is more volatility as every central bank, both major and minor, tries to get across a nuanced message that they are in control. The problem will remain that they are not, and that the evidence over time will prove that, be it in rising inflation or non-existent growth.

Good luck
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