Chinese Reaction to FED QE3: Not Happy

On April 4, 2012, the Chinese newspaper, ChinaDaily, published a piece titled, "US Urged to Consider Effects of Policies." 

Within the article I noted the withering green shoots in the U.S. would likely result in QE3 for the U.S.  This view passed Thursday.

China has reacted to U.S. QE in the past by expressing dismay, primarily given the overweight U.S. dollar position in their foreign currency reserves. Today's action, coupled with the signing of the ESM law in Germany by German President Gauk, is likely to bring China back to the European debt table. I would not be surprised to hear of Chinese institutions on the bid in the EUR/USD over the next few weeks. They will likely be joined by their Asian neighbors, as South Korea, etc., seek to limit the appreciation of their own currencies.

Asia will likely compete for Euros with Latin America's economies.  Note earlier Thursday, Brazil's Mantega said Brazil will "not allow the Real to strengthen." This means Brazil will be forced to buy U.S. dollars against the BRL, and then will diversify into other currencies, chief among them likely the Euro solely for liquidity reasons.

Against most people's views (not my own), the EUR/USD is now higher on the year and, in my view, likely to strengthen further. Indeed the EU/U.S. two-year basis swap is now at 30.75bps, a level last seen in July 2011, when the EUR/USD was trading around 1.4400.  A tightening basis swap implies a more relaxed view on European credit and tail-risk. While the move in the EUR/USD from 1.2050 to 1.3000 has predominantly been fueled by an unwind of the mistaken EUR/Collapse trade, the next leg up may come from the side-effects of QE3; notably enhanced diversification activity away from the U.S. dollar by Emerging Market Central Banks.