Quantitative Easing & Currency Strengthening

by Ashraf Laidi
Aug 6, 2009 17:22 | 37 Comments

Sterling Contracts as BoE Expands QE

Sterling dropped across the board today after the Bank of England expanded its quantitative easing program by adding an extra 50 billion of asset purchases into the next 3 months. Yields on 10 year guilts drop 35 bps to 3.57%, GBPUSD shed 200 pts, while EURGBP shot up 100 pts to 0.8555, further proving the 0.84 support to be a key foundation in the cross pairs cyclical ascent.

Quantitative Easing & Currency Strengthening - Quanteasing Text Aug 6 (Chart 1)
The above equation surely must have been examined by the Bank of England. With oil prices doubling year to date, sterling rising 25% vs USD and 11% vs EUR respectively and unemployment still on the rise, the Bank of England could run the risk of prolonging the tightening mechanism via excessive GBP gains in the event of closing the door on QE. For the ECB, euro is up 16% from the years lows, unemployment is back above 9% and oil prices are still more costly (despite strong EUR), all at a time when annual inflation has turned negative.

Quantitative Easing & Currency Strengthening - Cable Mnthly Aug 6 (Chart 2)


QE Easing vs. Currency Strengthening

Since the Bank of England has frequently addressed the positive impact of currency weakness in stimulating the economy, today's QE expansion was no major surprise, especially as it forecasts GDP growth contraction and sub-2% inflation well into Q1 2009. The BoE must also have been concerned with sterlings resurfacing positive response to improved risk appetite (mainly against USD). The other main risk to a definitive conclusion to QE is the potential negative impact on equity indices. Thus, tactically, the BoE could not afford to bear the currency repercussions from concluding QE, especially at a time when USD weakness has become synonymous with global recovery.

Building Blocks to Global Risk Aversion?

The charts below illustrate what could be the building blocks to a potentially concerted downturn in global risk appetite, ranging from peaking oil prices (failure to regain $73 triple top), struggling Chinese stocks (failed recovery from the years biggest daily decline) and prolonged signs of a well cemented bottom in the VIX (July chart showed classic sign of indecision at the bottom of the downcycle). With the US equities-oil correlation as high as 0.85 this past 8 weeks, the unsustainable run-up in the fuel seems to justify the bearish divergence in the oscillators throughout US, UK and Eurozone equity indices, as well as the Shanghai Composite Index below.

Quantitative Easing & Currency Strengthening - CHINAVIX OIL AUG 6 (Chart 3)

Loonie's Tipping Point

CAD's weakness is highlighted by its muted response to the latest spike in oil prices as the impact of Wednesdays interventionist remarks from Canadian Finance Minister Flaherty warning against excessive currency strength. But with US crude increasingly struggling to overcome the $73 resistance, Canadas jobless still on the rise and verbal intervention at its most vocal since last year, the downside risks for the loonie are growing appreciably. This renders equities as the potential tipping point for concerted CAD selling, especially as major US equity indices (S&P500 and Dow) have shown a 0.75 correlation with the Canadian currency (as expressed in USDCAD and CADJPY).

Readers have already been warned of the incipient recovery in USDCAD on Monday after bottoming out at the trend support of 1.0690. Our interim target of 1.0780, is expected to be followed by 1.09. Friday's release of Canada's July employment report (11:00 EST 1.5 hrs before US payrolls) could be the catalyst for prolonged weakness as Canada's unemployment rate may hit as high as 8.9% from June's 8.6%, with payrolls expected -20K after -7K.

Quantitative Easing & Currency Strengthening - CAD Aug 6 (Chart 4)

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Comments (Showing latest 10 of 37) View All Comments
Ashraf Laidi
London, UK
Posts: 0
10 years ago
Sep 3, 2009 10:14
Patricia, welcome to the site. There's also a blog for external contributers.

Ashraf
Patricia
United States
Posted Anonymously
10 years ago
Sep 3, 2009 8:48
I recently came across your blog and have been reading along. I thought I would leave my first comment. I don't know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.

Patricia
http://forextradin-g.net
speculator
Posted Anonymously
10 years ago
Aug 19, 2009 7:20
emerging market weakness if continues will be highly beneficial for the USD as risky cash unwinds back to USD.
forextrader
vologda, Russia
Posts: 127
10 years ago
Aug 17, 2009 16:05
Yes Jack, good Euro/USD short at 1.4110 and GBP/USD is good Short at 1.6330.
I am Bearish Cable/usd and Canadian/usd. i see 1.58 and 1.14 at the end of August
Dima
Ashraf Laidi
London, UK
Posts: 0
10 years ago
Aug 17, 2009 15:04
JackD, very good point. Then the same advice applies for NY Lunch time

Ashraf
JackD
United States
Posted Anonymously
10 years ago
Aug 17, 2009 14:40
Dear Group,

Be sure the take some profits as the London close nears. You'll get a chance to re-establish a better position if you're still bearish EM and bullish USD. Those who did not get in yet, that will be the chance for you to enter if you wish.

-Jack
Ashraf Laidi
London, UK
Posts: 0
10 years ago
Aug 17, 2009 7:48
hamish, look for 1.1100-20, a slight retreat then towards 1.13. Keep an eye on oil, NOW BELOW 67

Ashraf
hamish
vancouver, Canada
Posted Anonymously
10 years ago
Aug 17, 2009 6:27
Asthraf, don't worry I'm short CAD now trading 1.1058 . Do you expect a pullback or do we still hold for 1.13 ?
Ashraf Laidi
London, UK
Posts: 0
10 years ago
Aug 16, 2009 22:59
raulin, very good point. But not sure if the positive Japns GDP will be sufficient in extending Jpns stocks rally, shrugging last week's US selloff and playing risk appetite at the expense of the yen. Some profittaking in Japan has to ensue. And dont forget the deteriorating technicals in Shanghai Composite.

Ashraf
raulin
london, UK
Posts: 65
10 years ago
Aug 16, 2009 22:49
Hi Ashraf
Do you not think that positive news about Japan GDP will be positive for Japan equities positive for aussie/jpy and negative for JPY ? The only reason to buy the low yielding yen is in a risk averse environment. I do agree with you about usd/jpy looking bearish overall especially stalling at 97