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The US Federal Reserve has stated its intention to reduce its bond buying program known as quantitative easing. The US central bank has been purchasing $85 Billion in US treasuries every month. This policy was meant to stimulate the US economy, keep interest rates down, and help relieve unemployment. It was never intended to be permanent. As the end of this policy approaches the bond market has reacted with large scale selling and interest rates have risen. As a general rule increased bond yields drive the dollar higher. The USD rose against most major currencies and reached a three week high against the yen. While increased bond yields drive the dollar higher the Euro is maintaining strength on news that the European Central Bank does intend to drive interest rates down as the recession in the EU is finally relenting. Before looking at how this will affect foreign currency trading let us look at just what quantitative easing is.
What Is Quantitative Easing?
Quantitative easing or QE is an unconventional monetary policy. It has only been used when standard monetary policy is not successful in stimulating an economy. A central bank implements QE by buying financial assets from commercial banks and other private institutions. This increases the money supply. The goal is to keep interest rates low. In addition the central bank buys government bonds as another measure to keep interest rates low. This policy was used by the Bank of Japan to fight deflation in the early 2000’s. It has been used by the European Union, Great Britain and the United States since the onset of the
Great Recession of 2007 and forward.
QE 1, 2, 3 and the USD
The US Federal Reserve has had three rounds of quantitative easing, QE 1, QE 2 and QE 3. QE 3 will be phased out by mid-2014 according to the Fed. In the first round the Fed purchased $2.1 Trillion in bank debt, mortgage backed securities and treasury notes. In the second round the Fed purchased an additional $600 Billion of US Treasuries. QE 3 started in the fall of 2012 with bond purchases of $40 Billion a month and raised the amount to $85 Billion in December of 2012. The Fed program of quantitative easing was successful in that it helped the nation recover from the recession. And it was never intended to be permanent. But when the Fed chairman announced an eventual end to the program stocks fell and bond owners sold. Bonds have gone up as increased bond yields drive the dollar higher as well. What many traders anticipate is a further rise in the US interest rate. As increased bond yields drive the dollar higher there is the potential for profits in online currency trading. The ten year bond has been trading just under 3% and experts expect rates to go up to nearly $5 by the end of the third quarter of 2014.