Will Dollar Forex Futures Strengthen with QE2 Now in the History Books?
If one thing is certain in our forex markets, it is that they will continue to fluctuate, but the direction of prevailing trends will always be dictated by the market’s interpretation and assessment of numerous economic variables. Some factors obviously carry more weight than others in these minute-by minute valuations, but analysts and investors must go one step further when pricing forex futures by extending their best guesstimates over a subsequent period of time.
The recent pronouncements by Bernanke that QE2 is now concluded and that a QE3 program has a low probability of ever happening will undoubtedly revise our visions for the future for currency markets. Back in April, many of the best currency forecasters opined on the impact of this very topic. Most agreed that there would be little reason for the Dollar to improve. The Fed would maintain its low interest rate posture, as long as inflation was in check, which Bernanke claimed in his recent speech. Based on a survey of more than 70 economists, the Fed is also expected to keep its target rate at 0.25 percent or lower for the balance of 2010.
Back in March, the Dollar had posted a brief rally after the Fed concluded its initial portion of bond repurchases. However, analysts are not expecting a repeat performance this time around. Many factors will influence the trends to come, but the following chart provides an initial basis for discussion:
The “White” line represents the Fed’s Balance Sheet, increasing $600 billion during the asset-purchase program of QE2. The “Yellow” line depicts the Dollar Index decline as the money supply was expanded, hitting a new 16-month low in the process. The “Green” line has been added to reflect Gold prices, a facsimile for commodity prices that are generally denominated in Dollars, but have appreciated as the Dollar devalued.
The question now is what will the future bring? Are estimates from three months back still valid, or has the environment changed enough to expect a bounce-back from the battered Greenback? For the long-term, Dollar strength is dependent upon the Fed reducing its balance sheet holdings, but the near-term may find support as the European debt crisis continues to repeat its endless series of “three-act plays” to paper over the weakness of its member states.
Current estimates suggest a ranging market scenario for the balance of the year. Investors will focus their attention on each release of economic data, searching for some evidence that the domestic economic engine is alive and well. Support in the past has also come from capital flight when risk persists on the international stage, but the low point of the Dollar’s fall may shift allegiances to the Swiss Franc or the Japanese Yen. Whether the Greenback will remain the “safe haven of choice” is now doubtful.
Although key economic indicators like retail sales, unemployment, and industrial surveys have suggested that another economic slowdown is taking place, the potential for a QE3 program is highly unlikely considering the pressure directed at the Fed. Commodity and oil prices have boosted inflation to a degree, but it remains below its 2% target. Monetary tightening is not in the Fed’s equation at present. The Fed is also not expected to sell any balance sheet assets any time soon, so the focus for investors must shift to economic data for guidance.
The Dollar has hit new lows, but improvement may be stalled for the near-term. The immediate outlook depends on austerity measures working in Europe. This current rendition of “Groundhog Day” has yet to reach a finale.
By Tom Cleveland, Market Analyst for forextraders.com
