In the Fed's statement yesterday, it announced that the second stage of its quantitative easing program will involve the buying of 600 billion USD of Treasuries evenly divided over 8 months ending July 2011. The Fed also said that it will make additional purchases if necessary to make sure that employment and inflation picks up.
Since the actual program is slightly larger than the 500 billion USD figure that traders had initially expected, the dollar was sent tumbling across the board. After the announcement, EUR/USD flew above the 1.4150 level to post a new 9-month high. Meanwhile, GBP/USD managed to break out of its consolidation and pierce through the 1.6100 handle.
Do the Fed's concerns justify such a huge hole in the central bank's pockets, or was it just making a statement with this bold move? Let's take a peek at some U.S. economic data, shall we?
One of the Fed's major concerns is the country's employment levels. Judging by the recent unemployment figures, it has every right to be worried! The jobless rate has been sitting above 9.40% for the last 17 months, and it doesn't look like it's gonna go down anytime soon.
It is important to note that corporate profits tend to constrict as jobless workers slash their expenses. This makes companies reluctant to hire new workers, making workers even stingier with wages. You can see how this vicious cycle operates.
Another sore spot is the economy's inflation rate. Personal Consumption Expenditure (PCE) index, the Fed's preferred inflation measure, has been printing below the Fed's long-term target of 1.7% to 2.0%. In fact, the PCE report in September clocked in at 1.2%, the lowest since 2001. Yikes!
Our homies in the Fed also believe that by launching QE2, they will rub enough sticks and stones in the economy to spark consumer spending and business investment. Hopefully, the Fed's move will persuade banks to implement friendlier lending schemes.
The dollar's recent weakness that came in anticipation of the move can also help spur growth by making U.S. exports relatively cheaper compared to those of other countries.
Now let's talk about my outlook for the dollar...
It looks like the dollar will remain under heavy selling pressure, as the Fed's statement to open-ended bond purchases makes it a spankin' funding currency for carry trade plays.
Only time can tell where the Greenback will be headed to in the long run though. If QE2 proves effective, we may see the currency hustlin' on the charts when investor confidence is restored.
But you know that a QE isn't all sugar, spice and everything nice for any economy. This weekend, I'll go into detail about the possible risks associated with QE. Stay tuned for that!