Dollar boosted by Fed QE3 stimulus restraint

THE Federal Open Market Committee (FOMC) followed expectations by holding rates yesterday, and at the same time dispelled the possibility of an immediate third round of quantitative easing (QE3). Federal Reserve chairman Ben Bernanke pointed to “an improving economic situation”, though checked any untoward optimism by acknowledging that economic growth would be moderate. The central bank said its benchmark interest rate will stay between 0 per cent and 0.25 per cent until at least late 2014, though Richmond Fed president Jeffrey Lacker dissented, stating that he does not expect economic conditions to warrant ultra-low rates until late 2014.

Earlier in the day, the Commerce Department reported that February retail sales rose by 1.1 percent. Though this rise was in line with analysts expectations, they do come as part of a continuing trend of strong data releases – following on from the non-farm payroll figures on Friday that indicated that more than 200,000 jobs had been created in February.

This continuing barrage of strong economic data took the wind out of expectations of QE3 but Bernanke said that he would continue with Operation Twist – the Federal Reserve program of selling short-dated debt from its reserves and using the proceeds to buy long-dated debt securities with the aim of flattening the yield curve and pushing long-term interest rates downward to the Fed’s near-zero per cent target.

Though the dollar rallied yesterday after the Fed chairman made no reference to the possibility of a third round of QE, Bernanke still holds the option in reserve. Many predict that we will see QE3 in the next three to six months, with Fed purchases of Treasuries and mortgage-backed securities sterilised using reverse repos and longer-dated Treasuries in order to try and combat the inflationary effects of the measures.

The lack of another full-blown monetary stimulus operation and a generally “dollar positive” statement continued the risk-off moves as the dollar climbed against the euro, sliding back below the $1.3100 mark after positive news from Greece took the pair to $1.3108 in the US session, taking euro-dollar down 0.5 per cent on the day. News that ratings agency Fitch had upgraded its ratings of Greek debt from restricted default to B- had boosted the common currency, but the FOMC statement checked euro gains. And with few betting on the long-term stability of the Eurozone, don’t be surprised to see this trend reversed.