Disparity in global monetary policies

A number of newsworthy events have already hit the markets and we still have a few more to come out later this week, most notably the US employment report. The Bank of Japan (BOJ) cut its policy rate from 0.1% to a 0 – 0.1% range on Monday night. In addition, they announced steps to implement an asset purchase program and voiced a strong commitment to maintain the zero interest rate policy (ZIRP) until prolonged price stability is achieved. So, after 20 years of pursuing policies that resulted in their economy remaining in a quasi-depressive state, they are now “serious” about re-inflating their economy. The timing intimates a sense of desperation on their part as the prospects of stagnating global growth making its way eastward appears to have forced them to pull out all the stops. The lack of follow-through on their 9/15 intervention, a move that seems rather hasty and ill-timed in retrospect, coupled with the implications of this move could see the market further test the resolve of the BOJ in the near future. Given that every major economy wants to weaken their currency, the Japanese cannot expect co-operation in their attempts to stem the appreciation of the Yen. This is not to say that it can’t or won’t happen, just that a loss of credibility can be quite damaging to a central banker. That said, the severity of the economic situation will probably see them try and defend these levels and that, if nothing else, could give the market a bit of a pause.

The Reserve Bank of Australia (RBA) decided to surprise the markets next by not hiking rates to 4.75% as most were expecting. Rather than deal with their surging domestic economy, they chose to focus more on the international growth expectations for now, while hinting at higher rates later on. Assuming that the Australians aren’t too keen on seeing their currency appreciate dramatically (and which central banker would be, given the disruptive effect such an event would have on the economy), it might have been better if they did hike. The market would have probably sold off on “buy-the-rumor-sell-the-fact” price action and a much needed correction might have ensued. Instead, we had a situation whereby the resulting sell-off has, in some ways, given the market the opportunity to get long at better levels.The rate of the AUD/USD is above where it was prior to the announcement as participants look to push the unit higher on the belief that the RBA will have to act soon, maybe at their next meeting. The key factor is that their monetary policies are in stark contrast to that of the other major economies who, through their willingness to embrace quantitative easing (QE), are signaling their explicit desire for weaker currencies. This has created an environment that is forcing traders to stay long this unit. A test of the highs (click on chart to open in new window) is in the offing and it will be interesting to see what happens at these levels.

Gold is higher, as is silver, but we focus on the former because of its cachet value with the market. Precious metals retain their value in an inflationary environment while currencies lose value. Normally, a central bank, in its attempt to ward off the threat of inflation that is the result of an economy overheating, would be raising rates (see RBA). This higher yield shores up the local currency, attracts capital to flow into government debt and, in turn, out of precious metals. That does not appear to be the case with the US economy as the threat it faces is from stagnation and potential deflation, a fact that is being borne out with each economic data release. The negative correlation between the dollar index and gold (click on chart to open in new window) since September speaks volumes about the perceptions of the market.

The Automatic Data Processing (ADP) non-farm employment figures were released on Wednesday morning. The number came out at -39k, which was the biggest month-to-month drop since January of this year, as companies unexpectedly cut jobs. This figure has had a positive correlation to the US NFP due out Friday and, if this holds true, then this would give further credence to the notion that the US economy is stagnating. The next FOMC, the presumed date of the potential QE announcement, is about a month away but the tenor of the economic data stream leads one to believe that the FED has no choice but to reinstate this policy. To do so does not guarantee success, but to do nothing leaves the US economy at risk of going down a path that the Japanese have already traversed and one can be fairly certain the powers-that-be will do whatever they can to insure that does not happen.

Akhilesh S. Ganti
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