No QE3 Right - So Why Did The USD Just Hit A New Cyclical Low? Citi Explains Why

Tyler Durden's picture

If you are confused why at one point every word the Chairman said was the equivalent of one pip lower for the DXY and 10 cents higher for gold, wonder no more. Here is Citi's Steven Englander asking, and explaining why the USD just hit a new cyclical low.

From Citi's Steven Englander

Asset markets pretty much liked the FOMC statement and really liked the press conference, but that's not the same thing as liking the USD. Consider the chart below -- the blue line shows the tick-by-tick drop in DXY (the dollar index) from noon to  4PM New York time, encompassing the FOMC statement and the press conference. The red line is the S&P and the green line is the two year yield. The question is what surprised the market  to such a degree that the USD basically hit new cyclical lows.
 
The factors:
 
1) the Fed comfort zone with how core inflation is evolving -- investors may have been looking for an upgrading of the degree of inflation concern that did not emerge either in the statement or in the press conference comments -- neither emerged
 
2) the dismissal of USD weakness as a factor driving commodity prices -- echoing a speech by Fed Vice-Chairman Yellen a few weeks ago; rapid growth in EM economies was viewed as the major factor in commodity price strength
 
3) the comments on a strong dollar policy were treated pretty much as pro forma relative to the view that a stronger US economy is a prerequisite to a stronger USD in the medium -- a view that embraces USD weakness in the near-term -- "The second thing we are trying to accomplish is get a stronger recovery and achieve maximum employment. Again, a strong economy attracting foreign capital will be good for the dollar."
 
4) reference to the success of QE2 -- in particular to the gains in stock and credit prices as the measure of the success of QE2 -- by implication a weaker USD is an unindicted co-conspirator in that success
 
5) the emphasis on the measure of Fed ease being the stock of assets owned rather than the flow
-- by implication the end of QE2 would be the end of additional easing but not the beginning of tightening -- the implication for the FX market is that a backing up of asset prices at the end of QE2 would be unwelcome.
 
6) given the success claimed for QE2, the conclusion "we've taken our forecast down just a bit, taking into account factors like weaker construction and possibly just a bit less momentum in the economy" seems very tepid.
 
It is not clear how much of these comments should have been viewed as a surprise and certainly whether they merit taking the EUR and AUD among other currencies to new cyclical highs. At a minimum they reinforced the view that any shift in policy was happening slowly and is still heavily contingent on economic outcomes. From the perspective of markets there is little to discourage flows into EM and the ongoing reserves diversification needs that have steadily weakened USD with G10 as well as versus EM..
 
The USD moves reinforce a story that is well known and widely priced in. It is clearly the path of least resistance at the moment, but also is increasingly contingent on ongoing global growth and asset market strength. The Fed did nothing to discourage that thinking, but at a certain point the distinction between USD weakness and asset market strength may become more clear than it is now.