There is a clear regime shift that is starting to take place and will be the major theme of 2009. It is the switch from a quasi-Taylor rule – inflation target Fed stance to a quantitative easing policy. This change in policy by the Fed which has become increasingly clear in November will shift the focus from flight to quality to flight to alternative forms of purchasing power.
The quantitative easing era is upon us. The Fed has now consistently announced further purchases of GSE and corporate liabilities to solve the banking crisis and has moved further away from the use as interest rates as a solution. This is evident because the actual Fed funds rates has been falling consistently below the target level for weeks even with the change in policy to pay interests on reserve balances. This is becoming very much like the zero interest rate policy of the Bank of Japan which started in March 2001. The impact of flooding the market with reserves without regard to interest rates was very clear on the currency, depreciation. This same type of impact should be seen with the dollar.
The only argument against this unequivocal decline in the dollar is that the policy easings of other countries are still occurring. The declining interest rate gap between the US and the rest of the world will continue. The rates in some many countries are falling close to zero there may be global quantitative easing. Japan and Switzerland are the most likely places were rates will close to zero.
The risk aversion story of delevering with moving money to the US will dissipate. There will be less dollar buying from rebalancing hedged positions and global sell-off of other equity markets will slow. This will reduce the upward pressure on the dollar.
The biggest oil declines are behind us and there will be less dollar strengthening head winds from the energy markets which has been a consistent linkage. A decline in oil downward momentum will be dollar negative.
The European economic slowdown surprise is over. We know that Europe is in bad shape. The US growth, after holding up with tax relieve in the second quarter is looking worse so there is less dollar strengthening head winds from a fall-off in growth from other countries.
The key focus will be on the unique and extreme monetary stance of the Fed and that is dollar negative.
The only argument against this unequivocal decline in the dollar is that the policy easings of other countries are still occurring. The declining interest rate gap between the US and the rest of the world will continue. The rates in some many countries are falling close to zero there may be global quantitative easing. Japan and Switzerland are the most likely places were rates will close to zero.
The risk aversion story of delevering with moving money to the US will dissipate. There will be less dollar buying from rebalancing hedged positions and global sell-off of other equity markets will slow. This will reduce the upward pressure on the dollar.
The biggest oil declines are behind us and there will be less dollar strengthening head winds from the energy markets which has been a consistent linkage. A decline in oil downward momentum will be dollar negative.
The European economic slowdown surprise is over. We know that Europe is in bad shape. The US growth, after holding up with tax relieve in the second quarter is looking worse so there is less dollar strengthening head winds from a fall-off in growth from other countries.
The key focus will be on the unique and extreme monetary stance of the Fed and that is dollar negative.
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