If ‘twist’ flattens the curve and doesn’t send short yields down, it won’t hurt the dollar.
The FOMC concludes this evening with three policy options (other than doing nothing, which isn’t Mr Bernanke’s way): Cut the rate on banks’ excess reserves, increase the sum of bonds held on the Fed’s balance sheet, or extend the duration of that portfolio, switching shorter-dated bonds for longer ones. Commentators are flirting, in addition, with the notion of an inflation target. Of these options, duration extension (operation twist) seems the most likely. But aside from important debates like what it does for the economy (it keeps long-dated rates down, but at 30-year yields are already at a measly 3.21%), what does it mean for the dollar?
In the past, the announcement of QE has been dollar-negative. That’s partly because the message (we’re debasing our currency by printing more of it) is bad for the dollar and good for the yen, the Swiss franc and gold. But it’s mostly because the announcement has sent yields lower. Twist may send long-dated yields a little lower, but the front end which has been far more of a driver of FX trends than the long end since 2009, won’t get any help. 2-year Note yields are at 0.15%, their lowest level ever. I’m not a Treasury trader, or even a rates strategist, but I think the risk-reward finally favours shorting the front end of the curve. By extension, the FX conclusion is that perhaps down here at USD/JPY 76.30, a long USD/JPY position finally makes sense. We’ll find out this evening.
Earlier, we’ll get the minutes of the September UK MPC meeting (when rates and the size of QE were unchanged). It is assumed that Adam Posen, alone in voting for additional QE in August, maintained that stance. About half of those polled in surveys expect him to ‘find a friend’. Personally, I think there’s more chance of others switching camp in October and November, when the Inflation Report is published. Odds favour the Minutes helping GBP, though before 9:30 a.m, everyone can contemplate the oddity of the IMF effectively sanctioning the UK easing back on fiscal austerity as the economy struggle. Wonders will never cease.
A slightly more dovish stance from the Norges Bank, steady Canadian inflation and US existing home sales make up the rest of the day. There is a lack of euro news, which at the margin is a relief for the euro. We remain short EUR/GBP and short AUD and CAD vs the dollar, long SEK and NOK vs PLN, though the resilience of the S&P continues to thwart us.
Kit Juckes, lifers and german news (snb gold) below
Lifers’ duration extension can last six more years (economics Joe Lau)
The Japanese life insurance industry owns 20% of JGBs and they are the dominant buyers of long duration JGBs. In the recent years, they have been aggressively extending the duration of their assets to eliminate the asset/liability duration mismatch. The average duration of lifers’ assets was extended from 6.9 years to 9.5 years in the last 4 years. Such duration extension by lifers has been supporting the longer half of the JGB market despite Japan’s debt sustainability problem. In our view, the “duration extension” behaviour could last 6 more years. 6 years can be viewed as a long time for financial market, but it won’t be long enough for Japan to fix its public debt problem. We think the turbulence in the JGB market could be in store once duration extension is over.
News
Finmin schaueble says he has an 80% majority for the passage of the EFSF in Germany
http://www.handelsblatt.com/politik/deutschland/schaeuble-kalkuliert-efsf-abstimmung-neu/4629474.html
FAZ commentary saying external pressure on Italy is necessary for it to address its deficit.
http://www.faz.net/artikel/C30350/nach-italiens-herabstufung-druck-von-aussen-30689853.html
SVP wants to forbid the SNB from selling its gold reserve and maintain 20% of its reserves in it.
http://www.tagesschau.sf.tv/Nachrichten/Archiv/2011/09/20/Schweiz/SVP-will-Schweizer-Gold-schuetzen
Deflation in Swiss apple prices
http://www.gabot.de/index.php/News-Details/52/0/?&tx_ttnews%5Btt_news%5D=218579&tx_ttnews%5BbackPid%5D=1&cHash=76053dc4c2
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