The position for the dollar over the past three months has been the result of policies the Federal Reserve has failed to enact as much as for the policies it already has in place.
Considering the general market opinion that the next Fed move will be a reduction in the amount of its monthly securities purchases, questioning only when not if, it is remarkable that the euro is trading within 70 points of its two year high.
Chairman Ben Bernanke first raised the possibility of curtailing the Fed's market interventions in late May. Euro traders paid no attention and the euro gained 4.8 percent. It took a subsequent confirmation in mid-June to produce an impact and in the following three weeks the euro shed 4.9 percent. An equivocal commentary on the possibility of tapering from the Chairman in early July sent the euro climbing back that same 5 percent to 1.3400. Three comments from the Fed and the euro was five percent higher against the dollar.
Despite the back and forth from the Fed on the taper, the overwhelming market opinion going into the September 18th FOMC was that some amount of reduction would begin.
The logic was straight forward, the Fed had started the conversation and the central bank does not announce a policy change lightly. The surprise the afternoon of the 18th was almost complete. The euro gained 1.5 percent on the day and proceeded to a 3.7 percent jump within six weeks.
Even though U.S statistics since the September FOMC meeting have been relatively strong, particularly in employment, there are at least four good reasons to think the Fed will delay the taper until next year.
First, after so much emphasis on being data dependent and delaying the expected September reduction, the governors should be appreciably wary of changing their minds yet again. It took four months, May to September, for the Fed governors reverse their decision last time; will they be willing to pirouette again just three months later?
Second, a delay is safe where as a taper now risks repeating the credit shock that made the Fed quail in September, especially because the markets do not seem to have priced in a reduction. It costs the Fed nothing to wait and make sure the economy is strengthening.
Third, inflation is running below the Fed’s 2.0 percent target and has been trending down since 2011.
Finally Janet Yellen, the presumed new Fed Chairwoman, does not take over until February 1st. Her first FOMC meeting n the chair will be March 18th and 19th. Will the board want to circumscribe her policy choices in such an uncertain environment?
There are, however, equally compelling reasons to think that the Fed may restrict its bond purchases, among which are the closeness of the decision in September, the almost straight line economic improvement since then, the potential for bubbles in various markets and finally, quantitative easing is a policy that will be forever associated with the chairmanship of Ben Bernanke. He may want to write its finish as well as its start. He is, after all still chairman.
Markets have every reason to think that the end is approaching for quantitative easing. But having been burned the last time out, this time traders are waiting for proof.
Chief Market Strategist
WorldWideMarkets Online Trading