Thursday, June 20, 2013

Commentary: Market is Desperate to Take USD Higher

In terms of news, yesterday's press conference was a non-event.  The FOMC kept policy unchanged and reiterated that a reduction in asset purchases would be 'data based.'  Specifically, the committee is looking for signs of a sustainable recovery in the labor market.  The committee also expects inflation to remain subdued, though it believes that 'transitory influences' are keeping inflation below the Fed's 2.0 percent objective.   Additionally, Chairman Bernanke once again drew the distinction between balance sheet policy and interest rate policy.  Though the Fed may reduce asset purchases and therefore slow the pace of the growth of its balance sheet, rises in the Federal Funds Rate are still years away.  A final note of interest is that the two dissenting votes on the committee were on opposite sides of the issue.  Kansas City Fed President Esther George raised concerned about risks to longterm financial stability associated with extremely accommodative monetary policy. At the same time however, Saint Louis Fed president James Bullard advocated an increase in the Fed's monthly asset purchase program, arguing that it is imperative that the Fed defend its inflation target from below, especially during times of economic recovery.  

Markets for their part have largely latched onto any hint of a possible tightening (or in this case a reduction of loosening) in monetary policy.  The fact the mere discussion of a possible reduction of QE, even one predicated on good economic data, has sent the dollar surging, bond yields soaring, and equity and commodity markets into a tailspin shows a fundamental lack of conviction on the part of many investors.  Alas, we are now in a world where the value of nearly all assets is based in large part on monetary policy and not underlying fundamentals.  More disturbingly, many seem to forget that monetary policy itself is guided by underlying economic fundamentals.  A rate hike from the Fed would be proceeded by a strengthening of the economic outlook, which coincide with increased corporate profits, and therefore higher and not lower stock prices. In short, the market seems to be groping for any excuse to take profits on stocks and unwind FX carry trades.   

On FX, I continue to look for growth differentials, underlying economic fundamentals, but also diverging monetary policy from central banks.  If perceptions continue to exist that the Federal Reserve is on the road to tightening policy, the USD can no longer safely be used as a funding currency.  I booked profits on my long USD/ZAR positions this morning, and look to get long again in the 10.05-10 range.  Weak South African fundamentals should push this pair higher even if this recent bout of dollar strength subsides.  I also expanded my long EUR/CHF bet, jumping in at 1.2260.  I target 1.2350 in the short term. 


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