Analysis: QE2 not all bad for U.S. dollar if it stokes growth

NEW YORK (BestGrowthStock) – The prospect of another dose of quantitative easing from the Federal Reserve may be bad for the dollar in the short term, but some investors are already betting a U.S. economic recovery and rising inflation will change the greenback’s fortunes.

Estimates on further quantitative easing range from $500 billion to $2 trillion, with the Federal Reserve expected to announce a decision at the end of its November 2-3 meeting.

While that’s another hefty addition to the Fed’s balance sheet after it cut interest rates to near zero in 2008 and then bought $1.7 trillion of longer-term securities to pull the economy out of recession, the new measures are likely to bolster growth, analysts said.

“QE has already been factored into the market place,” said Dean Malone, a currency director at Compass FX in Dallas, Texas. “Some hedge funds are looking at it as the Fed comes in to drive growth in the economy, and that means only one direction for the stock market and the dollar. That is strength.”

The dollar index (Read more about the global trade. ) (.DXY: ), a calculation of the dollar’s performance against six currencies, is up 0.1 percent year to date, and the Standard & Poor’s 500 index (.SPX: ) has risen 5.7 percent — hardly signs that investors are not betting on profits from U.S. companies or that the dollar will weaken further.

TECHNICAL SIGNS

There are also clear technical signs that the dollar’s fortunes are already changing.

The euro/dollar has flirted with the $1.4000 level several times in recent days but has only managed to close above it once. That was the first and only close since January, according to Reuters data.

Sell signals on several major currencies against the dollar were triggered on either October 18 or 19 when the 12- and 26-day moving average convergence/divergence line moved below the nine-day signal line, according to Reuters data.

Those currencies included the Australian dollar, the euro, the British pound and the New Zealand dollar.

Conversely, buy signals on the dollar were triggered on the dollar the same dates against the Swiss franc and the Canadian dollar.

The MACD is used in technical analysis as an indicator of short-term momentum by focusing on exponential moving averages and closing prices.

The dollar will also get a boost, particularly against the euro, the second most actively traded currency, because of the relative central bank positions.

EUROPEAN AUSTERITY

“Once austerity measures take shape in Europe, the economy may contract relative to the U.S.,” said Mark McCormick, currency strategist at Brown Brothers Harriman in New York. “The base scenario, with fiscal tightening taking place in the euro zone, should slow down the euro’s momentum and probably slow down the talk of higher interest rates, which has been a source of euro strength.”

The IMF on October 6 ratcheted down expectations for the United States but still forecast U.S. economic growth at 2.6 percent in 2010 and 2.3 percent in 2011 compared with 1.7 percent and 1.5 percent for those periods in the euro zone.

“The ECB is more willing to raise rates at lower growth levels while the Fed is more aggressively easing,” said David Kupersmith, head trader at Third Wave Global Investors, a global macro hedge fund in Greenwich, Connecticut. “Higher growth may mean the Fed will change its path. Higher growth will lead them to stop QE or reverse it.”

All of which would be good for the dollar.

But additional fuel for a dollar rally comes from extreme bets against the currency, which will have to be reversed once any rally starts. While currency speculators have reduced bets against the U.S. dollar, net short positioning on the dollar against major currencies is still at extreme levels, according to data from the Commodity Futures Trading Commission.

Against Asian emerging market currencies, current market positions in eight currencies show significant short dollar positions.

To be sure, the dollar is expected to be volatile until the Fed completely clarifies details of its QE program, particularly the amount. The volatility will be even greater later if the Fed does not begin to retrieve the liquidity once the economy turns around.

And there is still some concern about the impact of adding more liquidity to the financial system and what comes next if it fails to provide the stimulus expected.

“This is getting really low in (the Fed’s) backpack of tools that they can throw at the problem,” said Jeffrey Bergstrand, professor of finance at Mendoza College of Business at the University of Notre Dame.

(Reporting by Nick Olivari; Additional reporting by Steven C Johnson; Editing by Kenneth Barry)

Analysis: QE2 not all bad for U.S. dollar if it stokes growth