Quantitative Easing?

Just what is Quantitative easing? It is a term heard frequently when referring to actions by the US Federal Reserve. The frequently used term is composed of two words, Quantitative, which refers to the money supply and easing, which means to increase the money supply. It is a tool of monetary policy and means that a central bank or government prints new money to increase the supply. The move by the Fed is bound to have an effect on the Interbank Forex market but to what extent is unknown at this time.

Fed Slashes Rates

On Tuesday the Federal Reserve cut overnight rates to zero to 0.25 %, an unconventional action meant to lift the economy out of a year-long recession. Doug Roberts, chief investment strategist at Channel Capital Research.com stated, “The message is they’re instituting quantitative easing on a fairly large scale.”

How it Works

Under quantitative easing, the Federal Reserve will flood the banking system with new money to promote lending. The action is usually taken when lowering interest rates is no longer effective because they already are at or near zero.

Central banks add cash by buying up large quantities of securities, mortgages, government debt, commercial loans, and even stocks from banks and financial institutions giving them plenty of money to lend. The Fed hopes the move will ‘prime the pump’ of the Interbank Forex market and get banks lending again.

Easing of Frozen Credit Markets

Recently the tool has been used by Japan to stimulate the economy and to fight inflation. Much of the global economic crisis is caused by frozen credit markets. Many corporations find themselves unable to secure loans necessary for day to day operations. The credit crunch has adversely affected the Interbank Forex market and banks have been unwilling to lend to each other.

Quantitative easing helped Japan to stimulate their economy and to make sure there was no shortage of liquidity. The Fed hopes it will do the same for the beleaguered US economy and stimulate lending on Interbank Forex markets.

LIBOR Falls

The cost of three month dollar loans between banks fell ahead of an anticipated rate cut by the US Federal Reserve. The interbank lending rate for 3 month dollar loans known as the London Interbank Offered Rate (LIBOR) fell to just over 1.87 percent according to the British Bankers Association. This move is expected to affect the interbank Forex market as bankers await the decision of the Federal Reserve.

Fed Expected to Cut Rates Further

The Fed is expected to cut its rate to 0.50, it’s lowest in history. At the same time the rate for 3 month loans in Euros known as the EURIBOR fell 0.04 percentage points to 3.25 percent. The equivalent rate for British Pounds fell 0.05 percentage points to around 3.13%.

Interbank Forex Affects Everyone

Interbank Forex rates are important because they affect the costs of loans such as student loans or mortgages. Many US citizens are unaware that their home loans may be tied to LIBOR rates. In recent months rates have been high as banks hoarded cash instead of lending, creating a credit crunch affecting the day to day economy. Interbank fx rates affect the average person in ways they unaware of.

Rates Remain Above Benchmarks

All three lending rates still remain above the benchmarks set by central banks, 1 %in the U.S., 2.00 %in Britain and 2.50 %in the 15-nation euro zone. These figures suggest that banks are still reluctant to lend and the interbank forex market remains somewhat volatile because of this reluctance. The difference between bank lending rates and official base rates have fallen back towards one percentage point , well below levels seen in the Fall.

The interbank force market affects us all and although the average small investor does not have direct access to interbank Forex data, close monitoring of movements by central banks can yield some very useful information that can be turned into profits on Forex markets.

What is the LIBOR?

We have all seen the London Interbank Offered Rate (LIBOR) cited in several articles and news items. What is the LIBOR and how does it affect currency markets including the Interbank Forex? Simply put, the LIBOR is a daily reference rate based on the interest rates at which banks are willing to lend unsecured funds to each other in the London money market.

LIBOR Published Daily

The LIBOR is published by the British Bankers Association and is released daily, usually at 11:45 AM (London Time). It is basically an average of interest rates charged by banks for loans ranging from overnight to one year. There are 16 contributing banks and the reported interest is the mean of the eight middle banks. The rates for shorter loans are considered to be reliable and reflect the rates at which banks are willing to lend to each other. The actual rate can vary several times a day affecting Interbank Forex markets.

LIBOR Used as Currency Reference

The LIBOR is used as a reference for the British Pound and other currencies including the US dollar, Euro, Japanese Yen, Swiss Franc, Canadian dollar, Australian Dollar, Danish Krone and New Zealand dollar. The LIBOR is closely watched by Forex traders and investors and has a profound effect on the Interbank Forex market.

When the LIBOR rises it indicates two things, 1. That interest rates in general are rising and thus LIBOR is also rising, and 2. Lending banks believe the banks they are lending to have a higher risk of defaulting on the loan so the lending bank has to charge a higher interest rate to offset this risk.

When the LIBOR is falling it indicates that 1. Interest rates are falling and thus LIBOR is falling, and 2. Lending banks believe the banks they are lending to have a lower risk of defaulting so the bank does not have to charge higher interest rates to mitigate the risk.

LIBOR and Interbank Forex

The interbank Forex market is strongly affected by the LIBOR reports. The LIBOR signifies several rates that are calculated in 10 different currencies and is set every business day. The LIBOR rate is calculated daily for these currencies,

1. Pound Sterling (GBP)
2. United States Dollar (USD)
3. Japanese Yen (JPY)
4. Swiss Franc (CHF)
5. Canadian Dollar (CAD)
6. Australian Dollar (AUD)
7. Euro (EUR)
8. Danish Kroner (DKK)
9. Swedish Krona (SEK)
10. New Zealand Dollar (NZD)

The LIBOR for a specific currency depends on the local interest rate for the currency, such as the Fed rate for the UDS, and banks’ expectation of future rates. The LIBOR is important to markets including the Interbank Forex for a variety of reasons; it is long established, it is a truly international reference rate, it has a wide commercial use, it offers the largest range of international rates, and its mechanism is transparent. The banks providing the data for the LIBOR are the most active in cash markets and have the highest standards and credit ratings.

LIBOR Has Major Influence on Forex Markets

Unfortunately individual investors do not have access to LIBOR data and to receive LIBOR reports must be licensed by the British Bankers Association. The LIBOR is easily one of the most important reports watched by Forex traders and has a major influence in Interbank Forex markets globally.

USD Currency of Choice

While the performance of the US dollar has baffled some experts the question remains: how long will this strong performance in currency markets last? At present, the US dollar seems to be the currency of choice despite the negative performance of the US economy. The fundamentals of the US economy are deteriorating, housing markets, stock markets, productivity, the recent collapse of several venerable Wall Street firms, and a lack of investor and consumer confidence all spell trouble in the near future. At present there are several factors that contribute to the dollar’s success. The dollar at present is the world’s reserve currency and is essential to the performance of interbank Forex markets.

Fast Action By US Government Calms Investors

The quick reaction of the US government and its institutions and the cooperation between the two major parties had a calming effect on investors and probably prevented a total market collapse. In the United States the problems are transparent and the willingness of government to try several approaches to reach a solution may inspire confidence in some. Credit markets remain a concern and most realize that it will be quite some time before the effect of the $700 billion dollar bailout will be felt. The infusion of cash has been slow to affect interbank Forex markets.

European Economy Deteriorates

The European economy is deteriorating rapidly despite the efforts of central banks to stimulate liquidity in credit markets. The UK is experiencing its own mortgage meltdown complete with collapsing banks and lowered real estate values. Many European financial institutions invested heavily in mortgage backed securities which are now worth a fraction of their original value. The French and German economies are experiencing accelerated economic slowdowns. Despite the actions of the central banks and governments credit markets remain frozen to the detriment of the European economy and has severely affected interbank Forex exchanges. The Euro has been declining against the US dollar.

Fallout Affects Asia

The fallout from the American economic crisis has affected Asian markets and economies. In Singapore, economists are predicting a downturn lasting several quarters and China is experiencing a significant slowdown. The declining demand for commodities has adversely affected both the Australian and Canadian dollars. The Japanese economy is expected to be affected by the crisis in the US. Japanese automakers expect to see a decline in US sales, the US being the largest market for Japanese automobiles.

Forex Markets

In the short term the economic troubles in the US are actually helping the dollar to retain its value. Whether the US enters a recession will determine the future of the US dollar in the medium and long term. At present the dollar continues to offer opportunities in Forex markets although it remains a mystery just how long it will last. The dollar continues to be the currency of choice on interbank Forex markets.

Bailout Agreement Bogged Down

The failure of the Bush administration and Congress to reach an agreement by weeks end the seizure of Washington Mutual (WaMu) is sending ripples through financial markets worldwide including the interbank Forex. Talks bogged down due to disagreements between Democrats and Republicans over several details of the Bush proposal. Legislators from both parties seem confident an agreement will be reached by Sunday.

The WaMu Seizure

The seizure of WaMu is the largest bank failure in US history. The bank’s assets have been sold to J.P. Morgan Chase and Company for 1.9 billion dollars creating the largest bank in the US. In Europe Belgian-Dutch financial group Fortis NV denied liquidity problems despite falling share prices. Banks throughout the world are heading cash driving rates that institutions charge each other for loans to a record high in London. These moves are certain to affect the interbank Forex market. In other European news HSBC Holdings Plc, said it was cutting 1,100 jobs, blaming the credit crisis.

Effect On Global Money Markets

All these factors have caused global money markets to dry up forcing central banks to increase injections of cash due to high dollar borrowing rates. Said Boris Schlossberg, director of currency research at GFT Forex in New York, “The markets are just caught like a deer in the headlights, watching Washington, trying to figure out what the next step is.” To add to all these concerns shares of Wachovia fell as much as 26%, and shares of Midwest based KeyCorp fell 7%. Despite the worries on Wall Street the strength of the US dollar has kept interbank Forex markets relatively calm compared to stock markets.

Uncertainties in World Markets

Because of uncertainties about the bailout and the political disagreements world financial markets reacted. US stock prices fell 1% and losses were reported in Asian and European markets. Banking woes extended into China where shares of Ping An Insurance fell 9.7%. Financial advisors have been besieged with questions and concerns from investors. Said Cleveland Plain Dealer columnist Teresa Dixon Murray, “There’s a feeling of helplessness that nobody seems to have the answers.”

Obviously the interbank Forex markets will remain in limbo until an agreement is reached in the US congress. With banks hoarding cash and rising lending rates, Interbank Forex trading conditions will remain difficult. One can only hope that the US congress and the Bush administration can reach a swift accord.