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Global Monetary Policy to Take Center Stage

11/19/2012

One of the problems for global capital markets has been the loss of the “carry trade.” Over the past few months there is no discernible funding currency which is necessary for a “carry trade” and its positive impact on global risk assets. However, investors over the next few weeks will need to digest multiple monetary policy initiatives and the potential impact they may have on both currency markets and risk assets. None of the expected measures should be viewed as a “negative” for risk assets. The question really becomes how much of a positive can the initiatives be, and when? 
 
First, a very positive condition in China is in place as the yuan (Figure 1.1) trades near its 18-year high. On November 14, the Yuan touched that 18-year high at 6.2202. Now that the transition in Chinese leadership is complete, I expect further inflows of capital to support the yuan and place a strong foundation for growth resurgence in 2013. Traditional emerging market economies (BRICs) have lagged other emerging market economies in 2012, discouraging investors in the EM class. For 2013, investors should be alert for a refresh in the traditional EM story, even as the developed economies appear challenged to grow.
 
In Japan, a December election may cloud the near-term fiscal and monetary initiatives for the country. However, on the other side of that expect the opposition LDP party to regain power and quickly adopt aggressive fiscal and monetary measures. The effect of that will be a much weaker yen (Figure 1.2), possibly reversing the multi-year bullish trend for the yen and placing it in a leading position to be the funding currency for a global carry trade. For over a decade Japan has struggled with deflation; the LDP seems as motivated as any government has been to actually target inflation. Last quarter Japan’s GDP contracted 3.5%, placing the country in its third recession since 2008. The governmental balance sheet for Japan is a mess – debt, deficit, and no growth. The only way out is a clear orchestration of currency devaluation.
 
Here in the U.S., the FOMC will need to address at its December 12 meeting the year-end expiration of Operation Twist. Unless the Fed wants the automatic tightening that accompanies the end of Operation Twist, they must announce the continuance of $85 billion worth of monthly purchases for long dated Treasuries and MBS.
       
In Europe, the ECB and its back pocket OMT program continue to keep sovereign yields trading in benign fashion. Although Spain’s 10-year (Figure 1.3) has modestly upticked from October 19th’s 5.26% low tick to 5.87% on Friday, it is still well below July 25th’s 7.75% print.  
 
The next few weeks will introduce much conversation regarding global monetary policy initiatives. The near-term impact will be muted, however, some of the initiatives might frame a positive effect as 2013 deepens. At the very least it is something for investors to pay attention to. Certainly I am…. 
 
Figure 1.1 Chinese Yuan, November 18, 2012 to November 17, 2012

Source: Bloomberg
 
Figure 1.2 Japanese Yen, November 2005 to November 2012

Source: Bloomberg
 
Figure 1.3 Spain 10-Year, November 18, 2011 to November 17, 2012

Source: Bloomberg

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