The Federal Reserve Chairman, Ben Bernanke’s new QEIII policy was announced last Friday. Skeptics believe that all the financial easing that these policies fails to anchor the economy for any long term benefits. QEIII calls for $40 billion worth of mortgage backed securities to be bought back every month, indefinitely. Moreover it is anticipated that exceptionally low levels for the federal funds rate are likely to be warranted, at least through mid-2015.
Skepticism aside, these measures give a boost to the stock market and are instrumental in making investments and choosing assets. Societe Generale’s SA (EPA:GLE) (PINK:SCGLY) post QEIII analysis believes that the current policy will be able to generate moderate impetus for high-beta currencies. The buy rated pairs are CAD/JPY and USD/JPY. It recommends buying SPX against AUS.
SocGen thinks that the fancy valuation of EUR/USD is not ‘real.’ The euro swings up in anticipation of the Fed and ECB, but the 15 percent loss in currency value, after structural flaws in the Eurozone were exposed, is never going to be recovered. From 2005-2008, the 2 year interest rate spread was the single dominant factor in EUR/USD, post 2008 sovereign credit risk started influencing euro (Chart 1). Chart 2 and 3 look at the relationship pre and post crisis. Chart 4 models EUR/USD based on relative rates and movements in the 2yr Bond/Bund spread.
Sketching a scenario for 2015, where eurozone GDP growth is just over 1 percent and the ECB raises the rates, while the Federal Reserve is dormant, with a projected 3 percent US growth, then the EUR/USD could then be valued at 1.50, but again those are just musings.
SocGen’s research estimates a fair valuation of EUR/USD based on short, medium, and long term models. Currently EUR/USD is trading below the medium term value of 1.36, and the short term model indicates that positioning above 1.30 will not sustain for long.
The analysis observes that EUR/USD do not face risks in maintaining current volatility, amid deflation in sovereign risk premiums and measures to increase liquidity with central banks’ support. However, the uncertain political scenario, and Europe’s conditionality model can pose a moderate upside risk. To circumvent the risk, SocGen recommends hedging against USD/JPY. The plan is to “Buy USDJPY 3M call strike 79 / sell two calls strike 82 / buy call strike 84 Indicative offer: 0.47% (spot ref: 77.50).” However SocGen’s analysis of the situation is not unbiased, as it admits itself.
The Fed’s new policy is seen by SocGen as a predictable attempt to induce a selling of USD. As a response to QE III, dollar is now resting at its lowest in a seven month term. Investors have moved to flowing cash in commodities and equities, after the Fed announced its aggressive MBS buying plan. The Asian index and US stock market rose to highs, while the prices of gold, oil, and copper reached new levels, evaluated on a short term scale of the last few months.