Dollar And Yen Dived On Risk Appetite After Fed's QE3 Announcement

Financial markets responded very positively to Fed's announcement overnight, sending the DJIA and the S&P 500 indices +1.55% and +1.63% higher to new 2012 high. Gold also enjoyed and impressive rally and breached 1780 level briefly today. Nonetheless, bonds have indeed weakened with 30 year yield breached 3.00% while 10 year yield closed flat at 1.756%.

Responses in bonds were interpreted as Fed showed tolerance of higher inflation by its open-ended MBS purchase. In the currency markets, dollar was broadly sold off with EUR/USD breaking 1.3 while sterling and commodity currencies were also sharply higher. Yen's gain against dollar was relatively limited so far as supported by yield and indeed, yen crosses were also sharply higher thanks to risk appetite.

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.

On the data front, Japan industrial production dropped -1.0% mom in July. Eurozone CPI will be the main feature in European session. From US, CPI is expected to climb back to 1.6% yoy in August with core CPI dropped slightly to 2.0% yoy. Retail sales are expected to show 0.7% growth in August with ex-auto sales up 0.6%. Industrial production is expected to show 0.1% growth in August while U of Michigan sentiment is expected to drop slightly to 74 in September.