Wednesday, March 16, 2011

One Eye on The Fed and the Other on the Yen

All eyes have been focused on The Fed and its various messages over the past several months. The FOMC met this week and said very little to change the expectation they have created for maintaining an easy money policy. Here is part of a FOMC Meeting Summary provided by Econoday.

Also reflecting a marginal upgrade to the recovery, the Fed dropped language regarding progress on unemployment as "disappointingly slow."

The FOMC decided to continue with its plans for QE2.

"To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability."

Most likely, the next (or even current) true debate at the Fed is what to do and when after QE2 concludes at the end of June. The Fed's balance sheet will top out at a little under $3 trillion and as soon as the Fed stops making additional purchases, the balance sheet will start to unwind on its own as securities mature and/or are paid down. So, the next key question is how fast does the Fed allow the unwinding to occur? The Fed may have to reinvest some pay down to keep the decline in assets at the desired pace. The next question is if this occurs, is it still QE2 or QE2.1 or QE3?

In addition, the natural disaster and follow on nuclear crisis in Japan is inspiring unexpected developments in the yen foreign exchange. As illustrated below, the yen has strengthened substantially today, in addition to the recent upward trend since the 11th of March when life turned upside down for much of Tokyo and northern Japan. A strong yen will slow exports and tourism while adding yield to government debt. The immediate issue will be the potential unwind of the yen carry. People who have borrowed at low rates in the yen are faced with suddenly more expensive costs and those will get resolved quickly. Tomorrow could be a big day down for the developed markets.

March 17, 2011: Peter Boockvar had this comment this morning. He was using a USD/Yen chart for reference. The chart below is a Yen/USD chart. "Overnight, the Nikkei started to bounce off its lows just 17 minutes into their day (still closed lower by 1.4%) and as it steadily recovered most of its losses, the S&P futures rallied too. The yen continues to rip higher vs the US$ as the repatriation process continues but is 2 yen off its overnight highs. Let’s hope we get facts from authorities today on what is going on rather than opinions of nuclear chief’s outside of Japan"