Forex Markets Affected By Fed’s ‘Easing Bias’

By admin / September 4, 2010

ForexDuring the course of the month of August, the market needed to absorb some interesting action taken by global central banks.

The Federal Reserve has taken steps to avoid a passive tightening of policy by preventing a contraction in its balance sheet. Instead of ending their bond-purchasing program, it was rolled over in an effort to avoid passive tightening.

Judging from Bernanke’s speech at Jackson Hole last week, the Federal Reserve has adopted what traditionally would be called an “easing bias” and although the precise trigger may be being debated, many expect that continued poor US economic data will prompt the Fed to take additional measures.This could potentially be a return to quantitative easing which is only supposed to be used in an economic emergency.

Japanese officials are providing additional monetary and fiscal support. The BOJ yesterday expanded a special lending facility by JPY10 trillion (~$117 billion) and the government indicated it will draw down its budget reserves by almost JPY1 trillion to boost jobs and investment. Japanese official are very concerned with the strong Yen, as the Japanese economy is export lead, and a strong currency makes their products less competitive – this is certainly something that Forex brokers will be analyzing.

Later this week, the ECB is expected to indicate that its special liquidity provisions will be extended into next year. With peripheral bond markets still very weak relative to German, the ECB needs to continue to provide liquidity and reassurance.

The Bank of England has hinted that more quantitative easing is possible. Many pundits are arguing that the central banks are running out of measures and are powerless in the face of the global de-leveraging.

Such cynicism however confuses two issues, which are the instruments that can be used to assist in rebuilding economies and the desire and will to make it happen. The tools seem to exist.

For example, if countries were willing to sacrifice their ratings, more fiscal stimulus could be provided. This applies to Japan as much as the US and Europe. The probability of anything more than initial success of unilateral BOJ intervention is low, there are still other measures Japanese officials could do to weaken the yen.

Talk of cutting the overnight rate to zero from 10 basis points is hardly inspiring, but Japan can adopt negative interest rates, and penalize depositors, like Switzerland and Germany have done in the past. The point is that there are numerous measures that governments and central banks can take, but the main obstacle is political will, which includes the perceptions of the cost-benefit of deploying such tools.

With so many central banks creating a zero interest rate policy, forex trading will lean toward currencies that are in tightening mode, such as Australia and Canada, which should outperform other currencies given the interest rate differentials.

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