After a worrying initial market reaction yesterday, the Fed’s aggressive monetary and credit easing measures appear to be working. The US dollar is generally weaker across the board, US equity futures are pointing up, and there are reasons to believe the pressure on financial conditions may be easing.
After reaching a fresh high yesterday, the Bloomberg Dollar index began to decline slightly. This is a broad measure of dollar strength; most major currencies have advanced against the greenback. The possible reasons stand out for the dollar paring back its gains: yesterday’s Fed measures beginning to improve sentiment and reduce demand for cash, or a note of concern among investors over the domestic US outlook.
The Fed’s measures were certainly large, timely, and broad enough to induce a rally in risk appetite and therefore allow a weakening of the greenback.
In addition to open ended QE at an initial pace of $125 billion a day, the Fed opened three facilities for credit easing that add $300bn of liquidity to corporate and consumer debt markets. For comparison, during the initial stages of the Fed’s third round of quantitative easing in September 2012, asset purchases totalled $40 billion a month.
However, concerns about the domestic US dollar outlook, or even misplaced hopes about an early end to the US shutdown period, could also be a source of the marginal offer on USD that’s emerged this morning. The Senate GOP bill for $2 trillion of fiscal stimulus was blocked twice by Democrats yesterday, who criticised the bill as a no-strings giveaway to large corporates. Democratic House leader Nancy Pelosi floated an alternative bill – but has today said she believes a deal could be struck “within hours”.
Given the size of the nascent risk rally is small compared to the losses of recent weeks, today’s session for US equities and bonds will be key – another capitulation could easily trigger more US dollar stress.
The fact equity futures are pointing higher is promising – these have traded tightly with high yield credit indices in recent weeks.
Performance of G10 currencies against USD (1-day period, spot returns %)
Author: Ranko Berich, Head of Market Analysis