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US QE Still Huge, Euro Going to $1.40

Why is the Dollar falling? Because the Fed's "taper" is only a scratch on QE...
 
MARC CHANDLER is chief currency strategist at Brown Brothers Harriman, the US investment bank and securities firm.
 
Here Chandler speaks to Mike Norman at Hard Assets Investor about the outlook for the US Dollar...
 
Hard Assets Investor: We came into the year with a lot of Dollar bullishness, but now it's under pressure. Do you think this is just a temporary thing, or the beginning of a trend?
 
Marc Chandler, chief currency strategist, Brown Brothers Harriman: I do think the Dollar is on the defensive. It will probably be on the defensive until we get a clear sign that the Federal Reserve is about to raise interest rates. And I think the most clear signal so far is no rate hikes, not just this year, but well into next year.
 
Because of that, I think the Dollar is going to be on the defensive, and we can see the Euro above $1.40. We could see Sterling at $1.70. I think we're going to look at new lows in the Dollar index as well.
 
HAI: Since the Fed announced a taper last December, and then successive cuts in asset purchases, the Dollar has not really taken off. Wasn't the taper going to be wildly contractionary and bullish for the Dollar? It didn't really work out that way.
 
Marc Chandler: Here we are middle of April, and QE is still now bigger than it was when it was first announced before Operation Twist was rolled into it. We're still buying $55 billion a month of securities. That's the first point.
 
The second point I'd say is, look at what's happened to Fed funds [interest rate]. Even though we've talked about the Fed tapering and why it's going to be good for the Dollar, it hasn't really translated into higher US interest rates. And that's what we really need. We need to have it so people are paid to be long Dollars. Right now they're paid to be short Dollars against most currencies.
 
HAI: So what is your take from the signals or the language from the Fed itself? It seems like they've moved up the time table for an eventual rate hike, maybe early part of next year. Is that your take?
 
Marc Chandler: No, I think there's a lot of different voices at the Federal Reserve. There's some doves, including in Chicago, Evans, who talked about a rate hike not until early 2016. My sense is that the consensus on the Federal Reserve and the consensus in the market now is tapering, not tightening. And tightening will not take place until the second half of 2015.
 
To talk about an earlier move seems highly unlikely to me. I think the Federal Reserve is still concerned about the broader indicators on the labor market, and we still have – when everything is said and done – very low inflation. So I think the Fed is really out of the picture. And until the Fed comes way back into the picture, the forward guidance stuff, until it gets back in the picture, I think we can't really be counting on the Dollar to have a sustained value.
 
Now there could still be some negative things coming from Europe. For example, my idea would be that the ECB is not going to do anything in May because we're going to get a tick up in inflation, because of how Easter fell this year compared to last year. So a window of opportunity for the ECB to do their own version of quantitative easing is probably not until June.
 
HAI: I want to talk about the Yen, which has been in a downtrend since about November 2012. That's when Abe came into power as prime minister in Japan, and saw basically just an extension of the QE that had been in place for maybe 20 years. Now it kind of looks like the Yen has bottomed. What do you think?
 
Marc Chandler: I think you're right that anticipating Abe getting elected – the election was in December – the market knew though that he was going to win. And they knew the kind of policies he wanted to pursue. So I think the markets may anticipate this. So it took us from ¥76 to the Dollar to about ¥100 or 102.
 
They went through a period of consolidation and I think that the bulk of the Abenomics is known. But now what we have to worry about is, how does the government respond to this retail sales tax hike? And it looks to me like a lot of people in the market are talking about how the Bank of Japan has to ease again for their monetary stimulus in order to get their inflation target and prevent the economy from taking too big of a hit.
 
But I think they're not going to be clear about the economy. They're willing to accept some short-term weakness, say that's this current quarter, April to June, but if we are still seeing weakness come the second half of this year, I think the BOJ will do something more. But it's still far enough away that I don't think it really plays a key role now. So there's more wait-and-see.
 
To me, the Dollar-Yen is really a range-trading currency. For a while we were trading, say, 75 to about 82 or so...we broke out the average...it looked like it was trending.
 
HAI: Broke out violently.
 
Marc Chandler: Violently. And we ended up moving to a new trading range. And right now it looks to me like the near-term trading range is something like ¥101.20 on the downside and maybe it's ¥104 on the upside. And we're in that range. And I think as we get to the low end of that range, it coincides with lower Treasury yields, weaker stock markets.
 
I think that's going to reverse, and we'll see a bounce back in the Japanese stock market. The gap lowered three out of the past four days [April 10, 2014]. So I think it's a bit overextended now. We get a pop back up in the Nikkei and I think we get a little bit pop up back in the Dollar; maybe it's ¥102.5.
 
HAI: Looking at some of the so-called commodity currencies – the Australian Dollar, New Zealand Dollar, Canadian Dollar – we're starting to see those rally. Yet there's a very pessimistic view in commodities and materials markets.
 
Marc Chandler: I'd say a couple of things. One, I think we can call these "commodity currencies", but I think it's deceiving. Here's why. What moves the currency market to a $5.3 trillion a day market? We've done enough foreign exchange this week to cover world trade for a year. So I think about what moves a currency market, I tend not to look at trade, especially for the major, large economies.
 
What attracts people to Australia right now has nothing to do with commodities that they're producing. It has to do with relatively high yields. It has to do with relatively strong data that the market has gone from the next move to be a cut to the next move to be a hike.
 
It has to do with low interest rates in the US, low interest rates, maybe the ECB has got to do more, maybe the BOJ is going to do more. Australia has got 2.5% overnight interest rates. There's still a carry, a yield pickup. You're paid to be long Australian Dollar, you're paid to be long...
 
HAI: You just mentioned it's 8 basis points in Fed funds, right?
 
Marc Chandler: Exactly. The first thing I'd say really is we can talk about these as commodity currencies, but as a currency strategist, I don't find it very helpful. I focus on the things that lead to capital movement, not the movement of goods. So why are these commodity currencies doing well during soft commodity times? Because it's not commodities driving them. It's high interest rates, it's the attractiveness. Australia's economy is trying to make this transition. It's got some weak spots, but the economy hasn't had a recession for, I want to say, close to 20 years.
 
HAI: Moving to the Chinese Renminbi, falling to like a 14-month low against the Dollar, will we see further weakness?
 
Marc Chandler: So I think what can be behind this? We know that the Chinese economy is slowing down. We know that their exports are weaker. But I don't think that the currency movement has anything to do with those factors that a lot of people want to talk about.
 
Instead I think what's happening is that the Chinese officials are trying to let some steam out, let some air out of the bubble. And the bubble is these moral hazards. A lot of people have been betting 2% currency depreciation every year. You can leverage this up and make these very complicated financial products that people can bet that the RMB is going to continue to weaken.
 
And they want to squeeze that out so that they can open up their capital markets. And there's a very important thing that's going to happen in June. The MSCI is going to decide whether it includes Chinese A-shares – the mainland stock – into the global indexes.
 
So the Chinese need to clean up their house in order to open it up further. And that's really the lesson that I think the Chinese learn from Russia, as well as East Asia. So this is an effort by Chinese officials to reduce the moral hazard in the system and basically reintroduce two-way risk.
 
HAI: But to let out steam, as you put it, all they need to do is say, "We're widening the band." Why does that cause people to suddenly want to sell RMB? Doesn't the Bank of China itself have to be the seller, price it lower?
 
Marc Chandler: I think I'm going to wait to see what happens. But my sense is you have a bunch of dominoes stacked up, you don't have to hit all of them down. All you do is hit one of them down. So China has this expression – I think I might have mentioned it to you before – that sometimes, to scare the monkey, you've got to kill a chicken. I think that means to make an example.
 
I think that what China has done is to try to make an example. Let a couple of companies fail on their debt. Have a couple of lower fixings on the currency so that helps squeeze out the short Dollar positions. The widening of the band I think comes after the fact. A lot of the currency depreciation had already taken place before they widened the band.
 
I'd say something about the widening of the band. Most of these currencies, we look at the major currencies – Dollar-Yen, the Euro – very rarely do they move 2% in a day. So having this 2% band for China is very important. They're not going to use it right now, but down the road this is a nice, almost a normalization. In Chicago, where they trade the currency futures, they trade the livestock futures right next to it. Does that make sense to trade money next to swine?
 
And so I think that China says, "We'll let our currency be used as a speculative vehicle a little bit," but here's 2%, here's your guidepost. Remember the old ERM in Europe was a 2.25% band. So this is a big step for China, even though the important point is they're not going to let it move 2%. When they had a 1% band, most of the time they let it move less than half a%.
 
HAI: All right, so a normalization.
 
Marc Chandler: Very slow, gradual.

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