The FOMC statement surprised with a plan that will see further debt monetization, a scenario that was not on everyone's radar screen, and the market bashed the USD anew. How bearish is the statement for the greenback?
The FOMC statement downgraded its view of the economy in today's statement relative to what it said in the June statement. Most importantly, the Fed has restarted a "back door" quantitative easing as it elected to (the following lifted directly from today's FOMC statement) "keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve's holdings of Treasury securities as they mature."
So today's FOMC statement is real, liquidity-enhancing quantitative easing because it will see the Fed monetizing more debt, even if it doesn't require that the Fed expand its balance sheet (and thus one could argue that it is simply an effort to maintain the status quo). And on the surface, this has all of the usual nominally positive implications for risk appetite, lower US rates, and therefore a lower US dollar - hence today's reaction. Importantly for the risk-mongers, the US S&P500 held its 200-day moving average, etc..
But while today's move by the Fed does represent a new move to monetize debt that the Fed likely hopes will keep long rates very low and continue to support the housing market and other asset markets and thus banks' balance sheets, this is not a "real QE2". And a new dribble of US treasury purchasing to offset MBS and agency debt offloading will do nothing dramatic towards solving the fundamental problem in the economy: lack of end demand. Also, the "risk" for those looking for further moves from the Fed is that this is a pre-emptive move, and that the Fed will now have to sit back and see if its new efforts are bearing any fruit before acting again. It is likely that the Fed does little else until after the early November elections in a little over 80 days due to the political headwinds it now faces.
The grand question that looms is whether today's move is a "first step" en route to a true QE2: quantitative easing that goes beyond the traditional policies of manipulating long and short interest rates via the interest rate mechanism, liquidity facilities and debt monetization and instead circumvents the banking system entirely by somehow forcing end users to receive and spend money. This is the true helicopter drop. But will the Fed ever have the political wherewithal to do such a thing or are the Fed's days of true independence fast running out? What the US government giveth away (the creation of the Federal Reserve System in 1913), it can just as easily taketh away if it decides so to do.
That latter paragraph is for the much longer term. For now, any USD negative impact from the Fed's move here may not last for long, especially if the rest of the world enters the soft economic patch that the US now finds itself in - or worse - thus collapsing the interest rate spreads at the short end of the curve that have moved so dramatically against the greenback's favor in recent weeks. That's because this is not a particularly dramatic move by the Fed even though it was not expected - it's just a recycling of QE past. USD calls, anyone?
Stay careful out there.
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