What a Year it was and Will be

‘Twas the hike before Christmas and all over the shop Short end traders were waiting for prices to drop. Bloomberg and Reuters, the FT all there To capture the moment – if Yellen would dare. (ZeroHedge)

Aside from Martin Shkreli and Star Wars, our watercooler chat was centered on the Fed’s decision to raise
key interest rates for the first time since 2006 to a range of ¼ to ½%, up from the previous 0 to ¼%. The decision to increase rates came as no surprise, as Fed Chair Janet Yellen had alluded to the desire to raise rates for some time in order align rates with that of a healthy economy, and more importantly, give the Fed some room to maneuver in case of another recession. It is suggested that at least 3% is needed in order to give the Fed the ammunition to combat another recession, but the Fed has already told us that they expect to raise rates in a very passive and predictable way so it shouldn’t generate a huge amount of volatility or uncertainty among financial markets.

The Greenback appreciated against the Canadian Loonie, British Pound, Japanese Yen, Australian Dollar and Euro Another conversation gaining more attention is that of the dropping price of crude. Due to this fact, the second biggest loser after the Pound last week was the Loonie. Relying heavily on the price of oil to maintain its value, the Canadian Dollar declined as its largest export devalued by over 7% last week. Western Canada Select was already well below $30/barrel.

The reasons for the change in the cost of crude are twofold – weak demand in many countries due to insipid economic growth, and second, surging U.S. production. United States domestic production has nearly doubled over the last six years, pushing out oil imports that need to find another home. Saudi, Nigerian and Algerian oil that once was sold in the U.S. is suddenly competing for Asian markets, and producers are forced to drop prices. Canadian and Iraqi oil production and exports are rising year after year and even the Russians, with all their economic problems, manage to keep pumping.

Goldman Sachs sees further weakness for oil due to the worsening of already weak fundamentals after oil cartel, OPEC, held back from cutting production at its recent meeting. The group of 13 oil-producing countries has kept its production ceiling around 30 million barrels a day for years, with kingpin Saudi Arabia standing firm against an output cut in order to maintain market share and drive higher cost producers out.

In addition to this, in a move considered unthinkable a few months ago, Congress agreed on Friday to lift the US’s 40-year ban on oil exports. This is an historic action that reflects political and economic shifts driven by the boom in U.S. oil drilling. U.S. oil producers will now be able to sell crude to the already saturated international market further driving down the cost.

There was positive news out of New Zealand, as the GDP Price Index posted a gain of 1.9%, a second straight gain for the key indicator, breaking a nasty streak of three consecutive declines. Positive GDP and Business Confidence also supported the currency’s 0.42% gain last week, but that’s hardly what anyone is talking about today.

The U.K. Pound was the big bear of the week having been previously immune to USD strength. Deutsche Bank has now revised their forecasts for 2016-17 suggesting we’ll see levels as low as 1.35-1.40 for the GBP/USD pair. In response to the FED rate hike the Bank of England is expected to raise rates in the New Year and all eyes will be on their next meeting on Jan 14th to see if they increase rates, but also if their statement is as dovish as the Feds.

Lastly, even with its most recent gains, Deutsche Bank and ABN Amro remain extremely bearish on the euro both predicting parity with the US Dollar in 2016 while others, including HSBC, are a little more optimistic predicting a high of 1.20 in Q4 2016. Although French, German and Eurozone manufacturing PMIs all beat expectation last week, when it comes to the euro in 2016, all eyes are on the Fed and a potential slowdown in China as possible indicators of future euro performance.

Three Currency Predictions for 2016

In the past few weeks, we’ve focused on the ever-growing influence of the Chinese Yuan in global financial markets. This has led us into our last Dispatch of the year, and some predictions for 2016. These predictions are not ours, but are reliably put together by the well-respected, Wolfgang Koester of FiREapps.

The biggest currency story in 2016 will be the Chinese yuan becoming more closely tied to world currencies other than the U.S. dollar, and the very significant business risk that represents for multinational companies. But there will be other significant stories as well.

We are now in an environment where CFO’s can no longer manage currency and the associated business risks by a version of the old “80/20 rule” (in this context, having a good [80%] understanding of the currencies impacting a financial statement). CFO’s are awakening to the fact that the less-understood 20% may present very material risks.

Given that environment, corporate boards, CFO’s, and CEO’s will be seeking greater insight into how currency could impact business operations. In 2016, more than ever, corporate executives will need to know “what it means for [this element of our business] if [this currency rises/falls].”

Here are three currency predictions for 2016:

1. Volatility will no longer be a “new normal,” but rather just “normal.” Currency-driven business risks are a fact of life for multinational companies. In this year’s third quarter, for the fourth quarter in a row, negative currency impacts to corporate earnings were magnitudes above previous years’ averages, according to an analysis by FiREapps. Contrast this sustained volatility with 2012’s euro-driven currency crisis, which lasted two quarters and caused more than $40 billion of negative impacts to U.S. corporate earnings, according to research by FiREapps. It’s a different world now, and all indications point to this trend continuing into 2016.

In 2016 hot spots might include the eurozone, Russia, Japan, and Latin America.

The eurozone: Since mid-2014, U.S. multinationals have cited the euro as an impactful currency as often as they’ve cited all other currencies combined. The euro hit historic lows in 2015 as concerns about the eurozone economies persisted, new geopolitical risks arose, and the monetary policies of the eurozone and the United States continued to diverge (the European Central Bank continued its pursuit of quantitative easing, and the U.S. Federal Reserve tightened policy with an interest rate hike). Expect uncertainty, volatility, and a weaker euro to continue.

Russia: The ruble was incredibly volatile in 2015, rising 42% from a late-January low to a late-May high, then falling 25% by late August. Early in the year, we saw multinationals like General Motors go so far as to temporarily suspend operations in Russia, citing accelerated volatility. In 2016, Russia will continue to be a big question mark.

Japan: Though not nearly as much as the ruble, the yen exchange rate was also marked by volatility in 2015. The yen isn’t in position to strengthen next year; the Japanese economy fell back into recession, and most analysts predict the Bank of Japan will respond as it has been responding: with more monetary stimulus that subsequently drives down the value of the yen. A weak yen has significantly weakened corporate revenue, and multinationals should prepare for more of that in 2016.

Relative to those currencies and others, the U.S. dollar is likely to continue to strengthen in 2016. Given the economic and geopolitical turmoil elsewhere in the world, the U.S. dollar will continue to be a safe haven and sustain an environment in which companies have to operate under a mandate to innovate and focus on quality, rather than produce the cheapest export/product possible. For U.S. multinationals, this means more business risk.

2. China will further loosen its grip on the yuan. Many multinationals are highly exposed to China’s yuan (the basic unit of the renminbi, or RMB, the country’s official currency, in much the same way that the British pound is the basic unit of pound sterling). But many haven’t been actively managing the currency and its associated risks. That was because of its close peg to the U.S. dollar, which meant there was little exchange-rate volatility for companies to worry about.

That changed on Aug. 11 of this year, when China surprised markets by allowing the yuan to fall by nearly 2% against the dollar. The decline continued in the following days, hitting a four-year low against the dollar. This led to volatility for many Asia-Pacific currencies as countries took action aimed at maintaining parity against the yuan. This tracks with what we’ve seen as the euro has weakened against the dollar. Volatility in a major currency creates a ripple effect around the world.

China is poised to further widen the yuan trading band in 2016, in large part because the RMB will become the fifth currency in the International Monetary Fund’s “basket of reserve currencies,” known as Special Drawing Rights (SDR) currencies. As China moves to a freely floating trading band (an expectation of the SDR currencies), the yuan will likely experience unprecedented volatility. In fact, the volatility we’ve seen in 2015 — and the associated business risk to corporates — will pale in comparison. In 2016, for the first time, the yuan will be a risk that many multinationals will actively manage. While Morgan Stanley is calling 2016 “Yen Year,” We think “Yuan Year” will turn out to be a much more apt characterization.

3. Boards, CFO’s, and CEO’s will look to FP&A for insights Corporate financial planning and analysis (FP&A) teams will need to be prepared to answer tougher questions about how currency volatility will impact business operations. The questions will require granular, often time-sensitive currency data. Such questions may include:

 What does it mean for the supply chain if the Brazilian real has another big first-quarter fall?
 What does it mean for expenses if China widens the yuan trading band by another 2%?
 What does the hike in U.S. interest rates mean for net income?
 What does it mean for the cost of goods sold in Japan if Japan resumes active devaluation of the yen?
 What does it mean for revenue if the euro falls to parity with USD?

Many CFO’s have been asking these questions for the last six months. Until this point, FP&A had not had to be particularly involved with currencies, nor had they been asked to take a specific look at them, at least not to the level that they have to now. These kinds of questions are getting vastly more complex, and they surely will be harder to answer in 2016.

U.S. Interest rate hike finally has "Lift-Off"

Yesterday, The U.S. Federal Reserve raised the fed funds rate by 0.25% to 0.25% – 0.50%. The zero interest rate policy had been in effect for 7 years, ever since the Fed slashed its key rate by 0.75% back on Dec. 16, 2008. The immediate reaction to the announcement saw a quick burst of USD strength taking USDCAD from 1.3780 up to 1.3847 – the highest level since 2004. The move was short-lived and the USD saw some broad-based weakness after the press conference taking USDCAD down to 1.3740 before rebounding towards 1.3780. Although Federal Reserve Chair Janet Yellen is confident in the U.S. economic outlook, she emphasized that subsequent rate hikes would be gradual and data dependent. Looking at the Fed “Dot Plot”  there are some changes from the previous meeting:

2016 = 1.375% unchanged

2017 = 2.375% down from 2.625%

2018 = 3.25% down from 3.375%

Longer run = 3.5% unchanged

The USD has been rising steadily over the past 2 years in anticipation of interest rate “lift-off”. The divergence in central bank policies is expected to be a shorter-term trend as other central banks have recently switched from a dovish to a neutral stance. It will only be a matter of time before global interest rates follow the Fed’s lead. For this reason alone, yesterday’s rate hike and subsequent rate hikes may already  be priced into the market. Significant further gains in the USD may be limited. A recent foreign exchange poll from the major Canadian banks suggest that the USDCAD rate will peak in Q1 2016 and then trend lower over the balance of the year.

A quick snapshot of where we’ve been and where we are today:

Dec. 2005

Bank of Canada overnight target rate was 3.25%

U.S. Fed funds rate was 4.25%

WTI oil was trading at $59/ barrel

USDCAD held a 1.1425 – 1.1750 range

Dec. 2015

Bank of Canada overnight target rate is 0.50%

U.S. Fed funds rate is 0.25% - 0.50%

WTI oil trading at $35/ barrel

USDCAD trading in a 1.3280 – 1.3971 range

Steve Brown

Senior Corporate FX Trader

stevebrown@vbce.ca

Loonie Down! The Canadian dollar is down more than 15% in 2015

The Japanese yen was the top performing currency of the week, spurred on by safe-haven moves by the unwinding of carry trades ahead of next week’s FOMC decision and due to falling equity markets. The big loser last week was the CAD as it nearly shed 3%. It was the second biggest down week for the CAD this year – the other occurring after the surprise January rate cut by the Bank of Canada. The big fall in crude was last week’s culprit. The Canadian dollar is down more than 15% in 2015, and next year doesn’t look promising considering that Bank of Canada Governor Stephen Poloz has suggested that further drops in oil prices may encourage more monetary easing. Furthermore, last Tuesday the BOC unveiled the bank’s new “Framework for Conducting Monetary Policy at Low Interest Rates”, which included tools such as quantitative easing and negative interest rates.

US Federal Reserve Chair Janet Yellen

With interest rate futures pricing in an 80% chance that the Fed will raise interest rates at December 16th FOMC meeting and 96% of the economist polled by Bloomberg expecting a rate rise, let us assume for now that it happens. At this point, Fed inaction could trigger a market meltdown, revealing fears over the health of the U.S.and global economy and, after having talked up the
prospects of tighter monetary policy for months, severely damaging the Fed’s hard-won credibility. Judging by our conversations with clients this week, they also expect the Fed to raise rates and for the USD to rally on this news. However, the price action in the currency markets last week suggest that the market has already priced in this event and has now shifted its focus to what follows after the hike.

The current economic backdrop in the U.S. doesn’t exactly scream “rate hike.” Equity markets are facing an earnings recession due to price pressure on crude and USD appreciation. The Nov ISM manufacturing index fell below 50 to the lowest since 2009, dragged down by high dollar and weak global demand. The Nov ISM non-manufacturing survey fell to 55.9, its lowest level since May. Inflation reading and consumer spending are running at very lackluster levels. Even the most recent supposedly good jobs report, that showed 211,000 jobs created in November, included a huge jump in the number of people (319,000) taking part-time jobs because they couldn't find full-time work. You might be asking yourself, ‘Why is the Fed raising the rate now?’, which is a valid question. If the current interest rate was at, say 4%, would the Fed by hiking rates then? Probably not, but the Fed wants to move off the zero interest rates in order to give themselves some room to move in cutting rates in the future, if the economy or markets need it.

The good news is that because of the current economic back-drop, the pace of interest rate hikes will probably be the slowest in history. The Fed will go out of its way to paint this interest rate hike as the most dovish hike of our time.

China Begins G-20 Leadership with Ideas to Reduce US Dollar’s Role

This week, we continue our coverage of China and its yuan as it enters a critical year of influence and inclusion in the global markets. The following is an excerpt from an excellent essay written by Enda Curran of Bloomberg Business.

As China takes the reins of the Group of 20 for the coming year, the first indications are emerging of its agenda. Among the priorities: making the global system more resilient to shocks and, perhaps, less reliant on the U.S. dollar. China is setting up a working group led by South Korea and France to develop proposals, including on ways to strengthen the role of the International Monetary Fund’s reserve-currency unit, which is set to incorporate China’s yuan as a component next year.

China also wants a discussion around whether some commodities should be priced in the IMF’s reserve currency, known as Special Drawing Right or SDR, according to a European official involved in the G-20 talks. Notably absent from a senior role so far is the U.S., owner of what’s still the world’s dominant currency. China’s leadership has for years sought to strengthen the international use of the yuan, and encourage debate about lessening reliance on the dollar.

A surge in demand for dollars as a haven during the 2007-2009 global financial crisis first spurred China’s calls. As chair of the G-20 in 2010, South Korea attempted to lead an effort to widen the international financial safety net, urging the adoption of permanent currency swap lines. The U.S. nixed the idea, withthen-Federal Reserve Chairman Ben S. Bernanke saying officials shouldn’t provide a "permanent service" to financial markets.

Half a decade later, Chinese President Xi Jinping has the chance to put his imprint on a forum first set up during the Asian financial crisis of the late 1990s as a grouping of the largest emerging and developed markets to address systemic risks. "We have seen China grasping every multilateral occasion to enhance its image and leadership role, be it regionally or globally," said Yun Sun, a senior associate with the East Asia Program at the Stimson Center in Washington. "There is little reason for China not to fully exploit the G-20 chairmanship."

China has an ever bigger stake in global financial stability as it endeavors to reduce its own limits on cross-border capital flows, part of a broader plan to give markets a more prominent role in the Communist-run country. Among the challenges for the coming year will be weathering the Fed’s shift to monetary tightening, potentially sending emerging market currencies lower as money heads into higher-yielding dollars.

The G-20 under China’s presidency will also need to consider whether to let expire $250 billion worth of its reserve unit issued in 2009 to boost liquidity during the global financial crisis. China’s G-20 chairmanship began at the start of the month, a day after the IMF said the yuan met the requirements for joining the dollar, euro, yen and pound as one of the currencies backing the SDR, a sort of overdraft account for IMF members. China central bank Governor Zhou Xiaochuan in 2009 advocated expanding the use of the SDR unit in calling for a "super-sovereign reserve currency."
Nothing came of Zhou’s call six years ago, and changing the global financial architecture now remains difficult, analysts say. "We will need another global crisis, and one whose roots can be clearly identified in the shortcomings of the current non-system, for this to happen," said William White, an adviser to the Organization for Economic Cooperation and Development. The G-20’s agenda can also become dominated by pressing issues of the moment. "I suspect that geopolitical issues will trump economic ones," White said.

Whatever else, China’s leadership of the group offers Xi a vehicle to promote his country’s rising global role. The last time China hosted the G-20, in 2005, it was the world’s fifth-largest economy. It’s now No. 2, having surpassed the U.K., Germany and Japan. Its Asian rival will be chairing the Group of Seven developed nations next year. G-20 members are Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, South Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey, the U.S., the U.K. and the EU.

"China can and should look to be ambitious, and aim for actions that demonstrate global leadership," said Tristram Sainsbury, a research fellow at the G-20 Studies Center at the Lowy Institute for International Policy in Sydney. "But China needs to be realistic of the limitations of the G-20 forum -- it is consensus based, and has several design flaws, such as a rotating presidency and a lack of focus stemming from an inability to drop items off the agenda."

Don't say we didn't warn you...

Over Promised and Under -Delivered

Sometimes our crystal ball is a little less murky. In last week's blog post, we essentially laid it all out for you. We stated: "One has to wonder if this week's ECB meeting will be the catalyst for the change in trend. With the market currently priced for perfection, i.e. an ECB move, there is scope for disappointment. "That is exactly what transpired - in the lead up to the ECB policy meeting ECB President, Mario Draghi, went out of his way to express his sense of urgency to do something big. Trial balloons were even launched about a two-tier deposit rate scheme, but it was not to be. Draghi simply overpromised and under-delivered, causing a massive short squeeze in the Euro. Was this his intention? Probably not. According to a Reuters article, Draghi's public stance of urgency ahead of the meeting was his way of trying to pressure the more conservative members of Governing Council to take bigger action. In the end, he was rebuffed. Hence, you see the under-delivery.

 In last weeks blog we stated: "our Spidey senses tingle when everything seems to be a foregone conclusion... with the majority of the market leaning the same way, it is entirely possible for a correction to ensue resulting from either disappointing ECB action or Fed hike uncertainty due to Friday's U.S. jobs report" And what a correction it induced! The Euro squeezed higher by 4 big figures moving from around the 1.0550 level ahead of the ECB announcement to over the 1.0950 level by the end of the trading day. That was the biggest gain in the Euro in more than six years.

Please don't mistake the market's reaction to the ECB move - the move was a reaction due to market positioning  not to the ECB move itself. The bottom line is that the ECB did make a move to ease monetary policy once more. Specifically, they made four moves. First, they cut the deposit rate by 10 basis points from -.0.20 to -0.30. Second, they extended by six months the end date of the current QE program from September 2016 to March 2017. Next, they broadened the range of securities that can be bought to include regional bonds. Finally, they stated that they intended to reinvest maturing bonds similar to the Bank of England and the Fed. Needless to say, policy divergence between the ECB and the rest of the central banks is alive and well.

The market was so convinced of an ECB move that the Swiss franc ended up the big loser in pre-ECB trading. CHF was sold aggressively in anticipation of matching move by the Swiss National Bank (SNB), whose next meeting is scheduled for December 10. Since the ECB didn't go full throttle, the pressure is off the SNB at this week's policy meeting. This has allowed the CHF to be last week's best performing currency with a gain of 3.37%. Meanwhile, the yen squeaked by the USD to finish in last place last week as the ECB disappointment led to a correction as market players shed the safety of the USD and yen. With the holiday season upon us and a light calendar for the U.S. in the week ahead, we suspect the correction will endure at least until the Fed meeting on December 16th.

IMF Adds China’s Yuan to World’s Top Currencies

In our blog post from November 16, we discussed the possibility of the IMF including the Chinese Yuan into the IMF's Special Drawing Rights (SDR) basket of currencies, which includes the USD, GBP, EUR and JOY. On November 30th, the IMF made their decision and the CNY is officially in.

Mover over euro! The CNY is mainly replacing part of the euro's role in the SDR. This is an important milestone in the integration of the Chinese economy into the global financial system. With this, China becomes more exposed to the risks associated with capital flows - particularly those flows associated with money leaving the country, but the following benefits will remain:

1. Increase in trade settlement in Chinese Yuan
2. Global Central Bank will increase their exposure in Yuan.
3. Reconfirm the importance of Chinese economy in context to world trade.
4. Strengthening the political prowess of China on world stage.

   




 




 

 

 





 


  

USD Continues to Shine

The USD continued to shine during the American Thanksgiving holiday-thinned week. The market continued to bid the USD higher driving home the notion of monetary policy divergence between the U.S. Federal Reserve and other central banks. It appears that the market is fully pricing in the Fed’s first interest rate hike in nine years on December 16th. The divergence theme is set to be reinforced this week with the European Central Bank policy meeting on Thursday, where expectations are very high that the ECB is ready to act.

And this brings us to the reason why the Swiss franc was the weakest of the major currencies last week. The market is so convinced of an ECB move that it has sold off the CHF in anticipation that the Swiss National Bank will quickly follow any ECB action with one of its own at its next scheduled meeting is December 10. We don’t know about you, but our Spidey senses tingle when everything seems to be a foregone conclusion. As it stands right now, the market appears to be fully pricing in an ECB move and a Fed hike. In marketspeak – these are expectations that have been discounted by the market. Thus, with the majority of the market leaning the same way, it is entirely possible for a correction to ensue resulting from either disappointing ECB action or Fed hike uncertainty due to Friday’s U.S. jobs report.

One has to wonder if this week’s ECB meeting will be the catalyst for the change in trend. With the market currently priced for perfection, i.e. an ECB move, there is scope for disappointment. If ECB President Mario Draghi underwhelms expectations then a short squeeze will ensue. The question then becomes is this a shakeout that provides investors with a better position, or a swan song for the USD and the monetary divergence theme?

This coming week is one of the most important weeks of the year, which could set the stage for 2016. It’s a big week data-wise with the IMF’s approval of CNY inclusion in the SDR earlier today (see our blog post from Nov. 16, 2015) ISM manufacturing report on Tuesday, ISM service report on Wednesday, ECB decision on Thursday, and the jobs report on Friday. Let’s see where the price
action takes us.

United Nations of Debt

(From World Economic Forum)

For much of the year, investors have been fixated on when the Fed will achieve “liftoff” – that is, when it will raise interest rates by 25 basis points, or 0.25%, as a first step toward normalizing monetary conditions. Markets have soared and plummeted in response to small changes in Fed statements perceived as affecting the likelihood that liftoff is imminent.
But, in seeking to gauge changes in US monetary conditions, investors have been looking in the wrong place. Since mid-August, when Chinese policymakers startled the markets by devaluing the renminbi by 2%, China’s official intervention in foreign-exchange markets has continued, in order to prevent the currency from falling further. The Chinese authorities have been selling foreign securities, mainly United States Treasury bonds, and buying up renminbi.
This is the opposite of what China did when the renminbi was strong. Back then, China bought US Treasury bonds to keep the currency from rising and eroding the competitiveness of Chinese exporters. As a result, it accumulated an astounding $4 trillion of foreign reserves.

The effects of these purchases attracted considerable attention. In 2005, US Federal Reserve Chair Alan Greenspan pointed to the phenomenon as an explanation for his famous “conundrum”: interest rates on Treasury bonds were lower than market conditions appeared to warrant. His successor, Ben Bernanke, similarly pointed to purchases of US debt by foreign central banks and governments as a reason why American interest rates were so low.

Now this process has gone into reverse. Although no one outside official Chinese circles knows the exact magnitude of China’s foreign-exchange intervention, informed guesses suggest that it has been running at roughly $100 billion a month since mid-August. Observers believe that roughly 60% of China’s liquid reserves are in US Treasury bills. Given that reserve managers prefer to avoid unbalancing their carefully composed portfolios, they probably have been selling Treasuries at a rate of roughly $60 billion a month.

The effects are analogous – but opposite – to those of quantitative easing. Recall that the Fed began its third round of quantitative easing (QE3) by purchasing $40 billion of securities a month, before boosting the volume to $85 billion. Monthly sales of $60 billion by China’s government would lie squarely in the middle. Estimates of the effects of QE3 differ. But the weight of the evidence is that QE3 had a modest but significant downward impact on Treasury yields and a positive effect on demand for riskier assets.

Menzie Chinn of the University of Wisconsin has examined the impact of foreign purchases and sales of US government securities on ten-year Treasury yields. His estimates imply that foreign sales at a rate of $60 billion per month raise yields by ten basis points. Given that China has been at it for 2.5 months, this implies that the equivalent of a 25-basis-point increase in interest rates has already been injected into the market.

Some would object that the renminbi is weak because China is experiencing capital outflows by private investors, and that some of this private money also flows into US financial markets. This is technically correct, but it is already factored into the changes in interest rates described above. Recall that capital also flowed out of the US when the Fed was engaged in QE, without vitiating the effects. That was what the earlier debate over “currency wars” – when emerging markets complained about being inundated by financial inflows from the US – was all about.

Another objection is that QE operates not just through the so-called portfolio channel – by changing the mix of securities in the market – but also through the expectations channel. It signals that the authorities are seriously committed to making the future different from the past. But if Chinese intervention is just a one-off event, and there are no expectations of it continuing, then this second channel shouldn’t be operative, and the impact will be smaller than that of QE.

The problem is that no one knows how long capital outflows from China will persist or how long the Chinese authorities will continue to intervene. From this standpoint, the Fed’s decision to wait to begin liftoff is eminently sensible. And, given that China holds (and is therefore now selling) euros as well, the European Central Bank also should bear this in mind when it decides in December whether to ramp up its own program of quantitative easing.