What the FED decide to do today?

The Federal Reserve took the step of initiating a new policy to try and help that push down longer-term yields. It will buy $400 billion of bonds with maturities of 6 to 30 years through June while selling an equal amount of debt maturing in 3 years or less. That figure came in right in the middle of expectations, and it’s about three-quarters of all the shorter-term debt that the Fed has on its balance sheet.

This policy, which has been dubbed “Operation Twist”, tries to accomplish a lot of the things quantitative easing does but without the need to print more money, or expand the fed’s balance sheets, therefore in principle it doesn’t stoke inflation as much. we had the same three dissenters from last meeting voting against the policy.

What Else? Lowered Outlook.

Fed also acknowledged that “there are significant downside risks to the economic outlook, including strains in global financial markets.” While the Fed took action with this policy it did not take any extra measures beyond “Operation Twist” – such as lowering the interest paid to banks to hold money at the fed – the interest on excess reserves – or make any commitments regarding holding its balance sheet steady through 2013.

Will “Operation Twist” Help?

In essence the market got a lot of what it anticipated, but the reaction was very sharp and favored the US dollar. Perhaps the market sees that despite this move the impact on the economy may be minimal. Early attempts at quantitative easing did not help push down the persistently high unemployment rate and the US is still suffering with a weak labor market. Those woes will not necessarily be helped because borrowing costs are bit cheaper. Lower borrowing costs are stimulative that they help the housing market through lower mortgage rates that make it more affordable for businesses to borrow in order to invest. But, we have seen the US 10-year yield falling to record lows recently and therefore we’ll see how much further they can fall with the help of the Fed.

Why did the US Dollar Gain Following What is More Accommodative Policy?

That’s a good question and the difference lies in the fact that with true quantitative easing you are expanding the central bank’s balance sheet or printing money, while here you’re simply shifting around the current portfolio and changing its composition to have more longer dated maturities. Therefore it shouldn’t carry the same diluting effects on currency.

We also had a generally risk off session today starting in Europe and continuing in the US as three large banks were downgraded cooling investor sentiment. Today’s Fed decision, while helping out on the margins, not in of itself going to be able to resuscitate a recovery that was battered by various headwinds during the first half of the year.

The uncertainty around global growth is causing commodity currencies to be sold off, and that was very apparent in today’s session as we had the Canadian Dollar test parity against the greenback and the New Zealand dollar through the 0.8115 support.

What’s Next for the Markets?

The attention most likely now returns to the European continent, and whether Greece will be able to finally secure its next installment of aid from the EU/IMF. The Greek government said that it would accelerate cuts to wages and pensions today which should be enough to secure it the next tranche of aid and keep the country from a default scenario for at least another quarter. If we do have a resolution there it could be a positive for the euro and risk sentiment, however the spate of downgrades – to sovereign such as Italy and banks such as US and French banks – will continue to take a toll on investor sentiment. The outlook for weak growth in the US and in the euro zone will also lessen expectations for the global recovery, which will have an impact on the higher-yielding commodity linked currencies.

The “risk off” route seems to be the path of least resistance, and today’s decision from the FOMC is not likely to change that general direction. To get to a more “risk-on” mode we would have to have governments coming together to bolster global growth, or countries pare back some austerity measures for the sake of short-term growth, or central banks continue to use intervention tools. It will take some stronger measures to get the world economy and financial markets out of the recent funk of this summer.

We’ll have to continue to monitor the data and see how equity markets progress as we move to the end of September and into the 4th quarter.

 

Nick Nasad
Chief Market Analyst
FXTimes

Information and opinions contained in this report are for educational purposes only and do not constitute an investment advice. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness. FXTimes will not accept liability for any loss of profit or damage which may arise directly, indirectly or consequently from use of or reliance on the trading set-ups or any accompanying chart analysis.

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