US Dollar Expected to Broadly Rise as Federal Reserve Withholds QE3
All Eyes on FOMC Rate Decision as Global Growth Trends Return to Spotlight
US Dollar to Rise as Fed Renews “Operation Twist” But Withholds QE3 Program
Pound to Fall if BOE Minutes Show Swelling Support for Asset Purchase Boost
All eyes are on the Federal Reserve monetary policy announcement as global economic growth concerns retake the spotlight from fears of a sudden rupture in the Eurozone following the weekend’s pro-bailout outcome to the Greek general election. With Europe expected to sink into recession while Asia sees its slowest growth since 2009 (according to a survey of economists polled by Bloomberg), traders are reasonably looking to North America, and specifically the US, to offer a counterbalance.
With that in mind, an outright expansion of asset purchases would prove most supportive for risk appetite and most damaging for the US Dollar. At the other extreme, doing nothing would amount to de-facto tightening since the so-called “Operation Twist” – a scheme to flatten the yield curve in place since late September – is due to expire this month, weighing heavily on risky assets and pushing the greenback aggressively higher. We suspect policymakers will opt for a middle path, renewing Twist to maintain the current status quo but withholding an outright expansion of QE.
Indeed, with nominal US Treasury yields already near record lows and real borrowing costs in negative territory out to the 10-year maturity, the likelihood that the Fed can generate a substantial increase in lending at the margin seems implausible. Ben Bernanke has explicitly said that it would be “very reckless” to seek a modest pickup in economic activity at the expense of higher inflation, meaning a QE3 program that amounts to little more than a confidence-building exercise is unlikely. Still, US economic data has increasingly underperformed relative to expectations over the past two months, meaning an extension of Twist and perhaps another extension of the time period within which rates are pledged to be kept low seems appropriate.
With markets pining for accommodation, this is likely to disappoint investors and drive risk aversion, boosting USD against its top counterparts (albeit less so than if the Fed did nothing). The sentiment-sensitive Australian, New Zealand and Canadian Dollars will probably see outsized losses. Near-term correlation studies suggest USDJPY is more sensitive to US Treasury yields than risk appetite at the moment, meaning the Japanese Yen is likely to decline against the Dollar even as it rides haven flows higher versus the other majors.
Minutes from June’s Bank of England meeting headline the economic calendar. The announcement is likely to reflect a dovish shift in policymakers’ thinking, but that revelation in and of itself is unlikely to surprise investors after Governor Mervyn King’s unveiled a new credit-loan program last week. Gauging the possibility that the new effort will be coupled with additional QE – an outcome explicitly left open by the BOE chief – will be far more important. With that in mind, a swell in votes in favor of expanding asset purchases is likely to weigh the British Pound. Separately, Jobless Claims are expected to inch slightly lower in May, down 4,000 from the prior month.
Asia Session: What Happened
Current Account Balance (1Q)
Current Account Deficit-GDP Ratio (1Q)
Bank of Japan May 22-23 Meeting Minutes
Merch. Trade Balance Total (