The Currency War May Have Just Gone Nuclear

The Daily Gold Report by Peter A. Grant

Mar 19 a.m. (USAGOLD) -- Gold rebounded sharply from intraday losses on Wednesday, spurred by unprecedented action from the Fed to monetize debt. The yellow metal surged from an intraday low of 883.72 to an intraday high of 948.12.

There had been talk for months that the Fed was considering quantitative easing -- printing money and buying Treasuries -- as a means to support the long end of the yield curve. Such talk ramped up last week when the Bank of England took the debt monetization plunge and had some success in driving down gilt yields. It was reported that the Fed had taken notice.

With interest rates effectively at 0% and the economy still struggling, there was no doubt that the Fed was going to grow its balance sheet. However, in advance of the announcement, the market seemed to think the Fed would simply buy more mortgage backed securities (MBS) and agencies, holding off on buying Treasuries for the time being.

The Fed did indeed announce that it would seek to buy up to an additional $750 bln in MBS, bringing the total projected purchases of such assets up to $1.25 trl. They also announced that they would buy up to an additional $100 bln in agency debt, bringing that total up to $200 bln.
On top of all that, the FOMC decided that late next week the Fed would begin purchasing up to $300 bln in longer-term Treasuries, with emphasis on the 2 to 10-year segment of the yield curve. Purchases will be conducted by primary dealers two to three times per week through competitive auctions.

If recent history is any indication, one might assume that this $300 bln is merely an opening salvo. The Fed's "non-standard" measures have had a tendency to escalate rather dramatically in both size and scope over fairly short periods of time during this financial crisis.
I don't see why this instance would be any different. You don't make a policy move of this magnitude to dabble and just see if it will work and then retreat. Quantitative easing is the A-bomb of monetary policy. Once it's unleashed, it becomes tough to de-escalate.
The FX market in particular seemed to be caught completely off guard and the dollar plunged in reaction to the FOMC announcement. A colleague that I used to trade currencies with back in Chicago said it was "near-panic" selling of dollars, particularly against euro although greenback losses were broad-based.

We have said all along that the recent dollar rally was tenuous at best, with no real fundamental underpinning. It wasn't so much dollar strength as more pronounced weakness in other currencies. Suddenly all that has changed and the dollar will likely play catch-up with the rest of the weak fiat currencies of the world.
In the dollar index, nearly 50% of the Dec to early-Mar rally has already been retraced. The DX -- which set a new 3-year high near 90.00 just two weeks ago -- suddenly seems destined to retreat to the 80.00 zone in fairly short order. An eventual break of the Dec-08 low at 77.68 would put the all-time dollar low from last Mar at 70.70 back in play.
So the world's largest economy has resorted to printing money and buying it's own debt. How do you suppose the rest of the world is going to react to that? The SNB just intervened last week to devalue the Swiss franc; how will they feel about USD-CHF suddenly being lower then where they intervened?

Will they intervene again to weaken CHF? How will the BOJ, ECB and BOE respond? Might the currency war just have been taken to a whole new level? Has the competitive currency devaluation that we all feared, now begun in earnest?

The truth is, as we discussed in our most recent USAGOLD RoundTable discussion, it is becoming increasingly difficult to predict just what might happen next. This uncertainty is just the circumstance that calls for a safe-haven asset. Something solid, something that has withstood the test of time. A place to store at least a portion of the wealth you have accumulated until the dust settles and some semblance of normalcy returns to global markets.

I surmised in my last report that SNB intervention effectively took the Swiss franc off the table as a viable safe-haven. I would now argue that the safe-haven appeal of the dollar has been severely eroded as well.

What's left? The yen? I think the BOJ is going to do whatever is necessary to prevent safe-haven flows into the yen in an all-out effort to protect their export market.
Gold. Gold is what's left.

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Pete Grant is the Senior Metals Analyst and an Account Executive with USAGOLD - Centennial Precious Metals. He has spent the majority of his career as a global markets analyst. He began trading IMM currency futures at the Chicago Mercantile Exchange in the mid-1980's. In 1988 Mr. Grant joined MMS International as a foreign exchange market analyst. MMS was acquired by Standard & Poor's a short time later. Pete spent twelve years with S&P - MMS, where he became the Senior Managing FX Strategist. As a manager of the award-winning Currency Market Insight product, he was responsible for the daily real-time forecasting of the world's major and emerging currency pairs, along with the precious metals, to a global institutional audience. Pete was consistently recognized for providing invaluable services to his clients in the areas of custom trading strategies and risk assessment. The financial press frequently reported his personal market insights, risk evaluations and forecasts. Prior to joining USAGOLD, Mr. Grant served as VP of Operations and Chief Metals Trader for a Denver based investment management firm.