Fed debt buying drives demand for risk at the dollar’s expense

By Tom Westbrook

SINGAPORE (Reuters) – The dollar nursed losses on Tuesday, after the U.S. Federal Reserve announced it would begin broad buying of corporate debt, boosting investor sentiment and appetite for riskier currencies.

The Fed said it will start purchasing a diversified range of investment grade U.S. corporate bonds on Tuesday in a bid to secure companies’ access to cash and ensure credit market liquidity amid the COVID-19 pandemic.

The announcement dispelled, for now, concerns about a second wave of coronavirus infections that had weighed on the mood in the previous trading session.

This drove the risk-sensitive Australian dollar, the New Zealand dollar and stocks higher, while safe-haven Treasuries and the greenback fell.

“It’s a dramatic turnaround,” National Australia Bank head of FX strategy Ray Attrill said, referring to the shift in mood.

“It just seems to reinforce that message that you shouldn’t and can’t fight the Fed here, and everything follows from that really.”

Against a basket of currencies the dollar <=USD> was steady at 96.546, almost 1% below Monday’s high of 97.396.

The risk-sensitive Australian dollar sits more than 2% above a two-week low hit on Monday, and rose 0.6% to $0.6968 on Tuesday.

The Reserve Bank of Australia reiterated in minutes from its June meeting that the national economic downturn may not be as bad as first feared.

The New Zealand dollar rose 0.4% to $0.6497, while the Chinese yuan also rose. The pound firmed 0.3% to $1.2637, while the euro was up marginally at $1.1332.

SUGAR HIT?

The Fed will make its debt purchases from Tuesday in the secondary market, and said it would also be buying bonds directly from issuers “in the near future”. The combined size of the primary and secondary programme is up to $750 billion.

Individual investment grade corporate bonds, with a remaining maturity of five years or less are eligible for the Fed purchase. That puts just under 40% of the $10 trillion U.S. corporate debt universe on the table, according to Morgan Stanley.

Credit spreads tightened after the Fed announcement and the yield on benchmark 10-year U.S. Treasuries jumped as traders favoured risk to the safety of bonds.

But safe-haven currencies such as the Japanese yen held firm at around 107.41 per dollar, settling back into a range held since April, suggesting some investors remain cautious.

“The key question for investors and traders is whether the gains represent a change in sentiment or a short-term sugar hit,” said CMC Markets’ chief strategist, Michael McCarthy.

Global cases of the novel coronavirus reached over 8 million on Monday, as infections surge in Latin America and the United States and China grapple with fresh outbreaks.

Later on Tuesday Fed Chair Jerome Powell also testifies before a virtual hearing of the Senate Banking Committee at 1400 GMT.

British labour market data due around 0600 GMT may offer clues as to the Bank of England’s next move at its Thursday meeting.

Traders are expecting it will expand its asset-purchasing programme by around 100 billion pounds ($126 billion).

“The question I have is whether a greater level of QE acts as a sterling negative or positive,” said Chris Weston, head of research at Melbourne brokerage Pepperstone.

“In theory, it’s negative. But FX markets have generally rewarded currencies where the central bank or government have gone harder to aid the economy.”

(Reporting by Tom Westbrook; Editing by Ana Nicolaci da Costa)