Forex Daily Commentary – Special Report: QE III
On June 22, 2011 minutes of the latest Monetary Policy Statement indicated the Fed “…decided today to keep the target range for the federal funds rate at 0 to 1/4 percent….”, in part due to the following reasons:
- The unemployment rate remains elevated.
- Inflation has moved up recently, but the Committee anticipates that inflation will subside to levels at or below those consistent with the Committee’s dual mandate.
- The Committee continues to anticipate that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate for an extended period.
But perhaps most importantly, the minutes also stated …”The Committee will complete its purchases of $600 billion of longer-term Treasury securities by the end of this month and will maintain its existing policy of reinvesting principal payments from its securities holdings….”, and furthermore indicated the Federal Reserve did not have the intention to initiate any further quantitative easing (no Q.E. 3). In other words, as the FED completes its purchases of $600 billion dollars of longer-term Treasuries that would in fact represent the end of ‘that kind of stimulus.
Just two short weeks later it appears the FED is now singing a different tune. In today’s Semi-Annual Monetary Policy Report to the House Financial Services Committee, chairman Bernanke stated in part “The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support…”, which many believe will lead to a third round of Quantitative Easing.
The question now arises, what effect could this have to financial markets? It appears on the surface equity markets have reacted favorably. Dow futures almost immediately spiked higher, around 100-points to the upside. Furthermore, an equal and opposite reaction was seen in foreign exchange markets sending the USD sharply lower.
Various forms of monetary policy including low interest rates and quantitative easing programs ultimately have a positive effect to corporate earnings of which equity markets anticipate (today) with higher stock prices. In addition, under a weak USD environment commodity prices tend to rise as a greater amount of USD’s are required to purchase the same barrel of crude oil and ounce of gold. The following 5-minute chart(s) shows the market’s immediate reaction.
5 Minute QE III Chart
Studying the market’s reaction a little closer now a degree of ‘divergence’ (might) have begun to reveal itself. Notice below how the (USD/CHF) and Gold almost simultaneously broke to new historic lows and highs respectively. It appears at least for the moment, these long-lasting trends show little signs of ending.
QE III USDCHF and Gold
However with that said, Crude Oil and the Dow index have not followed suit. Although strong today, Crude Oil trading just under $100 a barrel remains far off of its yearly highs near $115, and has in fact formed a triangle (consolidation) pattern reflecting a more ‘equal’ balance between buyers and sellers. Fundamentally speaking it is easy to justify as Crude Oil does not simply trade under the influence of a strong or weak USD, but rather is affected by a number of outside factors including seasonal changes, geo-political tension in the Middle East, and the anticipation of future consumption of oil, or lack thereof.
QE III Crude Oil and Dow
In regards to equity markets specifically the Dow (futures), a similar triangle consolidation pattern has also emerged retesting the 12,600 handle, yet still significantly below its (down-trending) resistance near 12,750 and multi-year highs of 12,900. The question arises, if the USD/CHF & Gold were able to achieve new lows and highs, why hasn’t the Dow followed suit? Are equity markets starting to ignore the monetary policy and various measures of stimulus? Is it no longer enough?
Technical analysts refer to this phenomenon as ‘divergence’ where markets that typically react in similar fashion begin to diverge or drift away from one another and behave in a different manner. Of course over the next few days and weeks if equity markets are in fact able to re-test highs and even achieve new highs, this ‘convergence’ or agreement will be easily explained. Furthermore, given the fact that we are now entering the July (corporate) earning’s season, if the market is going to make new highs, we certainly now have the justification.
However if the (equity) markets are not able to do so, this may be an early sign of a change to come. Of course only time will tell, but we hope in following these market reactions, to possibly identify early signals of a change in trend. Perhaps the answer we’re searching for is that if despite the Fed Chairman’s best intentions to stimulate the economy, the stock market may now not be as easily impressed.
