Nomura QE&USD Int'l Lessons (Part II) 2010-09-22

8/8/2019 Nomura QE&USD Int'l Lessons (Part II) 2010-09-22

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Nomura Securities International, Inc.

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FX InsightsFX Research and Strategy

QE and the Dollar: International Lessons (Part II)

The experience from QE-1 showed a clear USD weakening impact from the Fedsasset purchases. But the international experience is more mixed. The UKs QE

policy in 2009 did provide a weakening impulse on the GBP, but the Japanese QE

experiment, starting in 2001, did not. Whether QE will trigger FX depreciation is

likely to depend on the impact QE has on inflation expectations and implied real

rates. Importantly, the Feds ability to move these parameters depends on the

starting point for expectations. From current levels, Fed asset purchases are likely

to be less potent than was the case at the outset of QE-1.

Two weeks ago, we analyzed the impact that quantitative easing by the Fed from

December 2008 to March 2010 had on the US dollar (see QE and the Dollar:

Lessons from QE-1 (Part I), 10 September 2010). Here, we look at the international

experience with quantitative easing, using the lessons from QE in the UK (2009)and in Japan (2001-2006).

The UK QE Experience (2009): Our analysis shows that QE had a significant

impact on UK nominal yields and on sterling. The cumulative decline in the trade-

weighted GBP around the six key announcements pertaining to Bank of England

(BoE) asset purchases (QE) amounted to 4.0%, broadly consistent with recent

analysis by the BoE. The finding should be viewed in the context of a gradually

recovering GBP (from a very weak level) during the period of QE as a whole. In

terms of the transmission mechanism, it appears that the QE managed to depress

real yields, while breakeven inflation was not much impacted by the BoE s asset

purchases. Specifically, around the key announcements, nominal yields dropped a

cumulative 80bp, of which roughly 50bp was accounted for by declining real yields

(while only 30bp was due to lower inflation expectations). For further detail, seeAppendix I.

Japans experience (2001-2006): Our analysis shows that Japanese QE had very

limited measurable impact on Japanese yields and the yen. There is a long

literature on this, and in general our results are consistent with the consensus in

more academic analysis of the impact of Japanese QE. We analyzed 16

announcements relevant to Bank of Japan QE policy, and found that the QE

announcement never triggered a decline in 10Y JGB yields of more than 3bp over

a 2-day window. Moreover, the cumulative impact was for JGB yields to increase

marginally. Due to the lack of an inflation linked market in Japan before 2004, it is

hard to decompose yield moves into inflation expectations and real rate

expectations. But consistent with the notion that neither inflation nor real rates

Figure 1. Cumulative FX performance around QE announcements

Note: Initial announcements for JPY, GBP, and USD occurred on 3/19/01, 2/11/09 and 11/25/08,respectively. For event-specifics, please see relevant appendices. Source: Nomura.

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%

months following initial announcement

JPY (from 3/19/01)

GBP (from 2/11/09)

USD (from 11/25/08)

22 September 2010Contributing Research Analysts

Jens Nordvig+1 212 667 [email protected]

Anish Abuwala+1 212 667 [email protected]

This report can be accessed

electronically via:

www.nomura.com/research or on

Bloomberg: NSI
http://www.nomura.com/research/getpub.aspx?pid=390429http://www.nomura.com/research/getpub.aspx?pid=390429http://www.nomura.com/research/getpub.aspx?pid=390429mailto:[email protected]:[email protected]:[email protected]:[email protected]://www.nomura.com/research/getpub.aspx?pid=390429http://www.nomura.com/research/getpub.aspx?pid=390429http://www.nomura.com/researchhttp://www.nomura.com/researchmailto:[email protected]:[email protected]://www.nomura.com/research/getpub.aspx?pid=390429http://www.nomura.com/research/getpub.aspx?pid=390429


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Nomura | FX Insights September 22, 2010

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moved noticeably in response to QE announcements, we find that the yen was

very unresponsive to the QE policy, with median and cumulative moves of

essentially zero, despite the fact that part of this balance sheet expansion

coincided with a period of FX intervention (the heavy bulk of which occurred from

Jan 2003-Mar 2004). For further detail see Appendix II.

The US experience (Nov 2008Mar 2010): Our analysis of Fed quantitative

easing episode showed a notable impact on the dollar, even when controlling for

the effect of improved risk sentiment and improving USD money market conditions.

We find that the USD index declined 8.2% around key announcements pertainingto QE, driven mainly by significant declines in real yields, with additional

contribution from rising inflation expectations. Meanwhile, we find that the

immediate impact from improved money market conditions and better risk

sentiment was small in the short intervals around QE announcements. For further

detail, see Appendix III.

When does QE lead to FX depreciation?

In theory, QE should impact the spot exchange rate to the extent that it can alter

inflation expectations and real interest rate expectations. Specifically, we would

expect currency weakness to the degree that QE pushes inflation expectationshigher and/or QE manages to reduce real rate expectations. The reasoning is 1)

that higher inflation will necessitate a weaker nominal exchange rate at a given

(equilibrium) real exchange rate, and 2) that lower real rates will allow for a weaker

spot exchange rate currently in order for interest rate parity to hold over time (the

over-shooting concept).

In practical terms, we have seen QE have a significant weakening impact on USD

and on GBP, but not on JPY. In the US, the depreciation was consistent with a shift

higher in inflation expectations (from very low levels). In the UK, GBP weakness

around QE announcements was consistent with a shift to pricing lower real interest

rates. Finally, in Japan, the lack of yen impact of the QE policy, was consistent with

the apparent lack of shift in yields (nominal or real) following the various balance

sheet expansions.

Starting points matter

The bottom line from the international experience (on admittedly a very small

sample) is that starting points of expectations matter a lot.

Figure 2. Starting points for QE programs

Note: * Japans breakeven inflation shown as 3-5year average core CPI. Source: Nomura.

In the US the QE policy was initiated when inflation expectations (implied in themarket) were as low as 0.2% over a 10-year horizon. A part of this was a

market anomaly, due to a dislocation in TIPS markets, but a part of it was a

real fear about deflation. Relative to the Feds objective of inflation around

2.0%, this left significant room to move expectations towards the objective.

In the UK, the QE policy was initiated with inflation expectations fairly close totarget (inflation expectations derived from the inflation linked market stood at

2.1% vs. the 2.5% BoE inflation target). Implied real rates were at 1.7%. While

that level was roughly in line with pre-crisis averages, it was probably highrelative to the fundamental (very weak) backdrop, leaving room for a

meaningful decline.

In Japan, the nominal yields were at 1.1% for the 10Y when QE was initiated in2001. It is hard to ascertain with confidence what market expectations for

Nominal Rate (10Y) Real Rate (10Y) Breakeven Inflation (10Y) Actual Core Inflation

Japan QE 3/19/2001 1.1 1.1 0.0* -0.9

UK QE 2/11/2009 3.9 1.7 2.1 1.6

US QE-I 11/25/2008 3.3 3.1 0.2 2.0

US Now 9/22/2010 2.5 0.7 1.9 0.9


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inflation and real rates were at the time (given absence of inflation linked

markets). But 10Y inflation expectations are likely to have been in the region

0% at the time (consistent with the average inflation rate in the years ahead of

when QE was initiated). This would then imply ex-ante real rates of around 1%,

which possibly left only limited room for a further decline.

Conclusion

The experience from QE-1 showed a clear USD weakening impact from the Fedsasset purchases. However, the international experience is more mixed: the UKs

QE policy in 2009 did provide a weakening impulse for GBP, although not as large

as the impact of QE-1 on the dollar. Moreover, the Japanese QE experiment

starting in 2001 did not have any detectable impact on the yen.

Whether renewed QE in the US will trigger USD depreciation is likely to depend on

the impact QE has on inflation expectations and implied real rates. Importantly, the

Feds ability to move these parameters depends on the s tarting point for

expectations.

Currently, 10Y breakeven inflation is priced at 1.8%not far from the Feds

objective of 2% and very different from the implied level of 0.3% when QE-1 started.

Implied 10Y real rates are around 0.9% at the moment. For this parameter, the Feddoes not have a particular objective, and it would probably like to see rates as low

as possible at this juncture to provide maximum stimulus. However, from a starting

point of 0.9% (already an all-time low), it will not be easy to generate a large

additional decline.

It is against this background that one should think about the potential impact

renewed QE may have on the USD. Our strategy around QE-2 will be to stay short

USD into key announcements and stick to realistic and not overly ambitious targets

in terms of how far the dollar will decline. At this juncture, this strategy suggests

that short USD exposure is attractive into the November 3 FOMC meeting, at

which time we expect QE-2 to be initiated. We note that there may be potential for

the market to react excessively to QE announcements given the very large impactQE-1 announcements had on the dollar. Such overshooting may present

opportunities to take profit on USD shorts at attractive levels during November-

December. But at this point we are in the early phase of the USD weakening move,

and the focus should be on getting the right amount of exposure. We currently

have short USD exposure versus GBP and are looking for opportunities to broaden

that exposure to other crosses.


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Appendix I United Kingdom and QE

GBP Broad TWI FTSE All-share

10Y Gilts 10Y Breakeven Inflation

Summary of key events and 2-day market reaction

Note: Moves in FX in table above shown from GBPs perspective. Source: Nomura.

The BoE purchased 200bn in assets, of which a large majority consisted ofconventional Gilts (representing 29% of non-official holdings of Gilts). An

insignificant percentage was allocated to corporate commercial paper. In all, the

purchases represented 14% of nominal GDP and maturities were concentrated in

the 4-15yr bucket, with the weighted-average maturity at 2023.

The program was officially announced on March 5, 2009 and subsequently

expanded on three occasionsto 125bn, 175bn and 200bn. On February 4,

2010, the BoE announced its intention to cap the purchases at the 200bn mark.

70

75

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Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10

Feb. 09InflationReport

MPC capspurchasesat 200bn

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3400




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Feb. 09

InflationReport


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%



Date Dec is ion on QE FTSE EUR JPY USD CHF CAD AUD GBP broad 10y Gilt s (bp) 10y Linked (bp) 10y B /E (bp)

2/11/2009 Inflation Report -0.2% -1.5% -1.4% -1.9% -1.3% -1.9% -1.5% -1.6% -38 -45 5

3/5/2009 Rate Cut / APP set at 75bn -3.2% -0.7% -1.6% -0.7% -1.5% 0.4% 0.7% -0.2% -58 -30 -36

5/7/2009 APP inc. to 125bn 1.2% -1.6% 0.8% 0.6% -1.7% -0.8% -2.1% -0.8% 12 11 0

8/6/2009 APP inc. to 175bn / Gilt Lending 1.8% -0.3% 0.9% -1.8% 0.0% -0.9% -1.4% -0.8% -3 5 -7

11/5/2009 APP inc. to 200bn 0.7% 0.4% -0.6% 0.4% 0.5% 1.5% -0.6% -0.1% 9 5 4

2/4/2010 Maintain at 200bn -3.7% 0.0% -3.5% -1.6% -0.4% -0.8% 0.1% -0.6% -3 -1 -2

Baseline Event Set (Sum) -3.4% -3.6% -5.3% -5.0% -4.4% -2.4% -4.9% -4.0% -80 -56 -36

Cumulative change: 2/11/2009 to 2/4/2010 22.2% 2 .5% 7.3% 8 .6% 0.6% -6.1% -17.9% 3.3% 27 -74 68


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Appendix II Japan and QE

JPY Broad TWI Nikkei 225

10Y JGBs 1Y Inflation Expectation and Core CPI


Note: Dates taken from BoJ working paper titled Effects of the Quantitative Easing Policy: A Survey of Empirical AnalysesShaded area in charts represents QE period. Moves in FX in table above shown from JPYs perspective.* Estimated inflation expectation reaction shown over 30-day window. Source: Nomura.

The BOJ set an asset purchase target of 30-35trn, which consisted of long-term

JGBs, ABS, and limited amounts of stocks. Long-term JGBs made up by far the

largest item on this list (over 98%), both in terms of amount and increase in

holdings. At its peak, the BOJ allowed excess reserves (its current account

deposits) to rise to over 33.5trn (~$270bn at the time). In all, the purchases

represented 6.6% of nominal GDP. The average duration of BOJs JGB holdings is

slightly over 4 years.

The program was officially announced on March 19, 2001 and the purchase targetwas subsequently expanded on nine separate occasionsfrom 4-5trn to 30-

35trn. The program ended five years later in March 2006. Coinciding with this

program was a period of FX intervention from 2003-2004.

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Mar-00 Mar-02 Mar-04 Mar-06

$bn%

QuarterlyIntervention

JPY TWI

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1y Infl. Exp.

Core CPI

Date Decision on QE Nikkei EUR GBP USD CHF CAD AUD JPY TWI 10y JGBs (bp) 1y Infl. Exp. (bp)*

3/19/2001 Introduction of QEP -0.3% -0.6% 0.5% 0.7% -0.6% 0.6% -0.9% -0.1% 0 -18

8/14/2001 Higher rate of purchas es /CAB ceiling 2.4% 0.5% 1.0% 2.5% 0.5% 1.7% 0.2% 1.7% -1 2

9/18/2001 Increase in CAB ceiling 4.6% 0.0% 0.1% 0.2% -0.4% 0.1% 2.1% 0.3% 7 3

12/19/2001 Higher rate of purchases /CAB ceil ing 0.0% -0.3% -0.1% -0.7% -0.6% -0.3% 1.3% -0.2% 0 1

2/28/2002 Increase in rate of purchas es 2.3% 0.6% 0.7% 0.6% 0.7% -0.2% -0.2% 0.8% -2 -1

10/30/2002 Higher rate of purchases /CAB ceil ing -0.8% -0.3% -0.1% 0 .5% -0.4% 0.1% 1.0% -0.3% -5 7

3/25/2003 Increase in CAB ceiling -1.0% 0.2% 0.7% 0.7% 0.4% -0.2% 0.0% 0.3% -3 19

4/30/2003 Increase in CAB ceiling 3.4% -0.4% 0.0% 1.0% -0.2% -0.5% -0.3% 0.9% 0 19

5/20/2003 Increase in CAB ceiling -0.3% -0.2% -0.4% -0.5% -0.2% -1.1% -0.5% -0.7% -3 23

10/10/2003 Increase in CAB ceiling 2.4% 0.5% 0.1% 0.1% 0.5% -1.3% 0.2% 0.3% 6 1

1/20/2004 Increase in CAB ceiling -0.3% -2.0% -2.4% 0.3% -2.1% 0.2% -2.1% -0.1% 5 -2

3/9/2006 End of QE 3.1% -0.9% -0.2% -1.0% -0.2% -0.6% -0.7% -1.0% 5 0

Baseline Event Set (Sum) 15.5% -2.8% -0.2% 4.6% -2.7% -1.4% 0.3% 2.0% 7 54

Cumulative change: 3/19/2001 to 3/9 /2006 32.2% -22.0% -14.7% 3 .3% -20.2% -23.5% -29 .7% -7 .0% 52 77


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Appendix III United States and QE-1

Broad Dollar TWI S&P 500

10Y UST 10Y Breakeven Inflation


Note: Table above mirrors the FRBNY study done titled Large-Scale Asset Purchases by the Federal Reserve: Did They Work?Moves in FX in table above shown from USDs perspective. Source: Nomura.

The Fed officially announced on November 25, 2008 that it would buy up to

$100bn in agency debt and $500bn in agency MBS. A month later, longer-term

Treasuries were added to the list. Eventually, the up to language was dropped

and the Fed ultimately purchased $300bn in USTs (largely notes and bonds and

small amount of TIPS), $1.25trn in agency MBS and around $175bn in agency

debt.

Subsequently, the Fed moved to reinvest principal payments from agency debt and

agency MBS into longer-term USTs. The average duration of the Feds holdings is

around 5.5 years. In total, the purchases represent approximately 10.3% of

nominal GDP.

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Jan 2008 Jul 2008 Jan 2009 Jul 2009 Jan 2010 Jul 2010

Announcement

of QE

End

of QE

Index: 1 jan 2008 = 100

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of QE

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Announcement

of QE

End

of QE

%

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Announcement

of QE

End

of

QE

Date Event SPX EUR JPY GBP CHF CAD AUD USD major 10y UST (bp) 10y Breakeven (bp)

11/25/2008 Initial LSAP Announcement 4.2% 0.6% -1.7% -0.9% 0.9% 0.0% 0.3% 0.2% -35 13

12/1/2008 Chairman Speech -5.3% -0.2% -2.4% 3.1% -0.6% 0.5% 2.0% 0.0% -25 5

12/16/2008 FOMC Statement 4.1% -5.1% -3.8% -1.5% -7.5% -3.4% -5.0% -3.5% -32 16

1/28/2009 FOMC Statement -0.1% 1.6% 1.2% -1.2% 0.9% -0.3% 1.4% 0.4% 33 24

3/18/2009 FOMC Statement 0.8% -4.8% -4.1% -3.2% -5.0% -2.4% -3.4% -4.5% -40 18

8/12/2009 FOMC Statement 1.8% -1.0% -0.5% -0.6% -1.1% -1.3% -1.6% -0.9% -7 -9

9/23/2009 FOMC Statement -1.9% 0.8% 0.2% 1.9% 0.6% 1.9% 1.0% 1.0% -6 -5

11/4/2009 FOMC Statement 2.0% -1.0% 0.4% -0.9% -1.0% -0.1% -0.8% -0.8% 6 11

Baseline Event Set (Sum) 5.7% -9.0% -10.8% -3.4% -12.7% -5.1% -6.2% -8.2% -106 74

Cumulat ive change: 11/24/2008 to 3/18/2010 36.9% -4.8% -7.1% -0.4% -11.4% -17.7% -29.0% -9.8% 35 203


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Nomura QE&USD Int'l Lessons (Part II) 2010-09-22

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Transcript of Nomura QE&USD Int'l Lessons (Part II) 2010-09-22