22 September, 2010

Quantitative Easing II: An Analog for QE I

Posted below are charts from the dreary days of 2008 when the S&P 500 hit the devil's number. You know that ungodly spike in EUR/USD during December? The one where she rallied some odd 2,500 pips... and then collapsed all over again as equities dived into the abyss? Yes, we all wonder how many margin calls were actually triggered during those times. But it's not important.

What is important is why we had such wild swings in the financial markets and what caused them. On December 1, 2008, Ben Bernanke signaled that the US was taking measures similar to what the Bank of Japan did when they couldn't lower rates any further to avoid a deflationary spiral.

Furthermore, during the December 15-16 FOMC meeting, they lowered interest rates to 0% while making it official that they would pursue a policy of treasury purchases; or Quantitative Easing Phase I.

December 18 was when the EUR/USD topped out as rate expectations whacked the US Dollar index severely. Remember that markets generally react to expectations and not the events themselves. Taking that into account justifies why the USD bottomed out when it did; just two days after the FOMC meeting.

Subsequently while the S&P 500 continued to spew margin calls at the turn of the new year, EUR/USD fell back down to the 1.24-1.30 value area.

That's when expectations ran high once again that on the March 17-18 FOMC meeting of 2009 the Fed would finally announce that they're forced to begin outright purchases of everything under the sun. Que the risk rally until December 2009 payrolls, and a bit further for equities as the European sovereign debt crisis took hold.

Times are vastly different today. Nevertheless what counts are the rising expectations of further quantitative easing, possibly after the November elections. That's why it's important to take into account previous history as the USD sells off. Using historical analogs will help determine the general shape of price action that we can expect until the Fed finally makes it's decision for or against Quantitative Easing Part II.

The Pound Sterling reacts initially to US rates, but history shows
that the UK is not far behind the US in policy implementation.
E-Mini S&P 500 futures reacted to a poor economy but the cheap US Dollar
drove an equity rally into 2010.

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