Weekly Market Insight
November 5, 2010
NORTH AMERICAN & INTERNATIONAL ECONOMIC HIGHLIGHTS
Blue Days for the Greenback
By Avery Shenfeld
There was much ado about $100 bn last week. The Fed acted like a corporate CFO, guiding expectations for
the amount of quantitative easing downwards ahead of the announcement, so that it could “beat” street
expectations. Instead of a nice round $500 bn, it went with $600 bn so that it wouldn’t see a disappointed
market sell financial assets that day. The foreign exchange market in particular seemed to attach a lot of
importance to that bump in the first digit.
Note that in his Washington Post op ed, Bernanke listed all of the potential benefits of QE with one key
exception—its impact on the US dollar exchange rate. Sure, a firmer equity market and lower bond yields (if
not for the 30s) are an economic plus. But the market that has moved the most on the news of QE has been
that for the US dollar. In the market’s eyes, the more QE, the weaker your currency.
The Canadian dollar has seen the smallest gain of all major currencies over the past three months. Still, it
managed to appreciate despite the Bank of Canada’s veiled threat to intervene, and a decision to block a
major foreign takeover that cancelled the need for significant C$ purchases by the acquirer. A weaker US
dollar lifts the price of oil, gold and other commodities priced in greenbacks, and thereby makes an
appreciating loonie a bit less of a threat to Canadian growth.
In theory—often a dangerous phrase for those trying to understand market behaviour —the Fed’s QE program
needn’t be that negative for the greenback. True, by lowering US bond yields relative to others, it makes
capital outflows more attractive.
But much of the dollar-selling isn’t premised on a slightly wider spread between, say, German bunds and US
Treasuries, but on the misconception that the world is going to be flooded with “printed money” which will
debase the dollar. That’s simply not the case. The trillions of bonds that the Fed has purchased by creating
money has essentially all been sent back to the Fed as excess reserves on deposit with the central bank. The
money is not being lent and re-lent in the broader economy. US M2 has picked up a bit, but is running at 3%
over the past year, not far off the nearly 2% growth seen in eurozone M2 growth over the same period.
Bernanke continues to pledge to remove the extra dollars from the money supply when more vigorous lending,
and the associated economic growth, starts to emerge.
Still, theory can take a back seat to market dogma. We expected quick profit-taking on short-US$ positions
after the FOMC meeting, but that call seems to have been thwarted by that extra $100 bn, at least for now.
We’ll stick with our view that any further appreciation for the euro, yen and C$ will at some point soon run up
against a reality check, as investors rethink the abilities of the European, Japanese and Canadian economies to
tolerate these moves. There are risks that in the case of the latter two, they might intervene to counter undue
currency strength, and Europe’s fiscal and banking mess is far from over. But we will likely have to push back
the timetable for a significant correction in the US dollar’s favour into early 2011, given the tendency to see QE
and currency weakness as twins.