September 5, 2011
Sizing Up the Dollar's Pain in the Event of a QE3
The U.S. dollar is likely to take less of a beating from a third round of Fed stimulus, if it happens, than from the second round, though analysts still expect the currency to fall.
Traders have begun preparing for some punishment for the dollar after the U.S. Labor Department reported Friday that the economy added no jobs in August, feeding into expectations that the Federal Reserve will be compelled to act to boost growth. The dollar slipped against the Swiss franc, another popular safe haven, after the data.
The dollar has plunged nearly 20% against the euro over the last year and a half, a period that includes the run-up to and aftermath of the last round of quantitative easing, the Fed's $600 billion bond-buying program known as QE2. But a QE3—which isn't a sure thing—may not pack the same dollar-slamming punch.
If there is a QE3, the dollar's fall could easily approach 10% on a trade-weighted basis against rival currencies, said David Woo, head of G-10 global rates and currencies research at Bank of America Merrill Lynch in New York.
But "the market is now more skeptical of the benefits of QE for the economy," Mr. Woo said. "It is possible that by extension this means any short-term [dollar] decline on the back of QE3 will be also more limited."
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The dollar is already trading close to its worst level ever against other major currencies, including the euro, the Swiss franc and the yen. There is bound to be more resistance as the dollar continues to erode in value, especially because the U.S. currency remains in demand as the world's preferred reserve currency as well as the most actively traded.
In addition, other currencies are in much worse shape relative to the dollar than they were at the start of QE2, with the euro battered by concern about high debt levels in several euro-zone members.
Still, Douglas Borthwick, head of trading and a managing director at Faros Trading, said he likes his anti-dollar bet now more than ever, especially in the wake of Friday's jobs data. His main strategy for this year has been for investors to be long gold and the currency pair of the euro-dollar because of quantitative easing, and that trade would have returned 42% if gold were used as collateral, Faros said.
The idea behind that trade is to sell the dollar and buy gold. The dollar's stimulus-based decline was one of the biggest drivers of rising gold, helping fuel the yellow metal to record highs.
"I'm not sure the dollar is that much deflated" after QE2, he said, meaning he is confident the dollar has further to fall, he said.
Mr. Borthwick predicts the euro will hit a record high against the dollar in 2012. The previous record of $1.6040 was set in July 2008 during the U.S. financial crisis. Late Friday in New York, the euro was at $1.4206.
He also expects a record low of ¥70 for the dollar based on expectations for QE3. The dollar fell below ¥76 for the first time on Aug. 19, and was at ¥76.87 late Friday.
The dollar's drop could be smaller if the Fed undertakes stimulus that avoids flooding the market with more dollars via bond purchases. For example, the U.S. central bank could embark on what investors have called "Operation Twist," first used in the 1960s, where the Fed would sell short-term Treasury debt and buy long-term Treasury bonds.
"If it is merely a twist operation as has been rumored in the market, my guess is that it would be mildly damaging" to the dollar, said Stephen Jen, managing director and founder of SLJ Macro Partners in London.
http://www.allvoices.com/news/10244473-sizing-up-dollars-pain-from-a-qe3
