Whether it is fears of inflation, interest rate differentials, or geo-political events that are driving world markets, it is important to get to the root cause and try to understand what is going on around the globe to be able to ascertain what is the best course of action.The major problem around the globe is asset price depreciation, and the cheap money used to cause the bubble-like appreciation of those assets. Banks around the globe are on the hook for lending money to people through mortgages on assets that are now declining in value and stand to lose a tremendous amount of money.So Central bankers are not willing to return to normalized interest rate policies for fear that they will further depress asset prices. They commonly but mistakenly refer to this as “deflation”. So by keeping rates extraordinarily low, they hope to encourage inflation so that the black hole on banks’ balance sheets may be filled.
The problem is that the greatest amount of destruction occurred here in the US, so no amount of accommodative policy is going to return home values to where they previously were. So the Central bank is printing money around the clock to replace the funds that the banks are hemorrhaging through bad mortgages.
Only now the inflation has made its way abroad, as higher food prices manifest themselves in emerging economies causing social unrest as people can no longer afford food. Cue the rioting. As people organize, governments get toppled which causes further instability, thereby raising the risk premium in the market.
And the self-fulfilling cycle continues. But make no mistake about it, the root cause of what is going on today is overly accommodative monetary policy from the US Fed, and Dollar debasement just symptomatic of the overall problem.
In the forex market:
Aussie (AUD): The Aussie is reluctantly higher as risk appetite has increased this morning after a weekend where the world didn’t implode. China came out with its five-year growth targets which are reduced from previous years, and this applied downward pressure to the Aussie earlier in the morning. The RBA rate decision comes out tomorrow.
Kiwi (NZD): When life gives you lemons, you make lemonade and no truer could that statement be than in New Zealand. While the damage form the earthquake was horrific, this can actually be a longer-term positive as the rebuilding period will provide jobs and economic activity. Trade balance figures came in showing a surplus for the first time in nearly 7 months.
Loonie (CAD): The Loonie is also higher ahead of this morning’s GDP report which is expected to show 2.9% annualized growth. In addition, higher oil prices have pushed the Loonie to multi-year highs vs. USD. (Click chart to enlarge)
Euro (EUR): The Euro is higher this morning on anti-Dollar sentiment even though CPI data came in slightly lower than expected. The ECB rate decision is due out at the end of the week.
Pound (GBP): The Pound is higher across the board as there is little news for the UK this week that could change the view that rates should be going higher in the near future.
Dollar (USD): The Dollar is weaker against all but the Yen in what is a classic risk-taking scenario. Major highlights for this week are Bernanke’s testimony to Congress and Friday’s Non-Farm Payrolls report (NFP). The important thing to take away from this week is will there be anything out there that will cause Ben to strengthen monetary policy? I don’t think so at this point.
Yen (JPY): The Yen is weaker across the board as retail trade figures came in better than expected, but industrial production figures came in worse. Now that the market has successfully navigated the geo-political risk the weekend posed, continued risk appetite should continue. (Click chart to enlarge)
If I had to point to the one single source of the economic malaise that has plagued the world, I would say that it US monetary policy. Because the US dollar is the world’s de facto reserve currency and commodities are priced in Dollars, this affects everyone.
The problem is that in almost all developing nations around the globe who are getting hit the hardest, is that people cannot afford to feed themselves. Commodity inflation is taking place and Central bankers’ reluctance to raise rates to combat inflation is causing political disruption.
Let the media tell you that these political uprisings are about human rights—but make no mistake about it these started because of high inflation and low economic prospects. And you can thank the low US dollar for this.
As emerging markets countries raise rates to combat inflation, the US dollar will get weaker. How weak it can go is anyone’s guess, before it becomes the major risk theme in the market.
So keep an eye on the news this week and any sign that the US Fed may become less accommodative about US monetary policy. But don’t count on it—as the scheme is likely to continue unchallenged.
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