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The central bank divide: Must-know implications for investors

Russ Koesterich, CFA of BlackRock

The central bank divide: 3 key implications for investors (Part 3 of 3)

(Continued from Part 2)

As I write in my new weekly commentary, this growing divide has three implications for investors.

Low global interest rates in the near term. Even as the Fed pulls back, global interest rates are likely to stay low, and liquidity high, for the remainder of the year, given that other central banks aren’t following in the Fed’s footsteps. Relatively low rates – coupled with low inflation and a recovering economy – should be supportive of stocks.

A stronger dollar. To the extent the Fed is becoming less accommodative at the same time that other central banks are maintaining very easy monetary policy, the dollar is likely to strengthen. Weaker currencies should be supportive of international equity markets, like Japan (EWJ).

Market Realist – You can see from the graph above that the U.S. dollar has started to recover against the euro since Q2 and has sustained against the yen over the last two years. This trend is expected to continue, as the Fed will cut back its bond buying program and eventually increase interest rates. These moves will lead to foreign money coming to the U.S. (SPY)(IVV) in the short term, strengthening the dollar.

The increase in rates makes U.S. Treasuries (IEF)(TLT) and other bond classes (BND) look more attractive compared to those of other major economies as they’re slashing rates. This draws funds to the U.S., strengthening the dollar.

A positive for international markets. An earlier-than-expected rate rise from the Fed would put additional pressure on bonds, confirming my long-term preference for stocks over bonds. However, within the equity market, not all segments look equally attractive. In particular, lots of liquidity from the ECB and the BoJ (EWJ) should help support international equity markets, such as Japan, which closed at a three-month high last week. As such, I continue to advocate that investors look for value within select international markets, like Japan and the Eurozone.

Market Realist – To read more about the effects of clashing international monetary policy, please read European Central Bank’s rate moves cause Treasuries to increase.

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