Tag Archive | "Liquidity"

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China And US Data Boosts Markets

China started the new year with a surge in exports, imports and available credit. The results are welcomed by an anxious international community. The news comes with a warning that inflation may be looming in the world’s second biggest economy.

Exports – Registered 25 percent higher than in January 2012 surpassing analyst’s projections by a whopping 8 percent.

Imports – Spiked up 23.8 percent, 5.5 percent above projections.

Trade Surplus – The trade surplus in January came in at $29.2 billion, 7.2 percent above projections.

New Loans – January’s new loans came in at $172 billion, twice the volume of loans issued in December.

Social Financing – Social lending is a measure of liquidity and the January figure of 2.54 trillion yuan cruised past the December figure of 1.63 trillion yuan.

Economists approached these figure with caution suggesting that the impact of the Lunar New year may be partially responsible for the gains in year-over-year comparisons. Last year the Lunar New Year was celebrated in January. This year the holiday was in February.

China’s growth had suffered of late. After seven quarters of an economic slowdown, the pace began to pick up in the fourth quarter. While economists are cautious, the consensus is that China is in a solid recovery mode.

The rise in exports is especially gratifying. The majority of shipped products were sent to the US and to the European Union. Exports to the US increased by 14.5 percent over January 2012. EU exports rose by 5.2 percent, the highest rate in the last 13 months.

The January inflation rate shed 0.5 percent settling at 2.0 percent after moving to a seven-month high of 2.5 percent in December. Economists have predicted a 3.5 percent rise in inflation in China during 2013.

The People’s Bank of China explained its posture;”As the economy transits into another stage of growth, economic controls need to always emphasize containing inflation risks.” Food prices in January increased 2.9 percent.

China continues to provide many goods to the South East Asian Nations (ASEAN). In 2012, exports to these nations rose 48.6 percent to $20.1 billion.

US Revisions   

New data suggests that the US economy did not recede in the fourth quarter 2012. Original figures showed a contraction of 0.1 percent.

The US trade deficit closed the gap to the best level since 2009. In December, the export-import gap lowered to $38.5 billion, well below projections. In 2012, the US trade deficit fell by 3.5 percent to $540.4 billion.

Barclays reported that with changes to existing inventories and the new trade figures GDP expanded about 0.3 percent in the fourth quarter.

The US still imports more goods than it exports but areas where the country reduced imports are in the important petroleum sector. In 2012, the imports of petroleum fell to the lowest rate since 1997. In December, increased output of oil and gas and petroleum products increased by $1 billion establishing a new high standard.

The US also closed the gap between import and exports to China in December. As the US imported less, the gap closed by $4.5 billion. The Commerce Department reported that unsold wholesale products fell to 0.1 percent. Projections indicated a 0.4 percent rise.

On the news, the USD moved up against the euro to 1.3360.






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US Progresses, Euro Soars

A number of economic reports showed a positive trend for the recovering US economy while actions from the ECB raised the euro above the 1.35USD benchmark. The Labor Department reported that initial claims for unemployment last week rose by 38,000 to 368,000. This figure comes on the heels of a week where new claims were at their lowest level in five years. This figure was slightly above analyst’s projections but well within a range to suggest the paper-thin recovery had momentum.

Employment has been robust in January with 160,000 new jobs already filled. The total for December was 155,000.

Perhaps the most interesting and positive fact is the increase in personal income on December. The Commerce Department reported that personal income rose by 2.6 percent in December. This figure far surpassed the projected 0.8 percent gain.

However, much of this gain may be attributable to advance payments made by US corporations prior to December 31, the end of the tax year when Tax policy was unclear. Consumer spending fell just short of expectations rising by 0.2 percent.

Importantly, planned layoffs declined in December. This is the first decline in four months. December job cuts totaled 32,556, a sharp decline from November’s 57,081 job cuts, a 41 percent improvement.

Euro Continues Surge Against Dollar

The euro continued an impressive upward trend against the dollar as the European Central Bank (ECB) said that 137 billion euros would be repaid to the bank on the earliest due date. These payments are in the bank’s three-year loan program.

President Mario Draghi’s aggressive three-year loan program is credited with stabilizing the banking and credit crisis in the euro zone. The ECB will announce its second payment date on Friday. This will allow banks to properly assess their capital needs and liquidity.

The move to repay suggests that the borrowing banks have stabilized and that they have sufficient liquidity to meet their operating costs. The repayment is likely to be interpreted as an endorsement for higher interest rate, a consideration the ECB will likely determined after the next tranche.

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Euro Roars Back

On Tuesday, euro zone banks borrowed fewer euros than was borrowed last week from the European Central Bank (ECB). The total of the ECB’s weekly loan program was 124 billion euros less than the previous week. Coupled with the news that banks would be prematurely repaying the ECB 137.2 euros in emergency three-year loans, the currency rate moved higher. Euro Zone banks appear to have made great strides toward solvency.

When encouraging data from Germany was reported, the euro rose to 4-year highs against the dollar and yen Tuesday morning. Overall, there is more stability in the region than has existed since 2008.

The rise comes in advance of Wednesday’s release from the ECB about the demand for three-month loans. Industry analysts expect euro zone banks seeking liquidity will need about 10 billion euros for the three month cycle.

Overall, the banking news from the euro zone shows promise. The three-year loan scheme has been credited with stabilizing the region’s banks through 2011 and 2012. In this more liquid environment, three-year funding costs are expected to rise.

Wednesday is the first day that banks are eligible to repay the initial loans on a weekly basis. The second level of reduction is due on February 27.

Euro Gaining

The euro reached 14-month highs against the USD and yen on Tuesday.  Positive banking news and strong data from Germany were the primary rallying points. However, the euro gained more strength when US consumer confidence improved. The euro zone and EU rely on US consumer confidence to spur exports.

Germany’s positive manufacturing data and the banking progress have boosted the euro to impressive, steady gains. The trend has been upward since the fiscal cliff negotiations in the US resulted in a meaningless effort at conciliation between the two political parties.

It is expected that the US Federal Reserve will continue its quantitative easing scheme well into 2013. This aggressive easing policy will further weaken the USD. The Fed will commence a two-day meeting on Wednesday and analysts are anxiously awaiting new policy changes. With 11 million Americans unemployed, the Fed is unlikely to rock the boat.

The euro hit $1.3493 in morning trading. That marks the highest level since December 2011. Meanwhile, the dollar slipped 0.3 percent to 90.60 yen. This trend is contrary to analyst’s projections. There appears to be demand for the yen at 88 yen–to-dollar.




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ECB Holds Rate, Euro falls

While Washington continues to embarrass the world’s largest economy, the ECB released a dismal projection for the euro zone economy in 2013. The forecast has the ECB considering an interest rate cut to help countries trim their borrowing costs. Bad economic news in Europe spells big trouble for American business, which ships more products to the region than any other area.

In meetings with the ECB’s Governing Council, President Mario Draghi entertained a discussion about not only paring interest rates but also about cutting the deposit rate. In the end, the ECB took no action but Draghi is holding the door open on both possibilities. The historically low lending rate of 0.75 percent remains in effect. This rate has prevailed for the past five months but has not done much to fuel economic growth.

The ECB reported their projections for the euro zone showing that Gross Domestic Product (GDP) would fall between -0.9 and +0.3 percent in 2013. In a region that definitely needs growth, hopes are dim.

Berenberg Bank spokesperson Holger Schmieding told reporters, “The somewhat downbeat ECB forecasts, the somber tone of the ECB statement and Draghi’s admission that the ECB had a ‘wide discussion’ over many issues including a potential rate cut also keep the door open for a cut in early 2013.”

The euro zone and European Union have watchful eyes on the Fiscal Cliff negotiations, or lack thereof. As an importer and exporter, the US negotiations are making analysts work overtime to figure the repercussions of the US debt negotiations. The euro zone is clearly counting on the world’s largest economy to be running at optimum speed in 2013. A failure to do so would not only put the US in recession but would have the same effect on the euro zone and other economies.

One positive outcome of the ECB meeting was that Draghi indicated that the bank would continue to supply euro zone banks with necessary liquidity through the middle of 2013.

Now that the European Union and the IMF have taken action to help Greece, the ECB will be challenged to navigate through a regional recession. Inflation is expected to rise between 1.1 and 2.1 percent in 2013.

Euro zone interest rates vary greatly in the 17 nations. The ECB hopes that its continued reduced rates will stabilize nationals lending rates and reduce them as much as possible. But, like the US where corporations are sitting on more than $2 trillion in capital reserves, euro zone businesses are hoarding their cash. They remain unconvinced that the region’s debt crisis will settle and are prepared for worst case scenarios.

The euro zone’s most puzzling dilemma is Spain. The country is suffering 25 percent unemployment and is in the midst of national outrage and even threats of secession. The ECB has a new debt relief program called the Outright Monetary Transactions (OMT). Under this mechanism, Spain could receive funding assistance.

However, Prime Minister Mariano Rajoy must apply to the euro zone for assistance. Rajoy has asked Draghi to guarantee that borrowing costs would not increase, a commitment Draghi cannot make. Spain would be the first nation to use the OMT.

In the euro zone, the political dialogue has lessened. In the US, Republicans have walked out of Congress and Washington. Talks appear to be stalled and the fiscal cliff is becoming a little too real for Americans.

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Great Britain Not Waiting

Faced with a deepening recession and ever increasing unemployment, Great Britain is not waiting for the euro crisis and elections in Greece to deploy anti-recession tools.  Referring to the euro zone debt crisis as a “black cloud” which threatens the UK, Bank of England Governor Mervlyn King announced a plan to flood the country’s banks with low interest funds which the central bank hopes will be used to encourage borrowers and jobs.  King also said the Bank of England would activate an emergency liquidity tool.

Treasury officials revealed a separate plan that new funding would support up to 80 billion pounds in new loans. The Bank of England contributions will amount to 5 billion pounds per month for six-months.  King said the 110 billion pound injection should be used by businesses and civilians to “batten the hatches” before the crisis hits.

Finance Minister George Osborne supported echoed the global message that the euro zone put politics aside and solve the deepening crisis. Osborne stressed that the UK was not powerless to defend its economy or people.  Britain has not overcome the 2007-2008 recession that forced the Bank of England and Treasury to bailout the Nation’s banks.

Osborne has been criticized for implementing deep austerity cuts that have affected every walk of life in Britain. However, Osborne stated his case on Thursday saying that it was the austerity cuts that enabled the central bank to be able to assist in the current recession.  The austerity plan has come up a little short as the budget still runs at about a deficit equal to 8 percent of GDP.

Osborne and King have jointly developed strategies to spur growth, indicating that there is more assistance to come.  In the next few weeks, the BoE will be offering 3-4 year below current rate loans to the country’s banks. These loans will only be available to banks that have increased their lending to businesses and households.

The BoE will also commence using funds in the Extended Collateral Term Repo (ECTR) facility to help banks deal with liquidity issues caused by distressed loans. This facility was created in December for the specific purpose of offering banks six month relief from troubled loans.

In another area, King also hinted that there was a strong possibility of resuming quantitative easing, which was halted in May after the BoE had purchased 325 billion pounds in UK bonds.

While King emphasized the risk of the euro zone, he failed to mention that Britain’s economy is struggling with a new recession started in 2012. Britain’s Office for National Statistics reported that the trade deficit increased to 10.1 billion pounds in April 2012. This mark is the largest trade deficit since January 1988.  The biggest export gaps were recorded in the fields of chemicals and autos. Great Britain squeezed out a 0.1 percent growth 9in the first quarter of 2012 which appears to have been wiped out in the second quarter.

The Treasury and BoE moves have utilized the three weapons that Britain has moves available.  The first is the six-month liquidity loans issued by the Indexed Long-Term Repo (ILTR).  Through the Discount Window Facility (DWF) banks can swap stressed collateral for gilts for as long as one year.  The third tool is the Extended Collateral Term Repo facility which provides up to three years of financing for distressed assets which could come into play if Greece fails.

If Greece were to fail, the BoE has a large weapon, the UK Treasury’s Credit Guarantee Scheme, in reserve.  This plan was used to bailout banks to the tune of 250 billion pounds in 2008.  The majority of these funds have been repaid so this would be a stop gap available if Greece puts the nation’s banks under extreme pressure.



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ECB Cuts Off Greek Banks

Exhausted by the political and financial theater that has been dominating world markets, the European Central Bank (ECB) made a decisive move on Wednesday.  The ECB cut off assistance to certain Greek banks that have remained undercapitalized.  The ECB offered no further comment.

According to its mandate, the ECB cannot help banks that are insolvent. This move will force the Greek banks needing assistance to apply with the Bank of Greece for Emergency Liquidity Assistance (ELA). An unconfirmed report indicated that four bans were affected.

Meanwhile, President Karolos Papoulias released a statement declaring that Greeks were withdrawing their funds due to the tenuous political and financial drama. The country is divided whether to stay in the euro zone and abide by the terms of their bailout funding or withdraw from the euro zone and euro currency and default on their stated obligations.

After Tuesday’s last ditch effort to form a coalition government failed, the President named Judge Panagiotis Pikrammenos to serve as interim Prime Minister.  Another national election will be held in mid-June.

On a broader scale, the fate of Greece may mark the end of the single currency for Europe.  The region is deeply divided on the value of austerity versus growth.

The euro zone and European Union members have said that if Greece does not honor its commitments the country will have to stand alone.  This is not what Greeks who have been there and experienced life without the euro favor.  However, Alexis Tsipras, the leader of the radical left’s SYRIZA party has promoted a position that calls for re-negotiations of the terms for existing bailout funding and for Greece staying in the euro zone. If you can believe what you hear, the EU and IMF have vowed this cannot happen.

There is some merit to Tsipras’s plan. He advocates growth.  He appeals to the young voters and older, disillusioned voters who have no work and who have seen the value of their pensions drained.  The strength of his case is the fact that the biggest investors in Greece are France and Germany, the top 2 economies in the region.

The IMF’s Christine Lagarde warned the European Union to choose between giving Greece more time to sort through its political hodgepodge or prepare for the exit of Greece.  This would be a significant loss for struggling France and fragile Germany.

Spain’s Prime Minister Mariano Rajoy said that he wanted to keep Greece in the euro zone. He said that if Greece fell, Spain would be next.  In early Wednesday trading, Spanish and Italian bonds climbed above the treacherous 6 percent yield barrier. The world has heard too much about this region.  Investors are nervous and moving to US equity and bond markets.

Can there be any surprise here? In one of Greece’s most unnerving statements, the former President had to admit that Greece had cooked the books to gain membership into the euro zone.  Their original application was declined.  Greece does not see the world through the same lenses that Germans wear.

Hollande Meets Merkel

France’s new President, Francois Hollande, met German Chancellor Angela Merkel in what promised to be an interesting dialogue about austerity vs. growth.  Merkel was supportive of Nicolas Sarkozy’s run for another term.  That was one area of tension.

But the real tension should have been over their differing opinions about austerity cuts and growth as a means to an end of the euro zone crisis.  Hollande had run on a platform of growth, not austerity.  He had also said he would review France’s trade alliances, which the French feel are not to their advantage.

Hollande said on Wednesday that he wanted to re-negotiate previously agreed upon terms. Hollande said he drew confidence because Germany and France have overcome long odds before.

After their initial meeting, Merkel seemed to soften her rigid posture.  Growth has to feed through the people. That’s why I am happy that we will discuss different ideas on how to achieve growth,” said Merkel.

For more than a year, the euro zone leaders have mnaged to spin their plight.  Chalk Merkel-Hollande up as one more positive spin on what is already a frosty relationship that cou

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Emerging Market Currencies Still Look Good for the Long-Term

In my previous update on emerging market currencies, I wrote that in the short-term, it’s important not to lump them all together; high-yielding currencies must be distinguished from low-yielding ones. In this post, I’m going to backpedal a bit and argue that over the medium-term and long-term, emerging market currencies as an asset class are still a good bet.

Most emerging market central banks have already begun to tighten monetary policy in order to mitigate against runaway inflation, overheating economies, and asset bubbles. You can see from the chart above (where a dark shade of green signifies a higher benchmark interest rate) that the overwhelming majority of high-yielding currencies belong to emerging market economies. (In fact, if not for Australia, it would be possible to say all high-yielding currencies).

While industrialized central banks are also expected to begin tightening, the timetable is much less certain, due to slowing growth, high unemployment, and low inflation. If current trends continue, then, interest rate differentials should only widen further between industrialized currencies and emerging currencies. Without taking risk into account, the most profitable carry trade will involve shorting the lowest-yielding currency against the highest-yielding currency(s). Alas, liquidity must also be taken in account, and the Angolan Kwanza – with an interest rate of 20% – is probably not a viable candidate. As one fund manager summarized, “[If] we feel like it’s a country where if we exit we are sort of going to shoot ourselves in the foot [due to lack of liquidity], then we won’t go in the first place.

Over the long-term, meanwhile, emerging market currencies will receive a boost from two related forces: strong fundamentals and capital inflows. With regard to the former, emerging market economies already account for the lion’s share of global GDP growth. The World Bank projects that over the next 15 years, emerging market economies will collectively expand by 4.7%, compared to 2.3% in the developed world. As a result of this strong growth, combined with fiscal prudence, debt levels across the developing world are generally falling. It marks a significant reversal that none of the current sovereign debt crises involves an emerging market country. What is more amazing is that some emerging market economies (Mexico, Russia, and Brazil) that struggled with bankruptcy less than a decade ago now have investment-grade credit ratings!

As a result, capital flows into emerging markets should continue to surge. Even though emerging market equity and bond funds have witnessed record inflows over the last few years, portfolio allocations still remain extremely low. For example, “U.S. defined-contribution pension plans only have 2.1% of their funds allocated to developing economies, which make up nearly 50% of global GDP.” Emerging market bonds, meanwhile, account for an estimated 1% of total assets under management. This trend will be further reinforced by domestic investors, which will probably opt to keep more capital in-country.

Of course, the risks are manifold. First of all, there is a risk that these capital inflows will provoke a backlash. “Emerging countries have adopted a broad range of measures to regulate inflows and stem currency rises, increasingly resorting to capital controls and so-called macro-prudential measures such as credit curbs.” Now that they have the blessing of the IMF, emerging market currencies might conceivably be more audacious in trying to limit currency appreciation. On a related note, there is also the possibility that emerging market central banks will fall behind the curve, perhaps deliberately. Lower-than-expected interest rates and hyperinflation would certainly dent the attractiveness of going long such currencies.

Finally, it is possible that in all of their excitement, investors are bidding up emerging market assets to bubble levels. The Wall Street Journal recently reported, for instance, that commodity prices and emerging market currency returns have become strongly correlated. Given that many of these countries are in fact net importers of energy and raw materials, this shows that emerging market currencies are rising more in proportion to risk appetite than to economic fundamentals. If when this risk appetite ebbs, then, this could send emerging market currencies crashing.

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Has the Swiss Franc Reached its Limit?

The second half of 2010 witnessed a 20% rise in the Swiss Franc (against the US Dollar), which experienced an upswing more closely associated with equities than with currencies. It has managed to entrench itself well above parity with the Dollar, and has become a favored destination for investors looking for a safer alternative to the Euro. Still, there are reasons to wary, and it could be only a matter of time before the CHF bull market comes to a screeching halt.

The forces behind the Franc’s rise are easily identifiable. It basically comes down to risk aversion. While it can’t compete with the Dollar and Yen – its main safe haven rivals – in size and liquidity, it benefits from its perceived economic and fiscal stability, as well as through contradistinction with the surrounding Eurozone. In fact, the Franc’s rise against the Euro has been even steeper than its rise against the Dollar. As the Eurozone crisis radiates further away from Greece, Switzerland has come to seem more like an island in a sea of chaos.

Even an abatement in the EU storm has failed to produce a Swiss Franc correction. That could be because the bad news coming out of Europe seems to be never-ending; one country’s rescue is followed by the downgrade of another country’s sovereign credit rating and warning of imminent collapse. In addition, even as investors have embraced risk-taking, they still remain prone to sudden backtracking. Thus, the Franc has been one of the primary targets of risk-averse capital fleeing the Egyptian political turmoil.

Capital controls and intervention have scared investors away from some currencies, but the Swiss National Bank (SNB) lacks the credibility afforded to other Central Banks. The SNB lost $25 Billion in 2010 in a vain effort to hold down the Franc, and currency investors believe that it has neither the stomach nor the mandate to engage in a similar loss-making campaign in 2011. Besides, the Swiss economy has held up remarkably well, and the trade surplus has actually widened in the face of currency appreciation. The markets might be keen to test the limits of the Swiss export sector, in much the same way that they have challenged Japan by pushing up the Yen.

Still, their are limits to high the Franc can rise, and it appears that I’m no longer the only analyst who thinks it’s undervalued. Don’t forget- the Swiss economy is comparatively minuscule. Its capital markets can absorb only a small fraction of the inflows that the US and Japan can handle, and the Swiss Franc represents a mere 3.5% of all foreign exchange volume, 12 times less than the US Dollar’s share. In other words, it’s only a matter of time before investors run out of Swiss assets to buy, at which point they will have to decide whether to accept short-term returns of 0% in exchange for capital preservation and financial security. My bet is that they’ll walk.

Of course in the short-term, it’s possible that a handful of risk-averse investors will continue to steer capital towards Switzerland, and/or that another mini political or economic crisis will trigger a spike in risk-aversion. When investors once again look at fundamentals, they will be forced to reckon with the Franc’s 40% appreciation over the last five years, and probably conclude that perhaps it was a bit much…

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Japanese Yen Down on Risk Aversion

It seems the gods of the forex market read my previous post on the Japanese Yen, in which I puzzled over the currency’s appreciation in the face of contradictory economic and financial factors. Since then, the Yen’s 6-month, 15% appreciation (against the US Dollar) has arrested. It has retreated from the brink of record highs, and undergone the most significant correction since March of this year. Have investors come to their senses, or what?!

You certainly can’t give the Bank of Japan (BOJ) any credit. Aside from its single-day $25 Billion intervention in September, it hasn’t entered the forex markets. In fact, it has already repaid the funds lent to it by the Ministry of Finance, which suggests that it doesn’t have any intention to replicate its earlier intervention in the immediate future, regardless of where the Yen moves.

Perhaps the BOJ foresaw the current correction in the Yen, which was probably inevitable in some ways. After all, Japanese interest rates – while gradually rising – still remain at levels that are unattractive to investors. While US short-term rates are low, long-term rates are more than 1.5% higher than their Japanese counterparts. When you factor in that Japan’s fiscal condition is worse than the US, there is really very little reason, in this aspect, to prefer Japan. As one analyst summarized, “The whole interest-rate differential argument is turning out to be dollar supportive, at least in the near term.”

The same is true for risk-averse capital. For reasons of liquidity and psychology, the Japanese Yen will continue to be a safe-haven destination in times of distress. Still, it’s hardly superior to the Dollar, in this sense. Inflation is slowly emerging (or at least, the risk of deflation is slowly abating) in Japan, and it could conceivably reach 1% this year if the Bank of Japan has its way. Its proposed 35 trillion yen ($419 billion) of asset purchases dwarfs the comparable Federal Reserve Bank’s QE2 program (in relative terms) and contradicts the notion that the Yen is the best store of value.

Japan Economic Structure - Dependence on Exports
Finally, the Japanese economy remains weak, and vulnerable to a double-dip recession. On the one hand, “Japan’s economy expanded at an annual 4.5 percent rate in the three months ended Sept. 30.” On the other hand, its economy remains heavily reliant on exports (see chart above, courtesy of Bloomberg News) to drive growth, which is complicated by the expensive Yen and concerns over a drop-off in demand from China and the rest of the world. In fact, “Exports rose 7.8 percent in October, the slowest pace this year, while industrial production fell for a fifth month and the unemployment rate climbed to 5.1 percent.” In addition, the closely watched Tankan survey registered a drop in September, “the first fall in seven quarters.” While Japanese companies are still net optimistic, analysts expect that this to change in the beginning of 2011.

For the rest of the year, how the Yen performs will depend largely on investor risk-appetite. If risk aversion predominates, then the Yen should hold its value. In addition, it’s worth pointing out that even as the Yen has fallen against the Dollar, it has appreciated against the Euro, and remained flat against a handful of other currencies. Against the US Dollar, however, I still don’t see any reason for why the Yen should trade below 85, and I expect the correction will continue to unfold.

JPY comparison chart 2010

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QE2 Weighs on Dollar

In a few weeks, the US could overtake China as the world’s biggest currency manipulator. Don’t get me wrong: I’m not predicting that the US will officially enter the global currency war. However, I think that the expansion of the Federal Reserve Bank’s quantitative easing program (dubbed QE2 by investors) will exert the same negative impact on the Dollar as if the US had followed China and intervened directly in the forex markets.

For the last month or so, markets have been bracing for QE2. At this point it is seen as a near certainty, with a Reuters poll showing that all 52 analysts that were surveyed believe that is inevitable. On Friday, Ben Bernanke eliminated any remaining doubts, when he declared that, “There would appear — all else being equal — to be a case for further action.” At this point, it is only a question of scope, with markets estimates ranging from $500 Billion to $2 Trillion. That would bring the total Quantitative Easing to perhaps $3 Trillion, exceeding China’s $2.65 Trillion foreign exchange reserves, and earning the distinction of being the largest, sustained currency intervention in the world.

The Fed is faced with the quandary that its initial Quantitative Easing Program did not significantly stimulate the economy. It brought liquidity to the credit and financial markets – spurring higher asset prices – but this didn’t translate into business and consumer spending. Thus, the Fed is planning to double down on its bet, comforted by low inflation (currently at a 50 year low) and a stable balance sheet. In other words, it feels it has nothing to lose.

Unfortunately, it’s hard to find anyone who seriously believes that QE2 will have a positive impact on the economy. Most expect that it will buoy the financial markets (commodities and stocks), but will achieve little if anything else: “The actual problem with the economy is a lack of consumer demand, not the availability of bank loans, mortgage interest rates, or large amounts of cash held by corporations. Providing more liquidity for the financial system through QE2 won’t fix consumer balance sheets or unemployment.” The Fed is hoping that higher expectations for inflation (already reflected in lower bond prices) and low yields will spur consumers and corporations into action. Of course, it is also hopeful that a cheaper Dollar will drive GDP by narrowing the trade imbalance.

QE2- US Dollar Trade-Weighted Index 2008-2010
At the very least, we can almost guarantee that QE2 will continue to push the Dollar down. For comparison’s sake, consider that after the Fed announced its first Quantitative Easing plan, the Dollar fell 14% against the Euro in only a couple months. This time around, it has fallen for five weeks in a row, and the Fed hasn’t even formally unveiled QE2! It has fallen 13% on a trade-weighted basis, 14% against the Euro, to parity against the Australian and Canadian Dollars, and recently touched a 15-year low against the Yen, in spite of Japan’s equally loose monetary policy.

If the Dollar continues to fall, we could see a coordinated intervention by the rest of the world. Already, many countries’ Central Banks have entered the markets to try to achieve such an outcome. Individually, their efforts will prove fruitless, since the Fed has much deeper pockets. As one commentator summarized, It’s now becoming “awfully hypocritical for American officials to label the Chinese as currency manipulators? They are, but they’re not alone.”

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