Shortened amp Sterilized won 8217 t Help Gold

The Fed can afford to wait before extending Operation Twist due to the relative market stability prevailing compared to last summer when Operation Twist was decided:

- Today, the EUROIS spread (EURIBOR premium over more stable OIS) is at 0.43% compared to 0.71% on September 1.
- The US-relevant TED spread (Libor premium over T-bills)     stood between 0.37-0.39% since March, compared to the more volatile range of 0.16%-0.37% prevailing between July and September.

We expect the Fed to use today’s FOMC statement to communicate the extension of Operation Twist, likely to be underway in July or August but may last for no more than 2-3 months.

Outright QE, or QE3 is out of the question as the Fed has already spelled out the diminishing returns of such operation as well as its opposition to further balance sheet expansion.

Due to the limited amount of short-dated treasuries available at the Fed, the “selling” part of Operation Twist may have to be curtailed to no longer than three months.

This leads the Fed to announce Operation Twist at today’s meeting to be launched later this summer and possibly ends in September or October (just before the elections).

Since markets did not find Operation Twist (sterilized QE) to be sufficient in alleviating last year’s Oct-Dec volatility, will they find a shortened Operation Twist sufficient?

In such case, a three-month long Operation Twist may have to be complemented with extending the period of “exceptionally low” fed funds rate to mid 2015 from the current “late 2014”.

Gold out of touch with Euro?
“Shortened” and “sterilized” does not appeal to gold’s shine. As we speak, euro trades near its session highs, while gold nears its session lows. Our explanation to such unusual dynamics is the following:

Gold weakness is due to the anticipation that shortened and sterilized version of Fed purchases may not be enough in further boosting the yellow metal. Expect further losses extending towards 1575. Such fundamental rationale is also consistent with the improving technicals in the US 10-year yields (currently at 1.66%), which are likely to retest the 1.80% as early as end of this week. This may lead USD/JPY to recover the 80 level and into 80.50s.

Euro continues to shrug sharp deterioration in German business survey figures, is largely awaiting the formation of a new government, seen as the prerequisite for Athens to obtain its €1 bn tranche and repay the ECB €3.9 bn in interest later this summer. We expect EUR/USD to remain attempt regaining the $1.2800 figure on conflicting news from Athens and the Fed’s willingness to do more. Support has now risen to $1.2580.