Busch: Fed's Bigger Move on Currencies

In a surprise move, the Fed announced a massive expansion of their balance sheet yesterday and has embarked on an aggressive pursuit of quantitative easing.

Here are the key comments:

"In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months. The Federal Reserve has launched the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses and anticipates that the range of eligible collateral for this facility is likely to be expanded to include other financial assets."

The announcement had a profound impact on US interest rates and the US dollar: both fell dramatically. The US 10 year Tsy note fell 40 bp from 2.95% to 2.55%. The US dollar index from 87 to 84. The Euro moved from 1.30 to 1.35 and is still feeling the positive effects of intervention from the Swiss National Bank. The Fed's program to buy US Treasuries is seen as greatly expanded the money supply and therefore is deemed currency negative.

The UK QE program has had an immediate effect on UK rates and drove them down quickly. The Japanese program that was recently started has seen a similar impact on interest rates in Japan. The question remains: can QE and ZIRP jump start lending and therefore the economy. The Fed, the UK, and Japan are all attempting to push risk free (government) assets down to influence the price of riskier (non-government) assets.

Now the last country that engaged in QE to attempt to revive the economy was Japan from 2001-2006. The initial response was similar in that Japanese rates fell from 1.65% to 1.25%, but then retraced almost all of that over the next 6 months. It wasn't until the economy in 2002 that interest rates had their biggest move down. The Japanese yen weakened against the US dollar only in 2001 and then it strengthened until the end of 2004.

The Fed is taking this QE further by expanding the TALF program to buy asset backed securities (risky assets). Remember, Q4 2008 was the first time that home equity, credit card, student loan, and equipment leases had no issuance. In the $14 trillion US economy, consumer spending was about 70% and much of this was predicated on consumer spending. Of this consumer spending, 40% was fueled by these type of consumer loans. Extract the credit and extract that spending.

The question remains: by making government securities more expensive will it encourage other securities to follow? Will the market's appetite for securitized products be dramatically increased by the Fed's actions? With reports of collapsed auto sales, with home prices still sinking, with default rates for credit cards soaring, these securitized products will have to be extremely cheap relative to US Treasuries to lure investors back into them.

I'm not sure the Fed's program solves this problem, but it does show Ben Bernanke is aggressively pursuing the answer. Let's see if we can get the US Treasury to announce their toxic asset program soon to complement the Fed's QE.

Read what others are saying about the Fed Move on CNBC.com including:


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Andrew Busch
Andrew Busch

Andrew B. Busch is Global FX Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him here. </</p>