QExit Talk Overdone, But USD Rally Likely

Ben Bernanke reiterated on Wednesday plans to slowly wind down the US Federal Reserve's quantitative easing program, which the markets seem to be increasingly treating as a given. However, it's far from certain that QE will end and could be quickly reintroduced even if it is stopped.

Bullish Impact
But for as long as the forex markets buy into the QExit theme, the impact on USD is likely to remain bullish, a trend that could last months, if not until the end of the year when the tapering off is due to kick in, by which time it would have probably been discounted.

However, if QE is the fuel for the US economic recovery, then the suggested timing of its withdrawal is strange. There have been improvements in US real estate prices and consumer demand is holding up relatively well, but a steroid injected monetary policy is only stimulating a relatively tepid economic recovery and mild inflation against a backdrop of heightened uncertainty.

As such there are considerable doubts as to whether the US economy can stand its withdrawal. Already, 'real' interest rates are starting to rise and the US government is also tightening fiscal policy. Is the recovery really strong enough to absorb those sedative effects?

The FX Impact
The forex markets should also pay attention to Bernanke's statements that monetary policy will remain accommodative and that the pace of QExit depends on the performance of the economy. In other words the Fed is prepared to hit the accelerator again if necessary.

USD/EUR Should Rally On QExit Hopes
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Easing Currency War Tensions
Nonetheless, talk of QExit could achieve two useful outcomes. A stronger USD diminishes currency war tensions and the recently stronger JPY, if sustained, also helps in that regard. If financial markets plummet around the world JPY is likely to remain steady as Japanese investors repatriate funds back home.

The second factor is that it will blow some of the froth off financial markets, particularly in the case of equities where the rally has been significant, despite lacking equally impressive earnings growth or the prospect of such.

From now and probably into a good part of 2014, QExit is likely to remain a key focus for forex markets. However, a major stock market and bonds slump and a stalling in US real estate prices will test the Fed's resolve to end quantitative easing, which probably isn't as strong as many in the markets think.