Forex Investment and Currency Trading

Confronted with nominal policy rates now approaching zero but inflation still falling, and fiscal balances increasingly stretched by direct measures to support domestic spending, some central banks are switching to a lower gear, as it were, and starting to target the volume of credit more directly. This is what economists call ‘quantitative’ easing to distinguish it from the more common control of the price of short term money.

The Bank of England will attempt to achieve this objective by purchasing short-dated Gilts and hope that the money it prints to pay for these securities will be ‘multiplied’ as faster credit growth through the traditional banking channels, rather than being re-deposited with the central bank. In the Euro area, Natacha Valla argues that the ECB is likely to follow in the footsteps of the Fed and buy private sector securities for its own books, thereby circumventing banks. In the US, the Federal Reserve as been already engaged in asset purchases outside the banking system and on an outright basis, ‘pumping’ money in the real economy. The securities it has bought to date – government-backed mortgages and short dated commercial paper – have a limited credit impact on the central bank’s balance sheet. The same goes for the purchases of Treasuries, which have been aired on a few occasions and would presumably serve the purpose of capping funding cost should these rise inconsiderably.

The authorities’ main hopes currently rest on its extended US$1trn TALF program, which would see the central bank provide 3-yr lending on very generous terms (100bp over Libor on a non-recourse basis, and without mark-to-market and remargining requirements), to qualifying private sector investors for the purchase of credit financial assets. This has two potential benefits over direct purchases of credit risky assets: It may improve price-disclosure, as the private sector is setting the terms, and limits the public sector’s interference in the private allocation of capital.

Details on the program are being finalized and more could be out this week. As policies more directly designed to increase lending are being enacted, investors focus is gradually shifting to what the ‘exit strategies’ of such policies could be. Providing clarity to the public on this matter is important even if it seems a distant prospect today.

Turning to investment implications, some analysts remain constructive on nominal bonds, particularly in Europe where they still recommend holding long positions in 10-yr Gilts. Quantitative easing should help lower uncertainty over economic activity, lower volatility and start re-building confidence in riskier assets.