FED PUTS ITS MONEY WHERE ITS MOUTH IS

FED PUTS ITS MONEY WHERE ITS MOUTH IS

14/09/12 @ 07:06 GMT by Simon Smith, Chief Economist

The US central bank delivered more stimulus for the US economy yesterday and made stronger commitments to keep this going until after the economy is on a stable footing. The commitment to buy USD 40bln a month in mortgage bonds, together with adjustments to its current holdings of securities, is intended to further push down long-term interest rates in the US and spur the economy into sustained recovery. It also committed to keep rates “exceptionally low” through to mid-2015. Although the amount it is buying is modest by some measures, it’s the commitment to keep it going that has lifted risk assets and pushed the dollar lower. The 4.2% decline in the dollar index seen over the past four weeks is the sharpest seen for 11 months. Meanwhile, EUR/USD pushed through another key level at 1.2935 (Fibonacci from 2012 high), with 1.30 broken during the Asian session. Significantly, US stocks are now at a near five-year high.

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Commentary

The glittering of gold. No great surprise to see the strong gain on gold in the wake of the Fed decision yesterday. The inverse correlation between gold and the dollar has been getting stronger recently and at -0.71 is at the most negative level for the year to date. In the wider picture, one of the problems for the gold bugs is that it is an all too familiar investment theme. Prior to 2012, the gold price had increased in value for 11 consecutive years. Gold has been seen by many investors and traders as the only reliable store of value since the financial crisis first commenced four years ago, as well as a hedge against inflation and the potential break-up of the single currency. Returns from gold investments this year have been mixed to poor. At one stage in the middle of the year, the SPDR Gold Trust was down by more than 15% YoY, while the price of major gold shares such as AngloGold Ashanti and Gold Fields have fallen significantly so far in 2012. From a technical perspective, the gold price also has a problem. Since reaching a record high above USD 1,900 an ounce a year ago, gold has recorded a series of lower highs and lower lows - never a good sign. Gold really needs to clear USD 1,800 during this recent move otherwise there is a real issue. Gold may be glittering at the moment but, for those with a long-term perspective, there are some definite warning signs.

Steady course for Switzerland. After flat-lining for most of the past six months, EUR/CHF has come to life over the past week, in part due to the strength of the single currency pushing the cross to highs of 1.215. This prompted some speculation that the SNB may follow through with a move higher on the EUR/CHF cap to 1.22, but yesterday’s quarterly monetary policy review saw the central bank keep the current EUR/CHF floor in place. At the same time, the SNB saw the economy growing at a slower pace this year, now just 1%. So what does this mean for other currencies? Well, it’s not surprising to see the proportion of euros in the SNB’s reserves holdings increase over the past year, now at 60%. This is still some way short of the 70% proportion that was seen after the last period of intervention. The SNB has been keen to conduct operations that are not solely concentrated on the euro and has also been also using swaps. This has probably aided the strength of other currencies, with the proportion of reserves held outside the majors (EUR, USD, GBP, JPY, CAD) increasing from zero in mid-2010 to 3.4% today. And with reserves around two-thirds of Swiss GDP, the impact of Swiss efforts to keep the currency from appreciating are going to be felt far and wide for longer to come. This will continue to provide peripheral support for currencies such as the Aussie.