Quantitative easing has been declared!!!-dust off Gutenberg’s printing press.

The Fed can go no further with rates. That’s it. They will now have to rely on their balance sheet to fix ‘this’ financial crisis. At least Paulson is upbeat about the whole situation, he see’s no other major financial firms failing, a bold and brave statement. However, banks are showing no signs of easing credit in step with the Fed’s rates. Some one will be squeezed!

The US$ is mixed in the O/N trading session. Currently it is higher against 10 of the 16 most actively traded currencies, in another ‘whippy’ trading range.

Forex heatmap

Yesterday’s US CPI was not exactly a big surprise given the antics in the commodities market of late, but, it remains the biggest monthly decline in the post WWII era (-1.7% vs. -1.0). Perhaps even more eye popping was the core (ex-food and energy) remaining flat after recording a very rare -0.1% decline the previous month. Digging deeper, one notices that the ‘deep’ discounting on autos (-0.9%) and hotel prices (-1.1%) were the main reasons. The dominant influence was definitely lower energy prices; the decline in gas prices single-handedly shaved -1.54% off the headline figure. Stabilizing gas prices would suggest that its effect will be much less significant going forward. However a flat core-CPI reading emphasizes that ‘zero’ pricing power exists on average across the US economy. Is this deflation? Not necessarily, because of the dominant role of energy prices in bringing the headline down, but it signals the presence of disinflationary pressures. Other data showed that housing starts plummeted to a record low in Nov. declining -19% on the month alone. The US housing market is still searching for a bottom starts fell to 625k units. Weakness looks like it will persist in the coming months as building permits (616k), a short run leading indicator, came in below starts and also fell to a record low. Until the supply and demand mismatch begins to be rectified we would expect to continue to see weakness in future starts.

Yesterday, Bernanke and Co. unanimously (10-0) and aggressively cut funding rates 75bp. Their following communiqué highlighted their deep concerns. They appeased the ‘Zero’ Interest Rate policy advocates by establishing a target ‘range’ for fed funds rate of 0 to 25bps. This confirms that the effective fed funds rate is already trading within that range. Rate cuts have therefore reached the end and the Fed is shifting its full weight towards throwing everything it has at stabilizing financial markets. At the same time they also cut the rate paid on excess deposits to 0.25%. The Fed will use ‘all available tools to promote the resumption of sustainable economic growth and to preserve price stability’. But, and it’s a big but, nothing new that was offered by way of policies designed to achieve such an outcome. The Fed reiterated that they intend to ramp up ‘large quantities’ of agency debt and mortgage backed securities, and that it stands ready to increase those purchases as needed. They also repeated that it is evaluating the potential benefits of purchasing LT Treasury securities. This will weigh heavily on the long end of the US yield curve. This will force borrowing costs lower for consumers and companies; at least it will benefit mortgage holders. They also repeated that the Term Asset-Backed Securities Loan Facility will be implemented early next year to facilitate the extension of credit to households and small businesses. In hindsight the Fed is sending a message that it will ‘print money’ to an unlimited extent until it starts to see the economy expanding. The market reaction has basically said ‘bye-bye’ to the US$ and sent long dated US securities yields to explore uncharted waters.

The US$ currently is higher against the EUR -0.10%, GBP -0.26% and lower against CHF +0.15% and JPY +0.29%. The commodity currencies are weaker this morning, CAD -0.19% and AUD -0.53%. Yesterday, Canadian manufacturing broke the strong correlation between exports and shipments and fell -0.5%, m/m in Oct. this on the back of weaker gas prices and a faltering loonie. Real shipments eased -1.8%, m/m, to the lowest level since Dec. 2001, putting further downward pressure on real-GDP for this years 4th Q. But, impressively new orders surged +8.8% m/m and inventories advanced +1.3% m/m. It should be noted the main problem with some of the Canadian data is that it’s rather historical in nature. Leaving very much exposed to sharp future downsides. The loonie advanced yesterday as its US counterpart declined against all major currencies and crude oil prices hovered, thus increasing the currency’s appeal. It’s not necessarily the genuine strength of the loonie but the demise of the greenback that has given the CAD$ a temporary boost. Year-to-date the currency has shaved 17% off its value against its largest trading partner as a global recession reduces demand for commodities, which generate about 50% of the country’s export revenue. On a cross related basis the loonie has faltered and traders continue to want to sell the CAD$ on strength. With liquidity issues becoming more pronounced, one should expect violent trading ranges to remain until the New Year.

The AUD dollar rose to a 2-month high after the Fed cut its target interest rate to as ‘low as zero’, encouraging investors to purchase the nations ‘higher-yielding assets’. With global equities remaining in positive territory coupled with robust commodity prices has traders remaining better buyers on pull backs for the moment and shying away from the greenback as a safe heaven asset class (0.6931).

Crude is higher O/N ($44.95 up +125c). Crude prices received a temporary shot in the arm yesterday after Saudi Arabia, Venezuela and Iran said OPEC may need to trim output by -2m barrels a day at today’s meeting in Algeria. But, the early gains were not sustainable on skepticism that OPEC will not reduce production targets enough. Earlier in the week OPEC’s Secretary-General El-Badri said the group needs to make a ‘sizable’ output cut. It is expected that they will collectively cut production by another -7.3%. The market expects them to come out with a strong statement and also have Russia in their corner. In Oct. they reduced production by -1.5m barrels a day. OPEC has already asked Russia to reduce output by +200k to +300k barrels a day to help push prices towards their desired price target of $75. Last week we saw the ‘black stuff’ appreciate 13%, the biggest weekly gain in nearly 4-years as both investors and speculators believe that OPEC’s action will boost prices. The Saudi oil minister said that the Kingdom had delivered the output cuts promised to OPEC (last month). The market has taken this as a sign that world supplies are smaller than traders believe. The Kingdom pumped +8.493m barrels a day in Nov., in line with its OPEC production quota of +8.477m barrels. This ‘new’ policy of transparency from the Saudis has everyone looking to buy on pull backs. Last week’s weekly EIA report showed that inventories of gas and distillate fuel, a category that includes heating oil and diesel unexpectedly jumped. Gas stockpiles rose +3.7m barrels to +202.7m w/w, while distillate inventories climbed +5.6m to +130.6m barrels. They were anticipated to fall -400k barrels and distillate supplies by -1.5m respectively. Inventories of crude rose +392k barrels to +320.8m (analysts had anticipated a 10th consecutive increase of +1.3m barrels). Refineries operated at 87.4% of capacity and were up +3.1% from last week. The 4-week US fuel consumption averaged +19.3m barrels a day, that’s down -6.1% for the same period last year. Gold prices have rallied to a new 2-month high on the back of a weaker greenback; by default it has temporarily increased the appeal of the ‘yellow metal’ as an alternative investment ($856).

The Nikkei closed 8,612 up +45. The DAX index in Europe was at 4,653 down -76; the FTSE (UK) currently is 4,235 down -74. The early call for the open of key US indices is lower. The 10-year Treasury yields plummeted 23bp yesterday (2.30%) and a further 7bp in the O/N session (2.23%). Treasuries rose, pushing yields to record lows, after Bernanke and Co. slashed funding costs to a range of ‘zero to 0.25%’and enforced that they ‘will do whatever is necessary to ease the longest recession in 25-years. The Fed announcement has once again flattened the curve (2-10’s 171bp). They are done with rates; no further reduction will do anything. Gutenberg will be happy, as the printing press now becomes in vogue.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell