The Weight of 1 Trillion Dollars

Last updated 3/18/2009 6:13 PM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• THE WEIGHT OF 1 TRILLION DOLLARS
• EUR/USD: BIGGEST RALLY SINCE SEPTEMBER 2000
• GBP/USD: BOE WILLING TO DO MORE THAN LESS
• USD/CAD: SLIPS DESPITE BLEAKER OUTLOOK
• AUD/USD: GOLD PRICES SURGE $24
• NZD/USD: OIL PRICES STEADY AT $48.14
• USD/JPY: BoJ ADVANCES GOVERNMENT BOND PURCHASES

EXPECTATIONS FOR UPCOMING FED MEETINGS

THE WEIGHT OF 1 TRILLION DOLLARS

On Tuesday, we said that being long dollars equals being long pessimism, but what is more relevant to recent price action is that being short dollars equals being long optimism. The U.S. dollar has sold off across the board following the Federal Reserve’s decision to buy U.S. Treasuries.  Although the act of buying U.S. Treasuries is in of itself dollar bearish, the sell-off in the greenback also reflects the market’s confidence in the Fed’s actions.  Given the trend of the U.S. economy, buying Treasuries was inevitable but rather than wait a few more months, the Federal Reserve decided to deliver the stimulus now and in turn give the U.S. economy its best chance at recovery.  

Fed Commits $1 Trillion

In total, the Federal Reserve announced purchases worth more than $1 trillion.  More specifically they expanded their current commitments to buy mortgage backed securities by $750bn and agency debt by $200bn.  They will also add $300bn purchases of long term U.S. Treasuries, putting their total commitment to $1.25 trillion. The central bank has basically put a floor under Treasuries, keeping yields low.  To fund these purchases, the Federal Reserve will have to fire up the printing presses but the burden of $1 trillion may be too much for the greenback to handle.  This is a welcome consequence of the Fed’s actions because a weaker dollar will be positive for the U.S. economy.  Too many companies have reported that the previous strength of the U.S. dollar is dragging down earnings.  The Federal Reserve is not wasting any time because Treasury purchases will begin next week.  In our Instant Insight on the FOMC announcement , we talked about why the Federal Reserve made such a nuclear announcement.  Looking ahead, we expect today’s aggressive actions by the Federal Reserve to have a lasting impact on the U.S. dollar.  Although a relief rally for greenback is possible given the dramatic move in the EUR/USD, today’s price action should reflect a new trend in the U.S. dollar.  In addition to further dollar weakness, the Fed’s actions should lift bond and equity prices. 

All About the Fed Decision

How Does the Fed "Print Money?"

Many people may wonder how the Fed prints money.  Most of the time when we say that a central bank “prints money” that does not mean that they actually fire up the electronic version of a printing press.  They can and this is the way Bernanke described it in 2002 when he said that "The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation."  However more often printing money means that the Federal Reserve will hold an auction to buy assets like bonds or mortgage backed securities from banks. Then they issue a credit to the bank’s account, creating new money and the hope is that the bank will use the money to lend to businesses and consumers.Unfortunately by increasing the supply of dollars, each dollar is worth less.  The U.S. government also increases its debt burden, raising concerns for foreign investors. This is compounded by the fact that the Fed’s purchases of Treasuries will drive down bond yields, reducing the attractive of dollar denominated investments.

Next Up: Geithner and Obama

Over the next 36 hours, comments and actions by Treasury Secretary Timothy Geithner and President Obama could fuel further gains in the equity markets, which could drive the U.S. dollar lower as optimism continues to seep through the financial markets.  Geithner is expected to release more details about the private-public sector program to take toxic assets off bank balance sheets and more details and transparency will be taken favorably by investors.   President Obama on the other hand will attempt to reassure Americans by pitching his economic stimulus plan on the Tonight Show with Jay Leno.  In addition to these 2 events, the U.S. will be releasing jobless claims, leading indicators and the Philadelphia Fed Survey.  Most of the data is expected to be dollar bearish given the weakness of the Empire Manufacturing Survey and the sell-off in equities in the month of February.  Consumer prices and the current account balance were released this morning and the data was dollar bullish with inflation rising and the deficit shrinking.  

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EUR/USD: BIGGEST RALLY SINCE SEPTEMBER 2000

The Euro staged its strongest rally against the U.S. dollar since September 2000.  The close to 4 percent move drove the EUR/USD above many significant resistance levels to the end the U.S. trading session at a 3 month high.  As long as the currency pair holds above 1.35, which is also a critical point, we could see easily see an extension to 1.38.  The rally was due entirely to the Fed’s announcement as the currency pair basically range traded pre-FOMC.  If the trend continues like we expect, the strength of the Euro poses a big threat for the Eurozone economy and the European central bank.  It could even force a heavier hand by the ECB because the stronger currency has a similar impact on the Eurozone as an interest rate hike.  The surge in gold prices validates the significance of the sell-off in the U.S. dollar.  By printing money, gold may overtake the U.S. dollar as the primary destination for safe haven because it is the only currency that cannot lose value by being printed.  Meanwhile, ECB President Trichet negated expectations that the ECB has reached a point where they will no longer be cutting rates. Even though he has not made any explicit arrangements for additional easing, his contradiction with comments made by other central bankers about rate cuts no longer having an effect leaves the door wide open for further easing.

GBP/USD: BOE WILLING TO DO MORE THAN LESS

The British pound also surged against the U.S. dollar but the strength of the currency pair comes in complete contrast to the outlook for the U.K. economy.  Unemployment last month rose by a record amount of 138.4K, driving total unemployment above 2 million and the jobless rate to 4.3 percent.  The labor market is in terrible shape and will probably worsen in the coming months.  According to the IMF, the recession in U.K. could drag into 2010 even as other nations recover.  Not only are more Britons losing their jobs, but those still with work are making less.  Average earnings including bonuses fell from 2.0 percent to 1.8 percent.  This may explain why the Bank of England chose to do more rather than less earlier this month when they cut interest rates to a record low and officially began Quantitative Easing.  The decision was unanimous, suggesting that the central bank could open to further stimulus.  The most accurate reflection of the market’s sentiment towards the U.K. economy and the British pound is expressed in EUR/GBP, which hit a 1 month today.  

Unemployment Crosses 2 Million Mark

USD/CAD: SLIPS DESPITE BLEAKER OUTLOOK

The knee-jerk reactions in response to the Fed’s latest policy initiatives have benefitted the commodity currencies across the board. USD/CAD plummeted by more than 200 pips while the AUD/USD and NZD/USD both rallied by more than 150 pips. The Fed’s actions have clearly diminished the dollar’s safe haven status at the benefit of the kiwi, aussie, and loonie.  Canadian Prime Minister Stephen Harper had some disappointing news for economy watchers. The Prime Minister reaffirmed the relationship between the health of Canada and that of the U.S. by saying that Canada will not recover from the recession until the U.S. financial system stabilizes. Even though the dependence of Canada on the U.S.  is obvious to a certain extent, their late entrance to the recessionary environment promoted the idea that maybe they were not as affected by U.S. conditions. However, as of now Harper’s comments present the glaring truth. Canadian Wholesale sales fell to a new multi-year low as auto order took its toll once again. The country is set to release Consumer Prices tomorrow.

Gold Rush on the Floor

USD/JPY: BoJ ADVANCES GOVERNMENT BOND PURCHASES

USD/JPY has almost given up all hopes in its surge to 100.00, as the Fed’s decision to purchase government bonds sent the pair sharply lower. However, the Feds decision only followed statements made by the BoJ today that will significantly boost their own securities purchases. The BoJ is set to increase their monthly purchases of JGB’s by a total of ¥1.8T, an amount that far surpassed economists’ expectations. The ramped up monetary efforts only follow yesterday’s announcement to provide subordinated loans to Japan’s beleaguered banks. The country is clearly expending all resources at their disposal in order to avert another 10-year recessionary cycle that they only recently emerged from. The increase in JGB purchases should provide two possible benefits to the nation. The first is the obvious fact that the lower yields should prompt a return to normal lending and banking conditions. In addition, the reduced borrowing costs will facilitate the Japanese governments mounting debt, which has been building after their third attempt a fiscal stimulus package. Japan can definitely be commended for their discovery of Quantitative Easing practices that have been adopted by many major central banks across the globe. Today’s other economic data showed that the Leading index increased marginally in the month of February.

USD/CAD: Currency in Play for Next 24 Hours

USD/CAD will be the currency in play over the next 24 hours as we are expecting influential reports from both Canada and the US. Canada will report their Consumer Price Index at 7:00 am ET or 11:00 GMT. The US is scheduled to release Initial Jobless Claims at 8:30 am ET and the Philadelphia Fed Survey at 10:00 am ET or 14:00 GMT.

After today’s impressive move, USD/CAD has fallen into the Bollinger Band sell zone. In order to find the support for another round of weakness, we are looking at the Fibonacci retracement drawn from January lows to March highs. The 38.6% retracement at 1.2409 is the next level in reach and also corresponds with a low placed on February 24th. As resistance, the most significant and psychologically burdensome level to watch is 1.3000 but before that, the currency pair would have to clear 1.2750, today’s high and the 10-day SMA.

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.