Risk Rally Extended On Fed's QE3, Euro Gained Most

After much anticipation, Fed finally announced a new quantitative easing program that's open-ended, and is focused on MBS last week. While ECB's announcement of Outright Monetary Transaction paved the base for risk rally, stocks further skyrocketed after Fed's announcement.

S&P 500 jumped another 1.9% over the week to close at 1465.77 and is now just less than 7% from its all time high of 1576.09 set in 2007. The Dow closed at 13593.37 and was even closer to 2007 high of 14198.1, just 4.3% away. The Dollar Index lost 1.75% to close at 78.84 and further confirm the medium term trend reversal scenario.

There are a few important developments to note. Firstly, even though risk markets staged a strong rally, commodity currencies weren't the ones who gained most. Instead, Euro was the strongest currency last week. We've mentioned last week that Euro has shown sign of broad based trend reversal.

The impressive strength in the common currency affirmed this view. Secondly, note that EUR/CHF managed to extend prior week's rise even though SNB just maintained the floor at 1.2 rather than raising it to 1.22. Such development is an important vote of confidence for Euro. Thirdly, US treasury yield has indeed jumped after Fed's announcement. That could partly be due to the fact that Fed's QE3 is focus on MBS rather than a range of bonds.

Also, some attributed the surge in yields as a response to Fed's change in stance towards inflation. The surge in 10 year and 30 year yields has indeed boosted up USD/JPY and made yen the weakest currency.

So, looking ahead, we'd prefer to long EUR/JPY in near term, in particular, if BoJ would follow ECB and Fed and announce some additional easing measures this week.

To recap, Fed Chairman Ben Bernanke announced a number of policy changes to stimulate the US economy. First, he initiated purchases of agency mortgage-backed securities, starting tomorrow at a total of USD 23B through the end of the month and then at a rate of USD 40B per month for an open-ended period. Buying would continue until the employment market has shown desirable improvement. This program, as we mentioned in our preview would be different from the previous one which had defined a fixed period and amount.

The Fed maintained the option to alter the "size, pace and composition of its asset purchases" as appropriate, suggesting the purchase amounts might be adjusted depending on economic conditions. Meanwhile, operation twist will continue through the year-end. The interest rate guidance was adjusted as policymakers decided to keep the Fed funds rate at 0-0.25% "at least through mid-2015" from previous forecast of "late-2014."

More importantly, the Fed stated that it "expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable length of time after the economic recovery strengthens." This is a strong language than previously and indicates the Fed's commitments to leave interest rates at low levels even if the outlook begins to improve.

In Eurozone, Germany's Constitutional Court rejected the motion to block ESM as widely expected. The news was welcomed by all European officials and Luxembourg prime minister Juncker said that he will convene the first meeting board of directors of ESM on October 8. Nonetheless, the court also requested that Germany's liability through the EUR 500b ESM must be capped at agreed EUR 190b. And, the Federal Republic of Germany must express that it does not wish to be bound by the ESM Treaty in its entirety if the reservations made by it should prove to be ineffective. Today's ruling was a preliminary one and full review will be considered together with ECB's planned OMT and would be completed in December. But markets don't expect the court to make a u-turn.

The September SNB statement was uninspiring as policymakers decided to leave the 3-month Libor target at 0% and the minimum exchange rate unchanged at CHF 1.20 per euro. The central bank continued to pledge that it is committed to buying foreign currency in unlimited quantities in order to keep EUR/CHF at the above-mentioned level.

Concerning the inflation outlook, the SNB revised lower its growth and inflation forecasts. With inflation at negative territory this year before recovering to mildly positive territory in 2013, there is virtually no inflationary pressure in the country in the near to medium term.

The final RBNZ statement from Governor Alan Bollard was largely unchanged from July's. Yet, after looking into details, this one delivered a more dovish message than the previous one. The central bank left the OCR unchanged at 2.5% but pushed backward the timing of the first rate hike to end of 2013, from mid-2013. Global economic headwinds would eventually affect domestic developments while monetary easing from other major central banks has sent the NZD higher and higher. The market has now priced in a 50% of rate cut from current level next year.