The knee-jerk reaction to the Fed’s extension of Operation Twist to the end of 2012 quickly yielded back to the risk-on and a further sell-off in bonds, which could mean the most pressure will be on the JPY from here.
The initial reaction to the Fed’s new monetary policy statement was disappointment, as the Fed limited its new action at this time to a further extension of the Operation Twist program and kept the language on further possible easing measures vague. Specifically, the Fed said that it would continue to buy long term debt of 6 to 30 years and sell short debt (3 years or less) through the end of this year and do so “at the current pace”.
On the one hand, while the statement’s hint at possible additional measures was vague, it was certainly “upgraded” relative to the previous statement as indicated below:
April 25: “The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.”
June 20: “The Committee is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”
As well, the language on employment was downgraded: “growth in employment has slowed in recent months.”, as was the description of household spending which is “rising at a slower pace than earlier in the year.” The statement also noted that Inflation has declined, “mainly reflecting lower prices of crude oil and gasoline.”
Bonds initially tried to rally and risk appetite headed for the hills, but then bonds sold off sharply again, perhaps as a good percentage of observers were looking for the Fed to actually come out already at this time with a new outright bond buying program. The bond sell-off had the JPY weakening the most of the major currencies as USDJPY pushes back towards its recent highs and EURJPY had briefly posted a new high as of this writing. The weak gold market I mentioned earlier weakened even further in the knee-jerk reaction, but then had perked up strongly again as of this writing, suggesting that some are seeing this move as a hinting at a shift in the Fed stance to support the market.
Let’s wait till the other side of the Bernanke press conference before drawing any conclusion and see where the dust settles at the end of the day and in the days ahead – the most interesting development thus far is the very weak bond market and the potential for a fresh bout of JPY weakness if this continues. Stay tuned.
John J Hardy,
SAXO BANK