Quantitative Easing Two -- aka, 'QE2' -- was announced a year ago at the Jackson Hole Summit, and given recent statements from the Fed, the market is anticipating a repeat this year. A timetable of QEs to date follows:
There are entire segments of CNBC dedicated to deciphering what the Fed is signaling with its statements. The challenge is removing the subjectivity of the interpretation and developing a scientific approach or, at the very least, an approach that is falsifiable.
I have yet to develop a method, but I do find that so-called word clouds can assist in identifying trends in the Fed's musings. Below I've created two such clouds of FOMC statements leading up to the Jackson Hole Summit in 2010 and this year.
Fed 2012 Statements (January -- August, 5 Statements Total)
Fed 2010 Statements (January -- September, 7 Statements Total)
There are a number of informative shifts in rhetoric from 2010 to 2012. "Mandate" enters the picture in 2012, which is nowhere to be seen in 2010. This likely refers to the stubbornly high unemployment, which the Fed is responsible for under its duel mandate. "Recovery" sees fewer repetitions as well. Apparently the recovery is not invisible in the Fed's eyes, but it is fading. The Fed also "anticipates" more in 2012, where "likely" was the order of the day in 2010.
The increased discussion of the Fed's mandate has been in the context of falling inflation, best illustrated by the MIT Billion Prices Project (BPP). The BPP uses online prices to research whether prices are rising or falling on a daily basis. It excludes services, as they are difficult to find priced online, but still has an excellent correlation with reported CPI. On an annual basis, both the CPI and the BPP has shown inflation falling since July 25, roughly coinciding with the end of QE2.
EUR/USD, Post Jackson Hole
Given the inflation situation and the increase in rhetoric regarding the Fed's mandate, I'm expecting an announcement of QE3 this Friday. Where my thoughts differ from other commentators is the price action on the EUR/USD, post announcement.
In theory, QE3 should equate to a weaker dollar and, therefore, a rally in the EUR/USD. This can be due to an unsterilized QE program that simply prints money increasing the USD supply relative to EUR, or due to investors moving money out of U.S. Treasurys and into equity markets around the world, selling USD and buying foreign currencies in the process. In practice, the past two easings have seen differing price action:
Notice that after the QE1 announcement the EUR/USD rallied, whereas post QE2 the EUR/USD fell. That fall came despite a rise in the equity markets, decoupling from the "risk on" nature of the EUR. Interestingly, the EUR/USD rallied prior to the announcement, likely on the rumor. There was a substantial rally in the EUR after the fall, but keep in mind this is a weekly chart, thus the rally took place four months after the selloff. If you entered a long prior to QE2, you waited eight months to get back to even.
The Net Non-Commercial Commitment of Traders Positions leading up to Jackson Hole is also telling. On June 5 of this year, speculators were short 214,000 contracts worth 125,000 EUR each, or 26.75 billion EUR. As of last Tuesday, traders were short 124,000 contracts worth 125,000 EUR each or 15.5 billion EUR. What has the euro done in that time? Gone from 1.2529 to 1.2348, it has actually fallen in value as over 10 billion EUR short positions were closed by speculators.
Given the situation in Europe hasn't materially changed since June, I doubt these speculators have changed their view and walked away from the trade. Rather, I suspect profit taking was the dominant reason for the selloff and at the first opportunity I suspect they'll put the position back on, all 10 billion EUR of it.
In fact, it is probable that more money is on the sidelines now, as the most recent Tuesday's Commitment of Traders won't be released until this Friday (on the chart above, the EUR/USD is at 1.2348). The yellow line is now higher and the speculative positions lower.
In closing, I agree that there will be an easing announcement at Jackson Hole this Friday, but I expect the aftermath to be a EUR/USD sell-off. As with QE2, the upward leg of the move has been priced in prior to Jackson Hole and the sidelines are awash with cash seeking to go short. Look for an announcement from 'the Bernanke' this Friday followed by the continuation of the downtrend and demise of the EUR.
Disclosure: I am short FXE.
Additional disclosure: I am short the Euro in the cash FOREX market, not via the ETF.