The dollar index plummeted to an eight-month low at the end of the month. While yet more quantitative easing in the US may not be the only reason for dollar weakness – Simon Derrick at BNY Mellon makes the case that reserve diversification has been a major driver – it was the one getting the most press. The strange thing was that commentators were neither certain that QE2 was imminent nor that it would make much difference.
At the start of the week Mike Lenhoff at Brewin Dolphin was quoted by the FT’s Alphaville as “arguing that Fed won’t need more QE – rebounding equity markets and a weakening dollar will do the job”. That makes some sense, although surely equity markets are up largely on the basis of money needing a home in a low-yield, liquidity inundated, credit-constrained environment and the dollar is weakening further because of the very prospect of more QE. So yes, more QE probably isn’t needed, but the threat of it might be.
On Tuesday Dennis Lockhardt, president of the Atlanta Fed, noted that it was “not a foregone conclusion” that more QE would be necessary, while Nouriel Roubini published a piece that detailed how the problem facing the US is not liquidity but demand. Roubini’s piece contains a great graph showing how the velocity of money has plummeted.
Which brings me to my favourite piece of the week, by Ed Yardeni, posted on FXStreet, though originally from John Mauldin’s site (http://www.fxstreet.com/fundamental/analysis-reports/outside-the-box2/2010-09-28.html). It argues that not only will further QE not work but also that the Fed appears to know it won’t – the textbook money multiplier isn’t working.
Apparently Ireland’s deficit for 2010 will be a stunning 32% of GDP. And scurrilous rumours are circulating regarding the accuracy of Spain’s GDP over the last three years. None of that matters, US QE2 and Thursday’s successful LTRO trump all else.
Maybe, but at the risk of stepping in front of the juggernaut, it is starting to feel like right now could be the time to strap on a serious EUR short. Lee Hardman at Bank of Tokyo Mitsubishi UFJ certainly sees it that way, having circulated a note on Thursday with unequivocal headline “Sell EUR vs. USD = Target 1.2650 (7.5% from current level of 1.3640)”.
Hardman believes that dollar selling based on QE2 fears is overdone, implementation in November is not certain and any programme is likely to be on a smaller or at least more gradual scale than initial quantitative easing.
He, like Derrick, believes much of the move in EUR/USD has been down to reserve diversification, but “the euro’s status as a hard currency alternative to the dollar has been diminished by the recent decisions from the ECB such as purchasing peripheral eurozone sovereign debt and easing collateral requirements in order to provide liquidity support to the troubled eurozone banking system.” All very plausible but why that should suddenly be a factor now is not clear.
George Saravelos at Deutsche is still bullish for EUR/USD, seeing it supported by the “increasing attractiveness of the US dollar as a funding currency, continued European outperformance in the core, and a diminished influence of European sovereign risks into year-end.”
It looks like we have a market: German on the bid, Japanese on the offer.
Finally, its not often one gets to use the word pentennial – it even fails the spell check – but Paul Day at Market Securities managed it this morning (as did I, see what I just did?). Day points out something that might make a wave or two towards the end of the quarter: the SDR will be due the five-yearly revision of its component weightings.