Nomura QE&USD Lessons From QE-1 (Part I) 2010-09-10

8/8/2019 Nomura QE&USD Lessons From QE-1 (Part I) 2010-09-10

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Nomura | FX Insights September 10, 2010

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- US Treasuries yields declined sharply on the initial announcement of QE-1,

in late 2008. But nominal treasury yields gradually increased during 2009 as

financial system stabilized and the economy started to recover. At the end of QE-1,

the yield on the 10-year US treasury was around that same level as when QE

started.

- The S&P500 had remained very volatile in the early phase of QE, as

uncertainty about financial stability and the outlook remained highly uncertain. But

the S&P500 bottomed out in mid-March 2009, around the time when the Fed

announced a major increase in its assets purchases. The S&P then remained on apersistent uptrend into Q1 2010.

- Breakeven inflation expectations (as implied by TIPS) were at their

historical low at the outset of the QE episode in December 2008. Following the

announcement of QE, they jumped higher and continued to increase gradually

during 2009, reaching levels close to the one prevailing in early 2008 (pre-cisis) at

the end of the QE.

Figure 1. USD performance during QE1 Figure 2. 10-year US Treasury performance during QE1

Source: Federal Reserve. Source: Federal Reserve.

Figure 3. S&P500 performance during QE1 Figure 4. 10-year breakeven performance during QE1

Source: Bloomberg Source: Bloomberg.

The details of QE and the Dollar performance (event-study of QE

announcements, December 2008-March 2010)

It is hard to isolate whether it was QE which triggered the trends observed, or

whether it was an underlying dynamic in the economy or other external forces,which drove the trends.

In order to pin-point more precisely the effect from Quantitative Easing, we isolate

the effect of the various announcements pertaining to asset purchases. There were

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

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Index: 1 jan 2008 = 100

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eight major announcements, and we list them all in the table below, along with their

impact on asset prices (the details of the announcements are in Appendix 1).

Specifically, we report the 2-day change in the USD index, the change in the 10-

Year US bonds yield, the change in the 10-year German bond yield, the change in

the S&P500, and the change in break-even inflation (10Y).

Table 1. QE announcements and asset prices

Note: The dates are the same used in Large-Scale Asset Purchases by the Federal Reserve: Did TheyWork?, Federal Reserve Bank of New York Staff Report no. 441. Source: Bloomberg, Nomura.

The conclusion from this analysis is clear: The various announcements pertaining

to asset purchases (QE) pushed UST yields and the Dollar significantly lower on

average. The cumulative impact on UST 10Y yields was a drop of 106bp (driven by

a drop in real yields), and the cumulative impact on the USD index over the eightperiods was a depreciation of 8.2%. The announcements on December 16, 2008

and March 18, 2009 saw particularly large Dollar moves of of 3.5% and 4.5%,

respectively.

In terms of the individual USD crosses, USDJPY and USDCHF have been the

most sensitive in the two days following the announcements, with the USDCHF

declining 10.8% and USDJPY declining 12.7% on a cumulative basis around the

key QE announcements. Meanwhile, the GBP, CAD and AUD reacted less to QE

announcements, with cumulative moves of 3.4%, 5.1% and 6.2%, respectively vs

the USD. However, when considering the change over the entire QE period, the

USD declined the most versus CAD and AUD. This is likely the result of the impact

QE had on investors confidence and on risk appetite. We note that the impact of

QE was moderate versus the GBP, both around the specific events and during the

period as a whole, likely the result of the Bank of England also pursuing QE during

the period. Overall, it is interesting that the traditional safe-haven currencies, JPY

and CHF, have gained the most during periods of QE, despite the fact that the S&P

rallied on average after QE announcements and given that safe-haven crosses are

typically negatively correlated to the S&P. The most logical explanation is that the

decline in global real yields following from QE benefitted low yielders (JPY and

CHF) the most.

Table 2. QE announcements and the impact on various Dollar crosses and indices

Note: A positive number means a USD appreciation. The dates are the same used in Large-ScaleAsset Purchases by the Federal Reserve: Did They Work?, Federal Reserve Bank of New York StaffReport no. 441. Source: Bloomberg, Nomura.

To look more formally at the data, we also conducted a regression analysis where

we regressed the daily return of various USD crosses on dummy variable taking a

value of one the day of the announcement and zero otherwise. The equations also

include the daily returns of the S&P500 to control for risk and lagged value of thedaily FX return and S&P500 to control for inertia. The results show that the

coefficient associated with the dummy was of the right sign (negative) and

significant, showing that the announcement had a distinctive impact on the USD.

Date Event USD (%) 10y UST (bp) 10y Bund (bp) SPX (%) 10y Breakeven (bp)

11/25/2008 Initial LSAP Announcement 0.2% -35 -14 4.2% 13

12/1/2008 Chairman Speech 0.0% -25 -21 -5.3% 512/16/2008 FOMC Statement -3.5% -32 -21 4.1% 16

1/28/2009 FOMC Statement 0.4% 33 0 -0.1% 24

3/18/2009 FOMC Statement -4.5% -40 -15 0.8% 18

8/12/2009 FOMC Statement -0.9% -7 -5 1.8% -9

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

11/4/2009 FOMC Statement -0.8% 6 8 2.0% 11

Baseline Event Set -8.2% -106 -76 5.7% 74

Cumulative change: 11/24/2008 to 3/18/201 -9.8% 35 -30 36.9% 203

2-day changes around announcements

Date Event SPX USD major EUR JPY GBP CHF CAD AUD

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

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

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

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

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

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

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

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

Baseline Event Set 5.7% -8.2% -9.0% -10.8% -3.4% -12.7% -5.1% -6.2%

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

2-day changes around announcements (%)


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Special factors during the Dec 2008 Mar 2010 QE Episode

There are two special factors which may have played a role in the Dollar

weakening during the period of QE. First, the general improvement in risk

sentiment is likely to have been a factor. Second, the stabilization of the global

financial system, including the normalization of the USD money market may have

played an important role.

With respect to the effect from improving risk sentiment, our conclusion is that even

controlling for QEs impact on risk assets, there has been a significant impact onthe Dollar. In the appendix we analyze the dollar performance around each QE

announcement event in detail. Specifically, we take into account the performance

of risk assets as proxied by the S&P500 around each event, to control for the

effect that improved risk sentiment may have had on each dollar cross. We find

that Quantitative Easing led to USD weakness well in excess of what the general

improvement in risk sentiment can account for. The clearest example of this is

around the March 16 FOMC announcement, which had little impact on global

equity markets, but saw the Dollar decline 4.5%, with the biggest move, 5.0% vs

the Swiss Franc (which is normally negatively correlated with risk markets).

With regard to the effect on QE on the stability of the financial system, there is little

doubt that it had an impact on the dollar. The normalization of the USD money

market gradually eliminated the Dollar shortage which had emerged in H2 2008and this also served to gradually reduce safe haven demand for the Dollar. Overall

Dollar returns during the period of QE are likely to have been significantly impacted

from this relaxation. However, we dont think this effect accounts for the large USD

moves around the QE announcements. Specifically, as the chart below shows, the

improvement in money market conditions was fairly gradual (there was no sea-

change around the announcements), hence we think the bulk of the USD impact

around the specific events were duo to the effect on real rates and shifts in inflation

expectations.

Figure 5. US Libor spread Figure 6. USD positioning


Lessons from QE-1 and the Dollar Implications of QE-2

The lesson from QE-1 in terms of the impact on the Dollar is as follows: The Dollar

weakened notably as QE successfully pushed down real yields (and helped to

push inflation expectations higher, towards the objective). Meanwhile, improved

risk sentiment and normalization of USD money markets played a further indirect

role in the USD weakening during the QE period, amplifying the more direct impact

on the Dollar from QE.

The potency of QE-1 in relation to the USD may in part be a function of very lowinflation expectations at the outset of the QE period (as well as the high level of risk

aversion and spreads at the outset). A key question in relation to QE-2 is the extent

to which additional asset purchases can push real rates down further from the

current starting point. Our preliminary conclusion is that some additional reduction

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in real rates (and some increase in inflation expectation) can be achieved, provided

that the purchases are sufficiently large. But we acknowledge that the job will be

harder this time around, given current market conditions. We will publish more

research on this important topic shortly.

In relation to the finding that traditional safe-haven currencies, such as CHF and

JPY, will benefit the most from renewed QE, we have some reservations from a

forward looking point of view. From a valuation perspective, both the CHF and JPY

are getting increasingly stretched and intervention risk in the JPY has increased

lately. That said, additional knee-jerk USD losses in these crosses along with abroad-based USD move remain likely on a QE announcement.


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Appendix 1: list of studied events1

1. The initial LSAP announcement on November 25, 2008, in which the

Federal Reserve announced it would purchase up to $100 billion in agency

debt, and up to $500 billion in agency MBS.

2. Chairman Bernankes December 1, 2008 speech, in which he stated that

in order to influence financial conditions, the Fed could purchase longer-

term Treasury securitiesin substantial quantities.

3. The December 2008 FOMC statements, which indicated that the FOMCwas considering expanding purchases of agency securities and initiating

purchases of longer-term Treasury securities.

4. January 2009: see above.

5. The March 2009 FOMC statement, in which the FOMC announced the

decision to purchase up to $300 billion of longer-term Treasury securities,

and to increase the size of agency debt and agency MBS purchases to up

to $200 billion and $1.25 trillion, respectively.

6. The August 2009 FOMC statement, which dropped the up to language

qualifying the maximum amount of Treasury purchases, and announced a

gradual slowing in the pace of these purchases.7. The September 2009 FOMC statement, which dropped the up to

language qualifying the maximum amount of agency MBS purchases, and

announced a gradual slowing in the pace of agency debt and MBS

purchases.

8. The November 2009 FOMC statement, which stated that the FOMC would

purchase around $175 billion of agency debt.

1Taken from Large-Scale Asset Purchases by the Federal Reserve: Did They Work?, Federal Reserve Bank of New York Staff

Report no. 441.


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Appendix 2: Asset performance during various episodes

In the following Figures, we show the 2-day changes on various assets. The

impact category is the 2-day changes following the announcements. The

predicted impact category is the changes predicted by the historical relationship

between changes in the S&P500 and the asset.

Figure 7. Impact from the 11/25/2008 event






-3.0%

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-1.0%

0.0%

1.0%

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SPX EUR JPY GBP CHF CAD AUD USDmajor

Impact

Predicted impact

USDappreciation

-60

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0

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40

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80

10y UST 10y Bunds 10yBreakeven 10y TIPS

Impact

Predicted impact

bp

-6.0%

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10y UST 10y Bunds 10yBreakeven

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bp

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-1.5%

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Appendix 3: QE announcements and the impact on various Dollar crosses

and indices

Table 3. QE announcements and the impact on various Dollar crosses and indices

Note: A positive number means a USD appreciation. The dates are the same used in Large-ScaleAsset Purchases by the Federal Reserve: Did They Work?, Federal Reserve Bank of New York StaffReport no. 441. Source: Bloomberg, Nomura.

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%0.0%

0.5%

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Impact

Predicted impact

USDappreciation

-40

-35

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0


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Impact

Predicted impact

bp

-1.5%

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Impact

Predicted impact

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Impact

Predicted impact

bp

Date Event USD OITP MXN KRW BRL TRY

11/25/2008 Ini ti al LSAP Announce ment -0.8% -1.1% -2.4% -4.1% -0.6%

12/1/2008 Chairman Speech 0.6% 0.7% -0.3% 4.4% 0.9%

12/16/2008 FOMC Statement -0.8% -1.5% -3.1% -0.9% -2.3%

1/28/2009 FOMC Statement 0.0% -0.4% -0.9% -2.1% 0.5%

3/18/2009 FOMC Statement -0.6% 1.3% -0.8% -1.1% 0.8%

8/12/2009 FOMC Statement -0.3% -1.2% -0.1% -1.4% -1.7%

9/23/2009 FOMC Statement 0.1% 1.2% -0.7% 0.4% 0.7%

11/4/2009 FOMC Statement -0.3% 0.2% -0.2% -1.6% -1.1%

Baseline Event Set -2.1% -0.7% -8.5% -6.4% -2.7%

Cumulative change: 11/24/2008 to 3/18/2010 -5.9% -6.6% -25.1% -22.8% -3.7%

2-day changes around announcements (%)


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Nomura QE&USD Lessons From QE-1 (Part I) 2010-09-10

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