ANALYSIS - Dollar vs commodities play strong on end of QE2

LONDON Tue May 10, 2011 2:25pm IST

A U.S. $100 dollar bill is seen December 17, 2009.   REUTERS/Sam Mircovich/Files

A U.S. $100 dollar bill is seen December 17, 2009.

Credit: Reuters/Sam Mircovich/Files

Related Topics

LONDON (Reuters) - Prospects of an end to liquidity provided by the U.S. Federal Reserve have sent the inverse correlation between commodities and the dollar into overdrive and to many investors that means time to sell.

The inverse relationship has surged in recent days to levels not seen since early November when the U.S. central bank announced further liquidity boosting measures.

The Fed in November launched a second programme of bond purchases or quantitative easing, known as QE2. Due to end in June, it has pumped $600 billion into the financial system.

"What we are seeing is a little bit of de-risking – taking profit on commodity investments -- on concerns about what a post QE2 environment looks like," said Andrew Cole, a fund manager at Baring Asset Management.

"Periods of de-risking tend to be dollar supportive ... the market will be nervous until the moment QE2 ends."

Without another bond-buying programme, thoughts have inevitably turned to interest rate hikes in the United States, which is one reason why the dollar last week rallied as commodity prices plunged.

"If the Fed deems there to be no need for QE3 then presumably at some point short-term interest rates will normalise," Cole said.

"That will feed through to the cost of carry (cost of borrowing dollars to sell for commodities), which is one reason why you would be less inclined to own assets that don't pay anything (such as commodity futures)."

SPECULATIVE FROTH

The 20-day rolling inverse correlation between the dollar and the CRB index of 19 commodities is now around 70 percent compared with 10 percent in the middle of April.

Last October, in the run-up to QE2, the inverse correlation between the dollar and the CRB stood at 74 percent, while versus crude oil it was a 77 percent.

The dollar's negative correlation against crude oil is now about 73 percent from 3 percent on April 15.

"If there is no QE3 the dollar will get stronger which means it will be risk-off, which certainly, means more speculative froth coming off commodities," said Lars Steffenson, managing director at Ebullio Capital Management.

"We've taken a good 10 percent out of commodities, which is probably about half the speculative froth. Whether the other half gets lifted depends entirely on the dollar."

Spot silver plunged 25 percent last week and copper on the London Metal Exchange lost 5 percent.

U.S. crude oil futures fell $16.75 a barrel last week, the biggest weekly loss in dollar terms since oil trading began on the New York Mercantile Exchange in 1983.

"The biggest trade out there has been the short dollar, long macro trade, a lot of people have been playing that aggressively via commodities," said Michael Lewis, head of commodities research at Deutsche Bank.

"We are seeing renewed inflows into U.S. Treasuries ... the end of QE2 could see a big impact on commodities, particularly oil, there are some huge positions out there."

One trigger for dollar strength and the commodities rout last Thursday was European Central Bank President Jean-Claude Trichet, who signalled that euro zone interest rates are unlikely to rise next month, as some had been expecting.

That leaves the euro's interest rate differential against the dollar unchanged and markets used the news to drive up the U.S. currency to its highest in more than two weeks.

"The primary driver of currencies is going to continue to be the divergent interest rate policies between the Fed and the ECB and the debt situation in the euro zone peripheral economies," said Omer Esiner, chief market analyst at Commonwealth Foreign

Exchange in Washington.

"If we do see another move similar to what we saw last week in commodities, certainly that can't be ignored, but that will probably take a back seat to interest rates and debt problems in Europe."

Debt problems in Greece and Ireland are weighing again on the euro against the dollar.

(Additional reporting by Wangfeng Zhou, Julie Haviv and Anirban Nag; editing by Will Hardy and Jason Neely)

FILED UNDER:
  • Most Popular
  • Most Shared

DEFENCE

REUTERS SHOWCASE

Canonisation

Canonisation

Pope declares sainthood of two Indians, four Italians.  Full Article 

Stake Sale Strike

Stake Sale Strike

Coal India trade unions call off strike in victory for Modi.  Full Article 

Markets Weekahead

Markets Weekahead

Ride the bull with a finger on the ejector button.  Full Article 

Arms Purchase

Arms Purchase

India approves $2.6 bln mounted gun purchase - official.  Full Article 

Interview with Bulgari CEO

Interview: Bulgari CEO

Bulgari CEO: we shouldn’t have left India so we’re back  Full Article 

Formula One

Formula One

Hamilton takes second F1 title in style.  Full Article 

Available For Remake

Available For Remake

Bollywood finally wants to pay the price for remakes  Full Article 

Davis Cup

Davis Cup

Vintage Federer seals first Davis Cup for Switzerland.  Full Article 

Movie Review

Movie Review

"Happy Ending" is old wine in an older bottle  Full Article 

Reuters India Mobile

Reuters India Mobile

Get the latest news on the go. Visit Reuters India on your mobile device  Full Coverage