Foreign Exchange Frustrates

The US dollar saw its post-FOMC losses extended only against the euro as the perhaps the passable success of the Greek bond buy-back and bank supervision deal lent support to the single currency.  

Yet, even it succumbed to selling pressure in the European morning and returned to pre-FOMC levels near $1.3040.  Against most of the other majors, the dollar has been confined to yesterday's ranges.  This is somewhat reminiscent of the price action after QE3+ was announced on Sept 13, with the dollar bottoming either that day or the following day. 

Of course, we recognize that monetary policy is one of the factors the influence foreign exchange prices.  There are factors as well.  It seems that most investors and observers look at the same variables in their formal or informal models of currency determination, but differ on the coefficients, or weights that are given to the variables, which seem to change over time. 

The dollar extended its gains against the yen.  In fact the yen's weakness is one of the forces that have help the Japanese stock market buck the heavy tone in equities today and gain almost 1.7% to reach its best level since April.  The Nikkei is up 15.25% year-to-day., with 12.5% rise over the past month. Foreign investors have quadrupled their purchases of Japanese shares this year to about $11.3 bln.  These purchases are not sparked by desire to participate in a rapidly growing economy.  

To the contrary, the economy is contracting again and that will be the message from the December Tankan survey out first thing Friday in Tokyo.  Sentiment among large manufacturers is expected to deteriorate from the -3 reading in September to -10 with little improvement project for March.  Large non-manufacturer sentiment is expected to soft to 5 from 8 and be unchanged in March.  Capex is expected slow to 5% from 6.4%.  The key to the yen's weakness is the prospect that the new government that will be elected this weekend will pursue aggressive monetary and fiscal policies.  The BOJ meets next week and speculation is running high that it will expand its asset purchase program for the third time in four months and this is before the LDP takes charge. 

We have suspected that many observers were reaching regarding the Swiss National Bank.  Many expected that it would follow its two largest banks and impose a negative rates.  Others thought could lower its ceiling for the franc.  Others were hoping for some clues into its diversification of reserves and may have been positioned in the Norwegian krone as a likely candidate. 

The SNB disappointed on all counts.  There was no change in its LIBOR target range (0-25 bp).  There was not change in the cap.  There was no mention of the krone.  The euro slipped back below CHF1.21.  The SNB does hold a small amount of Swedish krona in reserves.  The krona has come under more pressure following another softer than expected CPI report that showed core inflation falling to 0.8% from 1.1% in Oct.  Separately, Sweden reported a jump in unemployment to 7.5% from 7.1%.  It reinforces expectations that the Riksbank will cut rates next week, while the Norway's central bank won't. 

What is most surprising by the FOMC yesterday was not the increase in QE3+, which many had expected, but move to provide numerical thresholds or guidance and away from the calendar approach.   The FOMC suggested that the new numerical guidance was not substantively changing the date guidance.   A Bloomberg survey found a consensus expects QE to continue through Q413 and possibly into Q1 14.  This will expand the Fed's balance sheet to around $4 trillion.   

In terms of what the Fed is buying, there appears to be more going into the 3-6 year bucket than observers had anticipated. Given that the focus is on the FOMC  buying $85 bln a month in MBS and Treasuries and the thresholds to raise rates, little attention has been devoted to the triggers for an increase in QE3+.  Depending on the extent of the fiscal austerity that will eventually come out of Washington (either before or after Dec 31), and the hit on the economy, an further expansion of the Fed's balance sheet cannot be ruled out.