QE and the Dollar: Lessons from QE-1 (Part I)

- QE and the Dollar: Lessons from QE-1 (Part I) "The potential for renewed Quantitative Easing (QE-2) has increased in recent months as the outlook for US growth has deteriorated. The first phase of Quantitative Easing (from December 2008 to March 2010) coincided with significant dollar weakening and our analysis shows that QE-1 was a key driver of the weakness, although not the only factor at play. Another round of Quantitative Easing (QE-2) is looking increasingly likely in coming months and this would be a latent catalyst for renewed USD weakening."
- Canada: A cut (hike) above "The Canadian economy is showing signs of a more sustained recovery, with strong domestic demand offsetting the drag from weaker US growth. With inflation well contained, the Bank of Canada is expected to continue to normalise rates. We also remain constructive on the outlook for CAD."
- Refining Flipping NOLI, and retaining a neutral view "We retain our neutral call on risky FX. Both Flipping NOLI and our alternative way indicate that there remains some error between actual and market-implied NOLI. However, the error has narrowed considerably since we recommended a tactically bullish stance (Flipping NOLI to reveal a positive side, 27 May 2010) – both as a result of prices of risky assets appreciating, and as a consequence of NOLI declining."
- SEK - Swedish National Debt Office starts to unwind long SEK positions "The Swedish National Debt Office (SNDO) announced that it will start to reduce its long SEK exposure, by gradually selling SEK in the market. The SNDO had accumulated a long position worth SEK50bn during the crisis, and may take up to a year to unwind its long SEK exposure. This suggests a daily pace of selling to the tune of EUR20mn, but the pace could be quicker, depending on market conditions. We do not think this will reverse the trend of SEK appreciation, but it does reduce the appreciation potential in the short term."
- New USD/JPY forecasts: A new all-time low? "USD/JPY has declined as the prospects of an economic recovery in the US have declined and expectations of lower US interest rates have taken hold. The situation in the US has a greater impact on USD/JPY than Japanese domestic policies and we think that any additional monetary easing by the BOJ or forex intervention by MOF is unlikely to halt the rise in JPY. We have therefore lowered our quarterly USD/JPY forecasts for end-September 2010 to end-March 2012 to take this into account. We cannot rule out the possibility that at some time between now and the middle of next year USD/JPY may briefly break below the all-time low of 79.75 it recorded in April 1995."
- Speculative positions/interest rate spreads and effectiveness of intervention to sell JPY "A growing number of market participants appear to take the view that with the BOJ now having eased monetary conditions, the monetary authorities' next move will be to intervene in the forex market. Using historical data on the size of speculative positions at the start of intervention and the US-Japanese interest rate spread once intervention began, we estimate the extent to which USD/JPY could rally if the monetary authorities intervene to sell JPY. We find that if USD/JPY declines to 82-83, intervention could trigger a brief rally, but probably to no more than 85-86 if US economic sentiment does not improve as well."
- BoK reinforces its pro-growth bias – stay received KRW IRS, long KTBs and long KRW "The Bank of Korea’s decision to keep policy rates unchanged today reinforces our view that the market continues to overestimate just how hawkish Asian central banks will be. We recommend
investors stay received KRW IRS and long KTBs. In terms of the KRW IRS forward curve, the 1fwd 1yr offers the most attractive slide-to-volatility ratio, while we continue to look for opportunities to initiate a recommendation to buy the 10yr KTB. We also maintain our long KRW (vs. EUR) recommendation despite the BoK’s pause. Normalising monetary conditions via FX strength remains a possibility, while support should continue to come from a strengthening Balance of Payments and increasing global political pressure."
- Recommend long HKD 2y3y vol against rates level and term premium "We introduce a fair-value  ramework for swaption volatility based on overall rates levels and term premium. HKD 2y3y  volatility appears to be cheap according to our model. This seems to be a good time to build long 2y3y ATM straddles against HKD IRS 2s and 5s."
- INR OIS curve – Receive 1fwd1Y OIS "Following the Reserve Bank of India (RBI)’s last meeting on 27 July, OIS yields have moved sharply higher. Although yields have retreated from their highs, they are still well above levels before the meeting. However, Indian data releases following this policy meeting suggest that inflation and growth are moderating. Global data trends have also raised questions about the sustained global recovery. As the RBI highlighted explicitly the risks of weaker global growth and its impact on India in its previous policy meeting, we view the change in macroeconomic data as an opportunity to establish our bullish call on rates and believe that receiving the 1fwd 1yr is the most efficient way of expressing this view."
- Malaysia: Updated outlook for interest rate markets "The momentum of economic growth is fading rapidly in Malaysia, as it is across Asia and in the US. With Bank Negara Malaysia (BNM) comfortable with its neutral monetary policy stance, we retain a preference for long-duration positions in MYR interest rate markets. However, the recent rally in the MYR interest rate markets has removed much of the value from the front end of the IRS curve. For investors looking to express a long-duration view via MYR IRS, considerations of slide, volatility and liquidity suggest that receiving the MYR 2fwd 2yr offers greatest value."
- Recommend adding a long PHP trade "We recommend a long 3M PHP/INR (3M 1.0525) position which carries negatively by -0.40% over this period. We expect the Philippine government to be able to enjoy its honeymoon period, having been inaugurated only two months ago. We would also expect to see improvements in the Philippines' ability to attract investment. Despite the recent hostage stand-off, the security situation in the Philippines in general is as good as it has been for years. PHP is also supported by solid basic balance characteristics. The caveat is that President Aquino has a major task on his hands to sustainably improve the fiscal accounts. In addition, there is a risk that the president's popularity declines - his handling of the hostage situation received bad press, and as the typhoon season closes in, the government's crisis management abilities could come under further scrutiny."
- Recommend adding a short EUR/KRW trade "We have chosen to reopen our short EUR/KRW position. KRW remains undervalued and is backed by a relatively strong balance of payments (including increasing interest in the KTB market). At the margin, we would expect less aggressive intervention against KRW appreciation ahead of the G20 event in Korea on 11-12 November. We are also less concerned that the North Koreans could cause problems around this time. However, as the global economy slows, appreciation pressures on KRW may subside, and/or the authorities may be less likely to allow appreciation. Indeed, we try to provide some (imperfect) insulation against any global risk sell-off by expressing the trade against EUR. However, we also show indicative pricing for KRW versus JPY on a 3M basis, as it is against JPY that the valuation proposition seems clearest."
- EMFX RV can be simple: Buy MXN vs ZAR "Cross-continent relative value FX trades usually come across as a stretch to investors, though occasionally there are straightforward opportunities. Given the current state of the world on risky assets, return profiles (flat year-to-date) and the lack of interest on high-beta trades, we think selling ZAR/MXN is an interesting proposal."

Nomura Global FX Weekly 20100909

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