US dollar may weaken if QE3 is announced: Barclays Cap

The European Central Bank's decision to opt for unlimited bond purchases led to a decent run up in the euro. But, Asian currencies were not perked up as much. Olivier Desbarres of Barclays Capital told CNBC-TV18, the rally in Asian currencies is limited due to concerns over China. Moreover, the markets are still not sure about a third round of quantitative easing or QE3 from the US Federal Reserve.

Desbarres expects the FOMC to launch an open-ended asset purchase programme and he believes the US dollar could weaken further if the Fed eases further and goes ahead with QE3.
Also read: Asian shares inch up, euro zone and Fed QE3 eyed Here is the edited transcript of the interview on CNBC-TV18. Q: We did see a fairly decent run-up in the euro and a fall in the dollar index, why don't we see that kind of a performance in the currency space in Asia?
A: As you pointed out correctly, we did see quite a sharp sell-off on the US dollar after the payroll numbers, where the market seems to be pricing in QE3 as a near certainty when the FOMC meets later this week. This expends a trend whereby euro-dollar has been pushing higher at a very steady and measured pace since July and that accelerated somewhat on Friday.
The feed through to Asian currencies has been more tepid and Asian currencies have appreciated against the US dollar, Taiwan Dollar, Philippine peso having decent sessions, but on the whole the game has been incremental rather than significant. I think part of the reason for that is that the positive for Asian currencies from potential QE3 is somewhat undone by the ongoing story of slowing Chinese growth.
We saw that with the data out over the weekend and the data for exports and imports released earlier today. I think the slowdown in economic growth and lack of policy stimulus in China is acting like a bull unchained on Asian currencies and that is why we are not seeing great rallies in currencies and we are seeing equities flat-line. Q: What about the euro, what is your view on the euro because we have seen quite a strong run up on an intraday basis on Friday, 1.28?
A: It has been a reasonably sustained rally, more impressive in recent sessions and with the potential for QE3 being announced on Thursday, we think that euro-dollar could push higher.
So far we think that it has been only a certain part of the investor community that has been pursuing euro-dollar high including hedge funds and model accounts. If real money starts to get involved in this trade, we could see euro dollar pushing higher.
But let us not forget that Thursday's decision is not necessarily a slam-dunk, there are a number of reasons to think that this is still a difficult decision for the FOMC. If you look at the US economy today, if you look at the economic and financial conditions today, they are far stronger than when the US announced QE1 and QE2.
There is still this residual risk that the FOMC extends interest rate guidance but does not announce a full fledged QE3 programme, in which case we would see euro-dollar coming off. I still think that like last week, there is a lot of data of event risk, the market seems to be pricing in some other benign outcomes but again this is not a 100% probability scenario.
_PAGEBREAK_ Q: Have brokerages like yours actually sliced what may be announced by the Fed in terms of levels or quantities of bonds they may buy? When you say QE3 what exactly is the market expecting in terms of range of expectations, how much more QE, what kind of bonds, when will they buy? Anything in terms of finer details in terms of expectations?
A: That is indeed the right question to ask because most of us have a slightly different definition of QE as same way we have different definitions as to what a hard landing is. US economy’s core scenario is that the FOMC will announce open ended purchases of US treasuries and mortgage securities.
It will be a mixed program. We think that the FOMC will not attach specific number to its purchases and more tailored purchases on the monthly basis depending on the economic situation and we think it would average around USD 50 billion a month. But, it is very clear that there are a number of possibilities open to the FOMC at this stage. Q: If that's what they say, it's an open-ended game in terms of how much the balance sheet will expand but it is a mix of government debt and private debt. If it is exactly what you are saying it is, then is it priced in at 1.28 on the euro and the dollar index just a shade above 80?
A: It's a tricky question because gauging what the market is expecting is difficult because pricing is always part-art, part-science. But we think that if the FOMC did make such a statement, we would see the US dollar continue to weaken i.e. the market isn't quite priced in for such an outcome.
Having said that, we think that the more bearish scenario for the US dollar is if the FOMC announce purchases purely of government securities rather than a mixture of treasuries and mortgage backed securities. At the other end of the spectrum, if the FOMC announces a limited programme of purchases of mortgage backed securities that would have a very limited impact on currencies. We could even potentially see the US dollar re-rally as the market is disappointed by the scope of the programme. There is a rate of expectations, we are still at the slightly dovish end thinking we may still have a negative impact on the US dollar at least in the near term.
The medium-term picture doesn't change materially. We still think that the dollar will be a currency that's appreciating on trend basis but, again it's going to be a very slow process with two steps forward, one step back as we have seen so far in this year. Q: If in case something does come out with regards to QE3 on Thursday, you do expect the dollar to possibly weaken. What would your target possibly be on the rupee at that point considering that there has been not much of a movement this time?
A: That's right and what's been remarkable about the rupee has been its stability. In mid May we had a slight spike and then sell off in late June. But we have been trading around 55.50 range for three-four months now, given what has happened to the rupee in the past couple of years, it has been a remarkable development.
It has made the rupee a reasonably attractive currency from a better returns perspective. What that tells us is that the rupee has been reasonably impervious to both domestic and global data. So I think we will have to see a particular potent surprise on Thursday in order for dollar rupee to move a great deal.
If our analysis is correct about what the FOMC will announce later this week then perhaps we see dollar rupee falling to the low end of the recent ranges. But, there is a degree of stability in the currency. So it is not necessary to breakout of these three-four months ranges. I think for that to happen we need greater development at a domestic level and of course let’s not forget the FOMC is an important decision but there is a lot of other news and data events surrounding the US, surrounding China and we have got industrial numbers out of India.
It's a more complicated story than just the FOMC decision. The regional growth has been soft in Asia. We are seeing central banks airing on the dovish side, we are seeing for example, Bank of Korea, Bank of Philippines will cut rate later this week. I think we are not quite at the stage where market thinks that the dollar rupee is naturally a one way bad regardless of what Mr. Ben Bernanke may promise us.
_PAGEBREAK_ Q: So you are not expecting any dynamic moves on the rupee, you expect it to be rangebound and what exactly will this range be?
A: Depending on the exact tone and details of the FOMC program I tend to think that the reaction in dollar rupee may not be that great. After all dollar-rupee has not really done a great deal in recent days despite the news from the ECB, despite the weak payroll numbers.
That's telling you that again there is a degree of stability there which is a rather remarkable characteristic compared to the past few years. But if you look at the charts since May, if you exclude the late June move, the range was just sub 55 and just above 56. So that one big figure range has helped quite nicely. We are broadly in the lower half of that range.
Again it is not clear to me that we are going to push much below that. But, that's not necessarily a problem if you are long on the rupee, given that it is one of the currencies in Asia with the largest interest rate, the largest carry.
In terms of returns, if dollar-rupee is flat it is making long rupee positions reasonably attractive. The question I think is, will this low volatility persist going forward? I think that's really the bigger issue rather than whether it is going to be a big figure or lower. It is really how quickly we move through these ranges and whether this stability is maintained.