Nomura USD QE-2 Effect 2010-09-23

8/8/2019 Nomura USD QE-2 Effect 2010-09-23

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Nomura Securities International, Inc.

See Disclosure Appendix A1 for the Analyst Certification and Other Important Disclosures

FX InsightsFX Research and Strategy

Revised Dollar Forecasts: The QE-2 Effect

We are revising our USD forecasts lower, taking into account the effect fromexpected QE-2 during Q4. QE-2 is likely to be less potent than QE-1 given that

inflation expectations are now much closer to the Fed's objective and real rates

have moved to historical lows. Nevertheless, we think renewed Fed asset

purchases will be a catalyst for USD weakness in Q4. In terms of specific crosses,

European currencies are likely to respond the most, especially now that Japan has

started to intervene to reduce strengthening pressure on the yen.

The FOMC statement on Tuesday cemented that the Fed now has an easing bias.

In the absence of significant positive growth surprises, we expect the Fed to initiate

renewed quantitative easing at its November 3 meeting. More specifically, we

expect the Fed to start UST purchases, likely in an incremental and open-ended

fashion. We have already published two research pieces which look at therelationship between quantitative easing and the dollar. Our findings were as

follows:

First, the experience from QE-1 in the US showed that asset purchases triggered

significant USD weakness, even when controlling for effects from improved risk

sentiment and normalizing money markets, effects which were unique to the period

and are unlikely to be repeated (for further details, seeQE and the Dollar: Lessons

from QE-1 (Part I), 10 September).

Second, the international experience with QE is more mixed, ranging from a

meaningful FX impact from QE in the UK in 2009 to no impact on the yen from QE

in Japan starting in 2001. Our interpretation is that the impact depends on the

degree to which QE is able to move inflation expectations and forward-looking realrates. From this perspective, it is the starting point of expectations at the outset of

QE that matters (for further details, seeQE and the Dollar: International Lessons

(Part II), 22 September).

At this juncture, the starting point is one where inflation expectations are not too far

from the Fed's objective and real rates are already very low. This means that the

potency of QE-2 is likely to be lower than QE-1 in terms of affecting market

parameters (inflation expectations, real rates, and USD). We would still expect

some impact, although a more moderate one than we saw during QE-1.

Figure 1. Cumulative 2-day returns vs. USD around QE-1 events

Note: Returns collected from event study done inQE and the Dollar: Lessons from QE-1 (Part I).

Source: Nomura.

0

2

4

6

8

10

12

14

CHF JPY EUR KRW BRL AUD CAD GBP TRY MXN

%

23 September 2010Contributing Research Analysts

Jens Nordvig+1 212 667 [email protected]

Saeed Amen+44 20 7103 [email protected]

Ylva Cederholm+44 20 7103 [email protected]

Jennifer Hau+44 20 7102 [email protected]

Anish Abuwala+1 212 667 [email protected]

This report can be accessed

electronically via:

www.nomura.com/research or on

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Nomura | FX Insights September 23, 2010

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Figure 2. Term structure of inflation expectations in US Figure 3. Term structure of real rates in US

Note: Used market implied expectations (i.e. breakevens).

Source: Bloomberg, Nomura.

Source: Bloomberg, Nomura.

Our analysis shows that the cumulative impact of QE announcements during QE-1

was in the region of 8-9%, when measured on an index versus G10 currencies. It is

clearly a daunting task to estimate the impact QE-2 will have given uncertaintiesabout size of asset purchases and the transmission mechanism to the economy

and asset prices. But we think there are good reasons why the impact will be

smaller on this occasion. Importantly, the starting point of inflation expectations is

fairly close to the Fed's objective, and certainly closer than in early 2009, when

deflation fears were prevalent (Figure 2). For example, the 10Y breakeven is

currently trading at 1.81%, not far from the Fed's 2% objective, and real rates (as

shown in Figure 3) have shifted to historical lows. As a rough benchmark, we think

a 4-5% move in the Dollar Index in response to QE-2 is a reasonable target. That

move could be spread out, depending on the Feds communication strategy

(regarding the size and speed of purchases). We are likely to have already seen

the initial portion of that move with the market sniffing QE over the last two weeks.

One risk factor in this context, which could lead to more pronounced USD

weakness, is faster paced reserve diversification away from USD. There was some

evidence of this in 2009, when EM central banks took down their USD share from

61% to 58%. This shift coincided with the Fed's QE policy. However, there are

many potential explanations for this, and we think it is too early to assume that QE-

2 will trigger an accelerated diversification away from USD by global central banks.

However, we will carefully monitor any evidence that global reserve managers are

reducing their USD allocations in response/anticipation of QE.

Figure 4. EUR/USD diverging from CDS price action Figure 5. USD share of allocated CB reserves falling

Note: CDS calculated as GDP-weighted average of individual

sovereign CDS. Source: Bloomberg, Nomura.

Source: IMF, Nomura.

-6

-5

-4

-3

-2

-1

0

1

2

3

1 2 4 5 10 20 30

%

Years

11/24/2008

9/23/2010

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

5 10 20 30

%

Years

11/24/2008

9/23/2010

1.15

1.20

1.25

1.30

1.35

1.40

1.45

1.50

1.550

25

50

75

100

125

150

175

Se 2009 Dec 2009 Mar 2010 Jun 2010 Se 2010

bps

Eurozone CDS

EUR/USD (rhs in verted)

57

59

61

63

65

67

69

71

Mar-04 Apr-05 May-06 Jun-07 Jul-08 Aug-09

% Advanced central banks

EM central banks


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A key question is which currencies will move most in response to QE. Figure 1

offers an answer based on the announcement effects from QE-1. It shows that low

yielding currencies (JPY and CHF) had the highest betas to QE-1, followed by the

euro. This is to some degree logical given that QE works in part by depressing

nominal yields in the US and globally. The potential for compression of yields is by

definition lowest in the countries with already ultra-low yields, hence rate

differentials tend to move in the favor of low-yielders when global interest rates are

declining. EM and commodity currencies, on the other hand, have generally had

lower betas to QE. A part of the explanation here is likely that if large institutionalinvestors are switching out of USD, there are few alternatives with sufficient

liquidity, and EM currencies would not figure at the top of the liquidity ranking. The

more obvious alternatives are EUR, JPY and GBP. In this context we note that the

observed impact on GBP, which was small relative to other G10 currencies, is

likely to have been impacted by the Bank of Englands QE policy, which was

concurrent to the Feds program.

This ranking also fits roughly with a more general sensitivity analysis of different

USD crosses to directional USD moves (for further details see Appendix I).

At this juncture, however, there are a number of caveats in connection with using

these betas. First, Japan is currently intervening in the FX market (as we noted last

week inJPY intervention starts as we expected; 15 September). This means thatone avenue for USD weakening has been reduced, if not shut down completely.

The corollary is that the weakening impact on European currencies may be bigger,

especially EUR and GBP. Second, valuations are different than in early 2009. For

example, CHF is already much stronger and that may limit its appreciation potential.

Based on these considerations, we are adjusting our global USD forecasts as

shown in Figure 6.

Figure 6. Revised G10 forecasts

Source: Nomura.

23-Sep

OLD NEW OLD NEW OLD NEW OLD NEW OLD NEW

EUR/USD 1.34 1.25 1.35 1.25 1.35 1.28 1.38 1.28 1.38 1.25 1.35

USD/JPY 84.4 82.5 82.5 80.0 80.0 82.5 82.5 85.0 85.0 85.0 85.0

GBP/USD 1.57 1.56 1.63 1.60 1.67 1.66 1.73 1.68 1.75 1.67 1.73

EUR/GBP 0.85 0.80 0.83 0.78 0.81 0.77 0.80 0.76 0.79 0.75 0.78

USD/CHF 0.98 1.12 1.04 1.12 1.04 1.11 1.03 1.12 1.04 1.15 1.07

EUR/CHF 1.31 1.40 1.40 1.40 1.40 1.42 1.42 1.43 1.43 1.44 1.44

USD/CAD 1.03 0.95 0.97 0.96 0.99 0.97 0.99 0.97 0.99 0.98 1.00

AUD/USD 0.95 0.94 0.98 0.96 1.00 0.96 1.00 0.96 1.00 0.96 1.00

NZD/USD 0.73 0.75 0.75 0.77 0.77 0.77 0.77 0.77 0.77 0.77 0.77

Q4 10 Q1 11 Q2 11 End 2011Q3 11

Box

Details about Individual USD crosses

EUR/USD: We have revised our year-end target to 1.35 from 1.25. There are two main elements to this

change. First, there is the effect from QE-2 which will put upward pressure on the cross. Second, we

can observe that the EUR is starting to trade more resiliently in the face of widening peripheral spreads.

In a way, the euro is starting to trade more like a Deutschmark again and less like an EM currency (as it

did over H1 2010 when it tracked moves in CDS). Moreover, we expect the ECB to assume a less

accommodative stance than the Fed, even if eurozone growth is moderating. We think we have entered

a new trading range of 1.30-1.40 over the next 2-3 months.

USD/JPY: Our year-end target for USD/JPY of 82.5 was updated on September 6 and already

incorporates a QE-2 effect. Having anticipated the level at which BOJ intervention started we havealready incorporated the policy in our JPY forecasts and hence we are not changing our projected

USD/JPY path. The projected path implies that US weakness, together with diminishing efficacy of

intervention historically, should push USD/JPY lower to 80 by end-March next year, only to resume

towards 85 by end-2011. As a result of the EUR/USD revision, however, the projected path for
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EUR/JPY is now higher than before. For details on our JPY views in the context of intervention, seeFX

Insights: JPY intervention starts as we expected, 15 September.

GBP/USD:Our year-end target for GBP/USD is 1.63 from 1.56. We expect EUR/GBP to trade to 0.83by year-end. Compared with our previous forecasts, our projected decline in EUR/GBP is more

moderate. This is mainly a result of the correlation between EUR/GBP and EUR/USD, as we now

assume a stronger EUR/USD path. Our view remains that GBP has more attraction than EUR: While a

continuing EUR rally may be capped by concerns of the debt problems in the eurozone and worse data

surprises going forward, we think that the downside tail risk for the pound has been reduced in line witha more stable global banking system and the announcement of fiscal consolidation. For a more

extensive analysis of GBP, seeStrategic Currency Views: The UK pound: Further recovery in store, 14

September.

AUD and NZD: For year-end, we place AUD on path to appreciate to 0.98 from 0.94 previously and

keep our NZD forecast unchanged at 0.75. The higher path for AUD/USD incorporated the effect from

QE-2 (reaching parity by end-Q1 2011) is consistent with our expectations of above-trend growth for the

next couple of years and a hawkish central bank. In New Zealand, Q2 GDP came in significantly

weaker than expected, and our economists are reviewing their GDP forecasts for downgrades. The fact

that we are not revising NZD/USD higher implies a constant AUD/NZD path, instead of a declining path,

which reflects our view that New Zealand will see a softer recovery and slower rate normalisation and

should therefore not appreciate vs. Australia.

USD/CAD: Our year-end target for USD/CAD is 0.97, up from 0.95 previously. We have moderated the

degree of implied CAD appreciation, despite the impulse from QE-2, following weaker-than-expected

Canadian data and weaker commodity (energy) prices. We still envisage a sizeable move into year-

end, especially if the Potash deal is completed by then. But we do not expect the CAD to have a very

high beta to QE-2 relative to European currencies.

USD/CHF: Our end-year target for USD/CHF has been lowered from 1.12 to 1.04. Our forecast for

EUR/CHF remains unchanged. Given our revision of EUR/USD, USD/CHF is lower in our new

forecasts, showing a stronger Swiss franc vs. the dollar in the next few quarters. However, our forecasts

for CHF vs. EUR continue to imply some weakening of the franc. We think that lower expected growth

next year and renewed deflation concerns add to the risk of further SNB intervention and push back thetiming for the first rate hike. This was highlighted by the dovish tone of the September SNB meeting

(see SNB Monetary Policy Meeting: Deflation risks back on the table, 16 September). Together with

expensive valuation, we believe this should push EUR/CHF up to levels in the low 1.40s next year.
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Appendix I Beta to moves in USD

Exhibit 1. Beta statistics Exhibit 2. Portfolio sensitivity to risk

Notes on calculations

In Exhibit 1, we calculate the sensitivity of major

FX crosses and our model portfolio related to 1%

returns in our USD index (equally weighted versus

EUR, JPY, AUD, CAD and GBP) and in the

S&P500. We also calculate the sensitivity related

to 10bp changes in USD2Y rates. We report all

sensitivities in terms of bp. For example in

AUD/USD the sensitivity to +1% returns in

S&P500 is reported as 21bps. Hence for a move in

S&P500 upwards of 1%, we would expect

AUD/USD to move up by around 21bps.

In Exhibit 2, we calculate the potential moves (in

USD K) related to 1% returns in our USD index

and S&P500 as well as 10bps changes in USD2Y

rates.

The sample for these regressions is 2005-2010

and we use weekly data.

Source: Nomura. Source: Nomura.

2005-present-> +1% +1% +10bps

Cross e s USD S&P500 USD2Y

EURUSD -112 -4 1

USDJPY 46 24 33

GBPUSD -105 -3 7

AUDUSD -140 21 11

USDCAD 95 -12 -12

USDCHF 107 15 10

NZDUSD -122 18 11

EURSEK 16 -12 -3

EURNOK 19 -8 -7

EURJPY -66 20 34

EURGBP -6 -1 -6

EURCHF -4 10 11

EURAUD 29 -25 -10

EURCAD -16 -16 -11

GBPJPY -60 21 40

AUDJPY -94 46 43

NZDJPY -76 43 44

AUDNZD -18 3 0

AUDCAD -45 10 -1

NOKSEK -3 -4 4

USDTRY 63 -29 -24

USDZAR 84 -33 -20

USDILS 37 -6 7

EURPLN 28 -17 -3

EURHUF 25 -18 -8

EURCZK 13 -8 0

USDBRL 72 -29 -22

USDMXN 35 -29 -2

USDKRW 48 -21 -2


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Nomura USD QE-2 Effect 2010-09-23

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