It’s easy enough to appreciate that what’s said by policymakers can drive valuations in currency, equity and commodity markets but what isn’t can be just as important. Here are a couple of examples from this week that have had a profound influence.
I always enjoy reading statements from the Reserve bank of Australia (RBS) because of their clarity and succinctness. What’s simpler than the following from the last meet on October 7, when Governor Glenn Stevens surprised nearly all observers by raising rates 25 basis points:
“The global economy is resuming growth,” he said. ” With economic policy settings likely to remain expansionary for some time, the recovery will likely continue during 2010.”
As Central Banks around the world responded to the financial crisis which began in 2007 and worsened dramatically after the collapse of Lehman Bros, the RBA lowered borrowing costs “to a very low level” due to “very weak economic conditions and a recognition that considerable downside risks existed.”
The Federal Open Market Committee (FOMC), which is charged with setting interest rate and other monetary policies for the Federal Reserve, is currently of the belief that “extraordinarily low interest rates” will need to be maintained for an “extended period” but in Australia, a very different situation now exists.
According the Governor Stevens, the need to maintain a very expansionary monetary policy has now “passed” and the RBA will now become the first member of the Group of Twenty industrialized nations to “begin gradually lessening the stimulus provided by monetary policy.”
There can only be one conclusion which market participants can glean from this; policy will continue to be withdrawn which means that the RBA will be leading the world in raising borrowing costs.
Let’s contrast this with what the Group of Seven industrialized nations (the U.S., France, Germany, Italy, the U.K., Canada and Japan) didn’t say at the conclusion of their meeting in Istanbul on Oct.5. The speculation had been that officials would change the wording from their last meeting in April and make a specific reference to the dollar’s recent decline (just over 12% on the dollar index since the S&P 500 bottomed in March of this year).
So, by not commenting on the dollar’s depreciation this year, traders took that as tacit approval of further dollar weakness. This sets up the following scenario:
We know the dollar weakens as stocks and commodities gain. It has to because if valuations of those assets rise, since they’re bought and sold with greenbacks any appreciation is a de facto lessening of the dollar’s value (you need to have more of them in order to buy the “appreciated” assets).
The key to understanding this situation is to realize something very important, which is that while asset appreciation will cause the dollar to trend lower, policymakers can cause the appreciation of assets by weakening the dollar. It works both ways.
So, look at what we have.
First, there is a Central Bank (the RBA) which has now embarked on a tightening policy. Second, a major group of industrialized nations (the G7) which has given tacit approval of further dollar weakening. Third, the policymaking body of the world’s reserve currency (the FOMC), the body responsible for setting the “price” for the medium of exchange of nearly every major asset class, clearly determined to depreciate its value for an “extended period.”
What we have is a recipe for a continued rally in global stock markets. A “bubble” if you wish. And while bubbles (as we’ve now learned so painfully) can be dangerous things, the time is clearly here dear reader to make hay while the sun is shining.