City Index’s chief global strategist Ashraf Laidi explains how to trade Fed QE expectations
SO FAR, we’ve had four Fed meetings, four US jobs reports and two congressional testimonies by Fed chairman Ben Bernanke this year. Currency markets interpreted each event in one of three ways: the Fed will reduce its $85bn in monthly asset purchases (tapering); it will maintain purchases intact (taper off); or there’s a possibility of increasing purchases (raising QE).
None of this is very different from a year ago, when US data were interpreted as follows: QE3, or sticking with Operation Twist (selling short-term bonds and buying long-term bonds). Go back to 2011 and the interpretation was again either QE2 or no more QE2.
In each case, the market reaction was and remains generally the same: a binary set of interpretations, implying more Fed stimulus or a continuation of the status quo. The latter would mean a stronger US dollar, falling European and commodity currencies and weak global equity indices. More Fed stimulus would imply the opposite. This used to be called risk-on, risk-off. Now it is known as taper-on, taper-off. The name is different, but the pendulum swings the same way.
And the “stimulus” side of the equation was further bolstered by the European Central Bank’s (ECB) September 2012 announcement that it would use its own version of QE (Outright Monetary Transactions) to stabilise sovereign bond yields and give politicians time to implement reform. It worked. Markets hit new highs, yields hit three-year lows, the euro stabilised, shrugging an election impasse in Italy and penalising depositors in Cyprus. The ECB has addressed the issue of “market stress”, now it faces the “macro stress”. Slashing ECB interest rates to negative will return to the agenda in autumn.
How to Trade it?
When all is said and done, we expect the Fed to maintain its $85bn monthly purchases unchanged into the middle of the first quarter of 2014, and the ECB to slash interest rates to negative levels by year-end. This may imply a neutral-to-strong US dollar, but with a higher confidence level play in selling the yen against both the dollar and euro.
The yen’s occasional gains during rare risk aversion episodes remain an opportunity to sell at higher levels. And the reactionary pullbacks in the US dollar from “taper off” signals become a greater opportunity to buy the US currency on the bolstering premise that another nine to ten year bear market in the greenback has been played out.
Ashraf Laidi is chief global strategist at City Index. He will be speaking at this year’s City A.M. Active Trader conference on 21 June 2013 at the Grange Hotel, Tower Bridge, London E1 8GP. Tickets are available for only £65 at www.CityAMactivetrader.com