QE2 MAY GIVE US DOLLAR A RELIEF RALLY

DIRECTOR OF CURRENCY RESEARCH, GFT

AS THE currency world turns its attention to today’s FOMC statement, which is expected to reveal the terms of its QE2 programme, it may be useful to ask why do US monetary officials insist on quantitative easing in the first place? After all, most economists agree that this round of asset purchases is unlikely to have much of a positive impact on overall demand. Japan’s experiment with QE failed to stimulate its economy and many believe the US experience will also disappoint.

Yet Ben Bernanke and the FOMC are likely to proceed with their plan not because they are wild eyed optimists but because they believe that the US political situation is in disarray as it suffers from complete absence of leadership. With Congress and the president at a stalemate, the US economy could quickly become vulnerable to a double-dip recession as paralysis in Washington translates into economic inertia. Above all Bernanke is a student of the Great Depression and he is familiar with 1936 when FDR curtailed spending only to watch the US economy come to a grinding halt for the second time in that decade. He is desperate to avoid another credit crunch and the possible failure of more financial institutions. Therefore QE2 will be put in place as the Fed assumes responsibility for ensuring banks stay solvent while Congress debates politics.

For the currency market the only question about QE that remains open is how much? Dollar bears argue that the Fed will announce a program of $500bn or more, but I believe the US monetary authorities will be a lot more cautious in their approach and will contain purchases to no more than $100-$200bn initially. If the Fed is much more parsimonious than the market anticipates, the dollar could see a relief rally. But given the overall negative sentiment towards the dollar, any pop could be short lived unless US economic data starts to show a considerable improvement.

Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read commentary at www.GFTUK.com/commentary or e-mail borisandkathy@gftuk.com.