Global Macro: Monetary Policy Driving Markets

TheStreet.com

NEW YORK (TheStreet) -- Quantitative easing across the globe has conditioned investors to play along with central banks in order to reap maximum benefit. The issue now is going back to an environment where fundamentals drive markets, not monetary policy.

This article highlights movements of global markets this past week through an observation of currency markets.

The first chart is of Guggenheim CurrencyShares Euro Currency Trust over DB USD Index Bullish. It looks at the relative strength of the euro over the U.S. dollar.

The spark that set off the global mess in financial markets occurred on May 22, when Federal Reserve Chairman Ben Bernanke spoke of a possible end to easy monetary policy near term. That brought uncertainty into markets and made every piece of U.S. data that much more important.


As uncertainty arose around the dollar, investors fled into the euro. The euro finally had more stability than the dollar. Although the U.S. economic picture is stronger than in Europe, the uncertainty of what the Fed will do next has kept dollar bulls on the sidelines.

As U.S. monetary policy remains up in the air and the European outlook continues to improve, albeit slowly, the European currency should remain in favor versus the dollar.

The next chart is of Guggenheim CurrencyShares Japanese Yen Trust over DB USD Index Bullish.

When the Bank of Japan began an aggressive monetary policy earlier this year, coined "Abenomics," it set off a large rally in the Nikkei index and depreciation of the yen. Markets moved up seamlessly as both the U.S. and Japanese central banks backed movements higher.

When the U.S. called into question time frame of its monetary stimulus, it incited volatility that had been largely absent until then. Japanese government bonds had also seen a large selloff that pushed yields into dangerously high territories.

This past Tuesday, the BOJ met to discuss the market volatility that has plagued Japan. The central bank decided to turn the other way on the matters of day-to-day volatility in markets and worry more about long-term trends.

Market participants saw that as just another incident of central banks letting them down and sold off riskier world assets. The yen showed ever more strength versus the dollar as investors lost confidence that the BOJ was determined to ease at all costs.

The yen/dollar continues to push higher, but the BOJ looks to be determined in the long run to keep easy policy. With a stronger dollar being predicted, that may just be an opportunity to find value in Japanese equities and an appropriate point to get short the yen again. It would be prudent, however, to wait till after the Fed holds its policy meetings next week in Washington.

Emerging markets have also experienced extreme volatility over the past few weeks. The final chart below is of WisdomTree Emerging Currency Fund over Guggenheim CurrencyShares Japanese Yen Trust.

Japan is notorious for its low interest rates, and in currency markets, the yen is generally sold when investors are looking to buy higher interest rate currencies. The selling pressure on the yen took a break as investors began reversing bets out of fear that the BOJ wouldn't stand behind its monetary stimulus commitment.


Emerging currencies sold off as the yen was bought back, and the flow of funds out of emerging markets as a whole led to increased volatility. That led to selling of emerging-market debt and equities, and an aversion to the perceived risky assets found in those countries.

As investors continue to fear the drying up of liquidity provided by central banks across the world, money will be pulled from emerging markets. But if Japan continues with its stance and European central banks turn toward more simulative policies, then fears of the Fed tightening its policy should not hurt emerging market assets as drastically.

At the time of publication the author had no position in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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