Monetary policy doesn't rule alone

Outlook:

A primary cause of currency market turmoil is divergence in policy, usually monetary policy. A key feature of the Plaza Accord in Sept 1985 was Japan agreeing to change interest rates to be more in sync with the US, while Germany and other European countries refused (they helped intervene, though).

We are now getting divergence in monetary policy that is sure to lead to currency outcomes that some will call “currency wars.” Japan is the most oriented to additional QE, with the UK now close behind. Technically, the ECB is not engaging in QE at all, and the US is thought to be closing in on talking about an exit. If we look at monetary policy alone—not a wise course of action but stick with it for a minute—the weakest currency should be the yen, then the pound, then the dollar. The overall strong currency left standing will be the euro.

Of course monetary policy doesn’t rule alone. We also have indebtedness, growth and employment, and politics, plus whatever else may deserve to get on the list from time to time. Today we get the FOMC minutes from the last meeting, with expectations rising by the minute that someone will have mentioned downsizing QE. We won’t get how and when and how much, but the beginning of the end is not exactly in sight, but imagined to be just over the next hill. Surely the Fed’s economists have figured out monetary policy in the context of the sequester. It’s not out of the question that the Fed will have thought QE is prolonged because of it, too.

Still on the currency war front, we have two developed countries, New Zealand and Norway, threatening action specifically to curb their currencies. New Zealand named intervention and Norway named a rate cut but specifically in the context of the currency. Others can’t be far behind, especially South Korea, which has intervened repeatedly and in size over the past few years.

And let’s not forget inflation. The UK MPC members spoke of raising QE despite inflation being acknowledged to remain over the 2% target for longer than originally thought. Tomorrow we get US CPI, thought to be fairly tame.

As noted before, we are always suspicious when the dollar seems strong for reasons we can’t identify. Normally, the dollar gets sold on the slightest whiff of anything negative, and positives get undervalued when it’s falling. If risk appetite is robust, as equity indices seem to indicate (copper notwithstanding), the dollar should be falling out of favor. So, we are puzzled and when puzzled, consult the chart. The big-picture euro chart remains in an uptrend but the current downside correction could reach as low as 1.3185 or 1.3160, about midway through the latest bump up from mid-November.

	SPOT	CURRENT POSITION	SIGNAL STRENGHT	OPEN DATE	OPEN RATE	POSITION GAIN/LOSS
USD/JPY	93.42	LONG USD	STRONG	10 /17/12	78 .71	15.75%
GBP/USD	1.5307	SHORT GBP	STRONG	01/18/13	1.5942	3.98%
EURO/USD	1.3396	LONG EURO	STRONG	11/26/12	1.2970	3.28%
EURO/JPY	125.15	LONG EURO	STRONG	11 /21/12	105.38	18.76%
EURO/GBP	0.9850	LONG EURO	STRONG	11/26/12	0.8095	21.68%
GBP/JPY	142.98	LONG GBP	STRONG	11/21/12	131.02	9.13%
USD/CHF	0.9205	SHORT USD	WEAK	01/30/13	0.9163	-0.46%
USD/CAD	1.0133	LONG USD	STRONG	01/24/13	0.9993	1.38%
AUD/USD	1.0330	SHORT AUD	STRONG	01/28/13	1.0392	0.60%
AUD/JPY	96.48	LONG AUD	STRONG	10/17/12	81.19	18.83%
USD/MXN	12.6564	LONG USD	WEAK	02/12/13	12.7736	-0.93%