It puzzles a lot of you I know from your emails and your posts on my sites. Frankly, it puzzles me. And I’d say that anyone who says this doesn’t puzzle them has more ego than sense.
The world’s central banks have flooded the global financial markets with cash—and they’re still hooking up more and bigger hoses. The Bank of Japan alone now promises to add $80 billion to the global money supply each month.
And yet there’s no inflation. There’s no sign of inflation. Investors aren’t afraid of inflation. And inflation hedges such as gold are sinking like a stone.
Does this make any sense?
You can find a potential key to unlocking this puzzle in The Vapors 1980 hit “I’m turning Japanese I really think so.”
Let’s start by trying to understand the logic of the Japanese market at the moment. Read more
Friday’s market action on the very weak U.S. jobs number—just 88,000 jobs created in March—put worries about U.S. economic growth on center stage.
At least in the short term.
What with earnings season highlighting companies’ growth for the first quarter and projected growth for the second quarter, and what with the Commerce Department set to release retail sales figures for March on April 12, I think it will be easy for the market to get caught up in growth worries and for the bulk of investors to start behaving as if growth were the most important issue facing the market.
Don’t go with the crowd. Recent numbers casting doubt on U.S. growth rates shouldn’t be ignored, but they haven’t changed the basic forces driving global financial markets.
This is still the central banks’ game. And currencies—the relative price of the dollar, the euro, and the yen—are still the most important mechanism for transmitting messages from the central bank to the markets.
If I’m right and this remains the central banks’ game, I’m looking for a strengthening dollar (and a weakening yen and euro) to continue to put downward pressure on the price of oil, copper and other commodities—and to continue the rout in gold.
U.S. economic growth does figure into this equation since weaker than expected U.S. growth will temper the boost that the dollar might otherwise deliver to Japanese and U.S. equities. Decent growth in the U.S. economy is likely to give the current rally more room to run.
But growth is really a sidebar to the main story.
Which isn’t to say that the story hasn’t changed at all. Read more
And in the two major fronts in the world’s currency wars: The Japanese yen resumes its decline as Prime Minister Shinzo Abe looks close to making a choice for the new head of the Bank of Japan, and the British pound picks up speed in its drop as the government indicates that it’s not backing off from its program of economic austerity even after Moody’s Investors Service downgraded the country’s credit rating to AA from AAA last week.
Japanese stocks staged a monster rally overnight with the Nikkei 225 index climbing 2.43% as news reports pointed to Haruhiko Kuroda as Prime Minister Abe’s choice to run Japan’s central bank. Kuroda is known as a staunch opponent of deflation so he’s likely to be a pedal to the metal proponent of weakening the yen in order to push domestic inflation toward the top of the Bank of Japan’s new inflation target band of 1% to 2%. Kuroda was in charge of the foreign exchange portfolio at the Ministry of Finance from 1999 to 2003 before leaving to head the Asian Development Bank. He’s known as a very able international financial diplomat and the thinking on Tokyo markets is that he will be able to sell Japan’s program to weaken the yen to the country’s international trading partners with relatively less push back. The Nikkei index rose pretty much across the board with 209 of 225 stocks up and only 10 down. The yen fell another 0.14% against the U.S. dollar to 93.29.
Damage to London stocks has been relatively minor this morning in reaction to Moody’s downgrade of the United Kingdom to AA and continued bad news on economic growth. The FTSE 100 Index is actually up slightly with a 0.45% advance. With so many companies listed in London actually focused on the global economy that relatively strong performance for London equities isn’t too surprising. For real damage you have to look to the pound, which is down 0.26% today against the dollar and looks likely to hit a two-and-a-half year low against the U.S. dollar.
That has produced talk that the pound could fall to parity with the euro. (The pound is now at 1.14 euros.) The pound traded at 1.02 euros at the end of 2008. Ladbrokes, the big betting house, is giving 6/4 odds that the pound will fall to parity with the euro in 2013. Ladbrokes is also giving 4/1 odds that the pound will reach parity with the U.S. dollar in 2013. That would require a huge drop since the pound now trades at $1.51. But you know what they say…Where there’s odds, there’s fire.
Is sterling next up in the currency wars? The pound hit a new 7-month low against the dollar yesterday.
Lots of reasons for the drop to what is a 16-month low against a trade-weighted basket of currencies. Standard & Poor’s is rumored, again, to be weighing a downgrade for the United Kingdom and unemployment numbers due tomorrow are likely to show the country slipping deeper into a triple-dip recession.
But the biggest driver comes from a change at the top of the Bank of England. Incoming central bank head Mark Carney, currently governor of the Bank of Canada, has made it clear to Parliament and the financial markets that will be more willing to tolerate higher inflation than his predecessor Sir Mervyn King. From those statements,financial markets are gradually starting to price in an intentional weakening of the pound—call it Japan lite—in order to revive the U.K. economy. That—along with a recovery in the euro that has sapped the pound’s appeal as a safe haven–has sent the pound down and yields on government bonds—Gilts—higher. Future contracts on the pound were net long—that is they were betting on the appreciation of the pound—at the beginning of February, but have moved to a net short position by the middle of the month. (Shorts are looking for the pound to fall in price.)
Bond buyers are now looking for annual inflation to climb to more than 3.2% over the next decade as Carney changes the central bank’s inflation target to a band of 1% to 3%.
I think it will be harder to find a way to play a falling pound in the equity markets than it has been to play a falling yen in the Tokyo market. The Nikkei 225 Index is dominated by exporters and financials that would all benefit from a weaker yen. Major London indexes such as the FTSE have a more diverse membership with a big dose of international companies that wouldn’t necessarily benefit from a weaker pound. This may be an equity trade where we don’t have any alternative, if we want to play, but picking individual stocks. I’m looking and I’ll report on what I find.
As expected the Bank of Japan decided to lie low today ahead of tomorrow’s meeting of leaders of the G20 economies in Moscow. Japan’s central bank kept interest rate policy steady, didn’t increase its program of asset purchases, and didn’t pour any verbiage on the currency wars fire. That topic, according to leaked memos ahead of the conference, looks likely to provoke heated discussions behind closed doors as host Russia seems determined to get a statement condemning government intervention in the currency markets out of the meeting and Japan and the United States equally determined to keep the concluding statement as vacuous as possible.
I think there’s every chance that Japan will resume its weak yen policy after the meeting—although perhaps with less inflammatory language from cabinet officers. Read more