Today should forever be known as the day Ben Bernanke and the Fed sent a clear message to the global financial markets: "devalue the dollar". Anybody that follows our updates knew there was a risk of the Fed announcing a plan to buy Treasuries and what would happen should they move forward with that plan -- short the USD, buy the EUR instantly right on the spot.
This afternoon the Fed announced it's printing an additional $1 trillion in fresh USD to buy Treasuries, MBS's and corporate debt. I'm going to use this update to break it all down on a level a child in grammar school should be able to understand. There will be long-lasting implications to this shocking Fed action and any trader of any market needs to understand the core fundamentals of this move and what it means for FX, commodities, equities, and Treasuries.
Fed buying Treasuries:
Starting next week and over the next 6-months the Fed will spend $300 billion buying 10-year and 30-year Treasuries through open market operations. The Fed will also buy an additional $750 billion in Mortgage-backed Securities. The objective for these moves are as follows:
It's really that simple. That's why the Fed did what they did in my opinion. There's no reason to over-think any of this, the moves and objectives are obvious and the market is receiving Bernanke's message loud and clear.
Forced USD devaluation:
The Fed's decision to buy Treasuries is the equivalent of using monetary policy to force the value of the dollar lower. The reason why this move is terrible for the dollar is very simple... here's the formula for how this works:
Only a central bank can create debt and use debt to buy debt -- in any other world this act would be impossible to accomplish and this is why we will never beat the central banks at this game, when you can beat them, you join them.
I stated very clearly many times the past 24-hours that if the Fed announces a plan to buy Treasuries I will immediately short the USD and buy the EUR and that's exactly what I did today. I got in several euro longs in the 1.3200's and plan to hold those open for the time being. I was 100% serious when I said I will mash the buy button if the Fed says they are buying Treasuries because that's a surefire signal the dollar is going to get brutalized in the near-term.
ECB next in line?
I did not go super heavy on my new euro longs and my highest long currently is a 1.3337. The risk is that the ECB will follow in the Fed's footsteps... the risk for Trichet to take the ECB's key lending rate to 0.50% or lower and to announce plans to begin buying German Bunds or other European sovereign debt. That move would have just as much a negative impact on the EUR as the Fed's move will have on the USD.
In fact, if the ECB announces a plan to buy European sovereign debt it's possible for the euro to recieve an even bigger punishment because European debt not rated as strongly as US debt. So, the ECB would be taking on riskier debt liabilities than the Fed is and that should hurt the EUR. This is a genuine risk that presents itself on the EUR/USD and why trading it should be done with caution and good risk management.
The ECB could come out with an announcement at any given moment saying they are following the Fed with their own currency devaluation plan. Should this occur we'd likely see the euro take a sharp dive.
If the ECB does not follow the Fed and refuses to buy debt, there is no telling how far the market will take the EUR/USD. We could easily be back around the bend on our way to test 1.4700 again. In the meantime, lets see if we can get to the 1.3650 level and then go from there.
Correlated markets:
The move made by the Fed today is positive for the following markets:
Equities surged and ended the day in the green. The Fed's announcement worked magic on spot gold as it soared from the $885 level to just under $950 before retracing. And already the market has taken out stops at the 1.3530 level on the EUR/USD. Everything is moving accordingly and just as it should. Unless the ECB drops a bomb on the markets with a crazy shock, I would expect the EUR/USD and all correlated markets to continue their respective bear market rallies.
Market landscape altered--
In my opinion this move by the Fed has added a completely new twist to the seemingly endless drama of the global financial turmoil. It's potentially set up the USD Index to take a violent fall, sending the EUR, AUD, NZD, CHF, and GBP higher. If the USD Index starts breaking down quickly and burns through stronger support levels it could get very ugly very fast.
The USD is in serious trouble right now thanks Bernanke and the Fed. If their comrades in Europe shine as the only G7 central bank with "tight" monetary policy I would expect the euro to keep rising from the ashes like a phoenix. It can't really go any other way.
I may have more to say later, but those are the basics and all I think a trader needs to know to be able to understand everything in their mind. Be advised that this Fed will cause an enormous amount of speculation and geo-politics. The volatility will be chaotic at times, the price swings will be sharp and violent... you've been warned, there are no excuses for not knowing what is ahead of us now.
If any traders have questions on what the Fed did and what this could mean for the markets, feel free to post your question in the blog or in the chat, we're glad to help make sense of it all the best we can.
-David
This afternoon the Fed announced it's printing an additional $1 trillion in fresh USD to buy Treasuries, MBS's and corporate debt. I'm going to use this update to break it all down on a level a child in grammar school should be able to understand. There will be long-lasting implications to this shocking Fed action and any trader of any market needs to understand the core fundamentals of this move and what it means for FX, commodities, equities, and Treasuries.
Fed buying Treasuries:
Starting next week and over the next 6-months the Fed will spend $300 billion buying 10-year and 30-year Treasuries through open market operations. The Fed will also buy an additional $750 billion in Mortgage-backed Securities. The objective for these moves are as follows:
- Drive down mortgage rates to extremely low levels
- Drive down consumer borrowing costs
- Stimulate the growth of credit and cause rapid credit expansion
- Forcefully devalue the USD
- Jump start inflation -- consumer price inflation
- Drive equities prices higher
It's really that simple. That's why the Fed did what they did in my opinion. There's no reason to over-think any of this, the moves and objectives are obvious and the market is receiving Bernanke's message loud and clear.
Forced USD devaluation:
The Fed's decision to buy Treasuries is the equivalent of using monetary policy to force the value of the dollar lower. The reason why this move is terrible for the dollar is very simple... here's the formula for how this works:
- Treasury prints $300 billion in USD that is not backed by a hard asset like gold
- The $300 billion in fresh USD is "collateralized" as new debt and made available for purchase on the open market
- The Fed borrows the $300 billion in USD from the Treasury to buy its own debt
- The US government creates $300 billion worth of liabilities, expands its balance sheet by the same amount, is now liable for $300 billion worth of debt to itself and the entire transaction is not backed by any hard asset
Only a central bank can create debt and use debt to buy debt -- in any other world this act would be impossible to accomplish and this is why we will never beat the central banks at this game, when you can beat them, you join them.
I stated very clearly many times the past 24-hours that if the Fed announces a plan to buy Treasuries I will immediately short the USD and buy the EUR and that's exactly what I did today. I got in several euro longs in the 1.3200's and plan to hold those open for the time being. I was 100% serious when I said I will mash the buy button if the Fed says they are buying Treasuries because that's a surefire signal the dollar is going to get brutalized in the near-term.
ECB next in line?
I did not go super heavy on my new euro longs and my highest long currently is a 1.3337. The risk is that the ECB will follow in the Fed's footsteps... the risk for Trichet to take the ECB's key lending rate to 0.50% or lower and to announce plans to begin buying German Bunds or other European sovereign debt. That move would have just as much a negative impact on the EUR as the Fed's move will have on the USD.
In fact, if the ECB announces a plan to buy European sovereign debt it's possible for the euro to recieve an even bigger punishment because European debt not rated as strongly as US debt. So, the ECB would be taking on riskier debt liabilities than the Fed is and that should hurt the EUR. This is a genuine risk that presents itself on the EUR/USD and why trading it should be done with caution and good risk management.
The ECB could come out with an announcement at any given moment saying they are following the Fed with their own currency devaluation plan. Should this occur we'd likely see the euro take a sharp dive.
If the ECB does not follow the Fed and refuses to buy debt, there is no telling how far the market will take the EUR/USD. We could easily be back around the bend on our way to test 1.4700 again. In the meantime, lets see if we can get to the 1.3650 level and then go from there.
Correlated markets:
The move made by the Fed today is positive for the following markets:
- Euro
- Pound Sterling
- Swiss Franc
- Aussie
- Yen
- Gold
- Crude
- S&P 500
- Dow
- Treasuries
Equities surged and ended the day in the green. The Fed's announcement worked magic on spot gold as it soared from the $885 level to just under $950 before retracing. And already the market has taken out stops at the 1.3530 level on the EUR/USD. Everything is moving accordingly and just as it should. Unless the ECB drops a bomb on the markets with a crazy shock, I would expect the EUR/USD and all correlated markets to continue their respective bear market rallies.
Market landscape altered--
In my opinion this move by the Fed has added a completely new twist to the seemingly endless drama of the global financial turmoil. It's potentially set up the USD Index to take a violent fall, sending the EUR, AUD, NZD, CHF, and GBP higher. If the USD Index starts breaking down quickly and burns through stronger support levels it could get very ugly very fast.
The USD is in serious trouble right now thanks Bernanke and the Fed. If their comrades in Europe shine as the only G7 central bank with "tight" monetary policy I would expect the euro to keep rising from the ashes like a phoenix. It can't really go any other way.
I may have more to say later, but those are the basics and all I think a trader needs to know to be able to understand everything in their mind. Be advised that this Fed will cause an enormous amount of speculation and geo-politics. The volatility will be chaotic at times, the price swings will be sharp and violent... you've been warned, there are no excuses for not knowing what is ahead of us now.
If any traders have questions on what the Fed did and what this could mean for the markets, feel free to post your question in the blog or in the chat, we're glad to help make sense of it all the best we can.
-David
david as usual your analysis of the current situation is spot on ..it brings clarity to a muddled market
thanks
victor