Dollar Firm, but the Pound is Sterling

The US dollar is still consolidating/correcting its recent decline against most of the major currencies today. The notable exception is the British pound, where a considerably stronger than expected initial estimate of Q3 GDP (0.8% quarter-over-quarter vs 0.4% consensus) and an upgrade in its sovereign rating to stable from negative has bolstered the currency. The data would seem to undermine the prospects a new round of asset purchases this year.

After underperforming in recent weeks, sterling began playing a bit of catch-up yesterday is firmer across the board today. The euro found support ahead of $1.39 in early Asia, but after being turned back from the foray above $1.40 yesterday, continued range trading is the most likely scenario. Stops are thought to be below $1.3880 now.

The Swedish krona is the weakest currency today (off about 1% against the dollar) following the Riksbank’s guidance toward a slower monetary policy trajectory after the hiking rates the third time since July. Emerging market currencies appear to be in a consolidative mode.

The prospect of QEII in the US remains a key market focus. While there is nearly universal opinion at the Fed will announce new long-term asset purchases next week, but there remains great uncertainty over the details. While US Treasuries have rallied as key Fed officials and voting members of the FOMC have signaled need for additional measures, it is difficult to know with any precision precisely what has been discounted. This is especially true, given that the US 10-year yield stopped falling on October 7th and has risen 20 bp since. At the same time, the Fed’s signaling channel has been very successful in raising inflation expectations as interpolated from various market prices. Some of these adjustments like the break-even on the Treasury’s Inflation Protected Securities.

The breakeven on the 30yr TIPS was 1.84% prior to Bernanke’s Jackson Hole speech in late August and now stands near 2.55%. This compares with long-term average of about 2.30%. The five-year/five year forward, a measure of inflation expectations, cited by both the Fed and ECB in the past, was around 1.90% in late August and was 100 bp higher yesterday. Market based measures of inflation expectations can be distorted in “normal” conditions by supply and liquidity considerations. The distortion may even be more pronounced now given the gaming of the assets that the Fed may buy, including certain parts of the curve and TIPS themselves. That said, while some like the Fed’s Hoenig does not think the economy requires more stimulus, others who see the need for more stimulus want to rely on fiscal support are concerned about the inflationary implications of the reliance on monetary policy.