Bullish Forex traders should enjoy the rallies in the major currencies while they can because once bond yields from around the world adjust downward to meet U.S. rates, the easy money will be over. In fact these markets are so far ahead of themselves I would venture to say that prices could collapse to more reasonable levels.
For some strange reason the Forex markets are acting as if the Fed pumped over $1 trillion into the market overnight. Now that the details of the plan have started to come out, traders should note that the Fed's long-dated debt buying spree will be spread over six-months. This gives global interest rates plenty of time to come down to more realistic levels.
Once interest rate differentials tighten then economic factors will once again become more important and from what I read the global economy is still in a decline. So enjoy the break in the Dollar while you can because a huge snap-back rally is coming.
Looking at the current economic scenario before the Fed announced its aggressive money-printing plan and after the announcement I see nothing different in the Euro Zone, the U.K. or even the Japanese economies. Everyone is fighting for business; this is why the U.K. tried to lower the Pound through quantitative easing last week. This is why the Bank of Japan announced a plan to buy government debt this week. This is why the Swiss National Bank intervened last week. They all want their currencies lower.
The problem I have with the Fed's move is it might have shown the other central banks all of their cards. Maybe $1 trillion was its limit, who knows? But now the Bank of England, the Swiss National Bank and the Bank of Japan all know what the Fed is capable of doing. This may mean that one or all three central banks will try to outdo each other and hit the markets again with another round of quantitative easing. If this happens then the Dollar will rise again. So do not jump on the weak Dollar leads to inflation bandwagon yet because in my opinion the quantitative easing war has just begun.
Who is left to play the game? The European Central Bank. It was the last to begin to cut rates in the summer 2008. It is going to be the last to cut rates to near zero in 2009. Furthermore it is going to be the last to use quantitative easing. Because it is so far behind the curve, the EU economy is going to get punished the worst. Believe me, the ECB does not want to see the EUR USD rise above $1.40 or get even close to $1.50. Nobody is going to buy anything from them because the cost would be too high. This will worsen the economy.
The growing recession in Eastern Europe will also have to be addressed at some point. Without financial aid this region is going to weaken further while spreading its gloomy outlook throughout the Euro Zone.
So celebrate from the long side while you can, but be ready because these rallies will not last. I believe the Fed's drastic move is a sign that there still are some serious problems out there and when they show up, the Dollar will once again become the safe haven.
The Euro continued its rally on Thursday as traders sorted out the details of the Fed's massive quantitative easing plan. It looks as if the buying spree will be spread out over six months which makes me believe this rally cannot continue at this current pace.
Furthermore, the European Central Bank will not tolerate a EUR USD over $1.40. This means that a drastic interest rate cut is coming or some other form of financial creativity. The ECB cannot really apply quantitative easing because of the structure of the European Union, but it may have something more powerful, more creative in the works.
Based on the financial condition of the Euro Zone and its neighbors in Eastern and Central Europe, it is clear that something has to be done to stimulate interest in Euro Zone goods. A Euro over $1.40 or nearing $1.50 will choke the economy.
Look for the ECB to try something spectacular at its next meeting on April 2 in an effort to silence critics and get ahead of the curve for once. In the meantime, enjoy the EUR USD rally, but watch so you don€™t get trapped too high when this market comes down again.
The GBP USD enjoyed another bullish day as traders are buying first then digesting the details of the plan to provide liquidity to the U.S. economy. In the short-run this will be a great strategy because all of the weaker shorts are being scared out of the market. This market will rally as long as there are weak shorts trading. Once it hits a level that the big traders want to defend then this market is going to go lower.
The Pound is going to go up as long as the U.K. financial markets have a slight yield advantage over the U.S. Bond market. Slowly, however, the yields on the gilt will drop lower thereby erasing any interest rate advantage.
What will happen next? Traders will wake up and see U.K. unemployment cracking the 2 million person mark and a housing market in shambles. The trick to trading this market will be to time the next short position just before the Bank of England either performs another round of quantitative easing or maybe surprises everyone with a little intervention of its own.
Earlier this week the Bank of Japan announced an aggressive plan to weaken the Yen through quantitative easing by purchasing government debt. It worked for one day as the Japanese Yen tumbled against the U.S. Dollar. On Wednesday, the U.S. Fed took similar action and announced it was going to buy long-dated government debt and mortgages.
The subsequent weakening of the Dollar increased the value of the Yen, erasing all of the good the BoJ did. If the BoJ and the Japanese government are truly committed to a weaker Yen policy then looks for them to become more active in their efforts to weaken the Yen.
This may mean more aggressive quantitative easing with a little bit of intervention thrown in to really get the message across. The Japanese economy is strapped for cash because foreigners have stopped buying Japanese goods. This includes autos and electronics. Take a look at how badly the exports have gotten as well as the current account balance. Furthermore, the GDP projections for 2009 are outright bearish. These are not symptoms of a currency you'd want to own.
After the dust clears following the Fed's announcement, start looking for a place to get long the USD JPY as the Bank of Japan is likely to help you out by driving the Yen lower.
The dilution of the U.S. Dollar gave Swiss Franc traders no other choice but to buy. This is not what the Swiss National Bank wants to see and my feeling is that it is getting ready to apply pressure to the Swiss Franc through another round of intervention.
Last week the SNB shocked the Forex market by selling Swiss Francs, but the strong move by the Fed yesterday erased some of the weakness and once again put upside pressure on the Swiss Franc.
The thing about central banks is once they start in a particular direction they will stay with that policy until it is completed. Right now there is a weak Swiss policy. This means the SNB will do all it can to get the Swiss Franc down to an acceptable level.
I don€™t know when the SNB will do it - it will probably happen following a bad export number - but the SNB will hit this market again and again with intervention until it gets the Swiss Franc down to a level that will stimulate foreign interest in Swiss goods.
The Canadian Dollar soared on Thursday as it got a jolt from a weaker Dollar, higher equity markets, strong gains in commodities and a surprise uptick in Consumer Prices.
With the weaker Dollar come higher commodity prices. The very act of flooding the market with Dollars often acts like a porch light for the inflation bugs that come out and start buying up assets that could increase in price if there is inflation. It seems to me that this can become a self-fulfilling prophecy. If inflation is too much money chasing too few goods then show me where the demand for the goods is coming from. The last reports I saw showed consumer spending down. Sure, February retail sales may have been better than the guesses, but they were still down from January.
The Fed is saying that inflation is not a concern - that deflation is the concern. The Fed is saying look, we know that printing money is inflationary, but we can handle a little bit of inflation. We have no other tools against deflation except to print money. This tells me that the Fed is seeing a lot of problems that we may not know about.
Look for the USD CAD to continue to feel downside pressure as long as equity and commodity prices move higher. Once the euphoria wears off, there could be a substantial rally. Traders should also continue to monitor the global banking situation. If previously unknown problems arise then traders may return to the Dollar for safety once again.
The Australian Dollar rose again as it benefited from trader appetite for risk following the drop in interest rates in the U.S., and the rise in the commodity and equity markets. The interest rate differential between U.S. bonds and Australian bonds is making the Aussie Dollar a more attractive investment.
Traders can continue to enjoy this benefit as long as Aussie rates remain high. This is likely to continue as long as the Australian economy is showing some growth. According to the recently released Reserve Bank of Australia minutes from March 3 (the day the policymakers voted to leave rates unchanged), there are still some major concerns regarding the current stimulus plan and the Australian manufacturing sector.
Policymakers are prepared to slash rates to near zero if this economy does not improve. Last quarter's GDP was bad so the economy is on a short leash at this time. What this means is that as long as equity and commodity markets remain strong then trader appetite for higher yielding assets will be great. If the economy falters and rates are forced lower, then the Aussie will lose its interest rate differential and collapse to more reasonable price levels.
The New Zealand Dollar is in the same boat as the Australian Dollar except that the Reserve Bank of New Zealand is tired of the slow pace it takes interest rate cuts to work through the economy. It may be considering an intervention to help lower rates and the currency price.
Like all other nations that rely on exports, the price of the currency is constantly being monitored. If the NZD USD gets too high then a foreign buyer will seek the same good elsewhere for a cheaper price. This is especially true in the grain complex. Foreign buyers, for example, can go anywhere in the world for wheat, but when times are tough they forego the quality and seek the lower price.
If the New Zealand Dollar gets too high the export market will choke and the economy will go deeper into its current recession.
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