Market commentary: Diverging market policies

Investors find themselves in a monetary changing environment, and the “known assumption” that all major Central Banks will adopt comparable and similar policies to organically help the global economy to recover does not longer apply.

On the contrary, with an uneven recovery and countries growing at different speeds, Central Banks have departed from the practice of align their policies for the common good, and begun focusing more on their individual countries’ needs.

This new divergence in monetary policies started to emerge when the FED began to reduce its QE program by reducing monthly bonds purchases, and soon after, Japan embarked into a massive QE operation in an unprecedented attempt from the Bank of Japan to pull the country out of a decade of deflation.

The aim of these measures were to boost domestic consumers’ spending, while at the same time, support exports through a substantial devaluation of the Yen. Although Japan has not been completely successful in reviving domestic consumption, the weakening of its currency has helped the country’s export driven economy to post some growth over the past few quarters.

Most recently, other Central Banks and government followed suit, departing from austerity and adopting monetary easing measures to address the different economic issues faced by their respective countries. Examples are Canada’s surprise interest rate cut last January, in an attempt to mitigate the negative impact of plunging oil export revenues, and Australia’s somewhat expected interest cut at the beginning of February.

Both countries were facing increasing pressure from falling commodities prices and growing budget deficits and decided to adopt policies aimed at devaluating their currencies as a mean of relief for their economies. Over the past few weeks both the Aussie and the Canadian Dollar have sensibly depreciate against major currencies, especially the US Dollar and the British Pound.

China also embarked into easing policies after witnessing its economy slowing down while the country is trying to shift its economic system from a mainly investment driven model to an internal demand and consumers based economy.

On Tuesday, a pool of economists survived by Bloomberg stated that they believe the People’s Bank of China will cut again its benchmark deposit and lending rates next quarter, while the country’s leaders are gathering this week to map out policies concerning state-owned companies and the nation’s budget.

Despite facing completely different economic issues from Japan, Canada and Australia, China Central Bank has also begun to increasingly adopt easing measures to support its economy and banking sector.

On January 22nd, the ECB also joined the club and announced a sizable QE program that effectively starts this month, with the Central Bank’s President Mario Draghi firm on his intention to flight deflation and spur some economic growth through a large liquidity injection and a substantial depreciation of the Euro that will hopefully support European export driven countries such as Germany and France.

While it is yet to be seen if this move of the ECB will result in real economic growth, the immediate effect of this announcement was the rapid and sizable depreciation of the Euro which is currently at multi-year lows against all major currencies.

This is perhaps the most evident sign of a global monetary policy divergence. In fact, since the financial crises the Bank of England, the FED and ECB have strived to align their monetary policies in an attempt to stabilize and restore confident in the global market and economy.

However, nowadays the US and the European economies and labor markets could not been more far apart from each other, and their respective Central Banks have therefore adopted two opposite monetary policies: ECB undertaking unprecedented QE, while the FED discussing the first interest rates hike since the 2008-2009 financial crisis.

And so today investors are witnessing most of Central Banks around the world moving into some form of monetary easing and currency devaluation, while the FED and the BoE stand alone in exiting QE programs and discussing interest rates hikes. The immediate result has been a run up of both the Dollar and the Pound against all other major currencies, but this monetary divergence is also presenting a unique opportunity for bond investors, that have seen the spread of US Treasury yields jumping over the yields of EU government bonds, German Bund especially.

The unusual monetary environment we are moving into, despite still being a somewhat unchartered territory, is poised to offer interesting opportunities across bond and equity markets, and investors will most likely be able to advantage from the diverging monetary policies to capitalize on both US and European investments.

This article was issued by Paolo Zonno Trader/Analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.

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