The quantity of money (or size of balance sheet) in the system needs to be addressed before talking about monetary policy in the conventional sense - hence UBS economists note that for now policy tightening is not imminent. In December, the Fed placed a surprising amount of emphasis on the programs due to roll off, despite keeping the wording on the Fed Funds rate staying low for an 'extended period of time.' Admittedly, these items constitute barely 4.5% of the balance sheet. Our Fed view is that confirmation of an end to extraordinary policy is not the ideal catalyst for dollar strength, but removes a path for further downside. MBS purchases will continue with little sign of expansion so far, but this is an area where the dollar may slip as housing figures have disappointed of late. I anticipate USD strengthening phase more as a consequence of double dip, rather than forecast for monetary tightening. Look for USD and JPY strength against AUD, CAD and NZD to be of the most vulnerable. There remains a correlation between equities and risk appetite in currencies. As vol increases, so drops risk.

According to preliminary 2009 debt issuance statistics from SIFMA, the $1.1tln raised through debt securities in the US represents a 14.9% rise on 2008, but the figure is still barely half of 2004's figure. The key decline came in the asset-backed debt and non-agency market, while healthy demand for other forms of corporate issuance suggest risk appetite and liquidity do exist. The Fed's MBS purchases and government underwriting of agency debt and MBS has probably crowded out private issuance and on December 24th, the Obama administration extended an unlimited credit line to Fannie Mae and Freddie Mac until 2012, effectively guaranteeing any losses on its securities. It is almost impossible for a private institution to compete on an equal footing and the lack of competition will cause a serious misallocation of resources. The Fed's exit from the MBS market will help to rectify the situation as GSEs lose a guaranteed buyer and though some short-term spread widening/risk aversion may occur, encouraging private participation is a key incentive for the Fed to stick to its current purchase program.

Source: UBS, Bloomberg

Tags: FOMC