Why the Global Currency War Will Shape the ASX

The ASX is expected to recoup its losses for this year when it opens later today. It’d cap off a solid few days of trading, with the ASX gaining almost 100 points since Friday. At 11am AEST, the local share market was up 22 points to 5,374.

The ASX is riding the same high that global markets have been on this past week. Ever since the European Central Bank (ECB) suggested it was keen on more stimulus. The ECB’s dovish tone increases the likelihood of credit expansion. And it could follow through on its promise as early as December.

Then, late Friday China’s central bank sneaked in a 0.25% rate cut. China’s official cash rate now sits at 4.35%. It’s the seventh time the PBoC has lowered rates in the past year.

As you might expect, this central banking ‘goodwill’ is buoying stock markets.

For most of 2015, markets assumed a global credit tightening was coming our way…that the US Federal Reserve would lay the ground for a monetary reversal. But those fears proved misplaced. The Fed shows no sign of changing its policy on rates anytime soon.

And now other central banks, led by the ECB and PBoC, are easing monetary policy again. Whether that comes as a result of interest rates or stimulus isn’t important. European rates can’t go much lower. At least not without falling into negative territory…But interest rate policy is merely one side of the coin. With near zero rates, monetary stimulus is gaining more support. Especially across European and Japanese central banks.

When central banks talk about easing, markets can’t help but lap it up. They’re the central bankers’ biggest cheerleaders. And why wouldn’t they be? The more credit sloshing around the system, the better off stocks become.

New money from easy credit, in an environment of low rates, typically winds up in stocks. There’s little else that can provide the kind of high risk, high reward returns investors seek. Markets live by not biting the hand that feeds them. And you won’t see any investor talking down central banks when they’re in such a dovish mood.

This means stock markets are heading in one direction — up. Until the landscape on monetary easing shifts, nothing will change. Especially in the short term. Yet one way or another, the long term outlook for the ASX is filled with less upside. The taps will run dry eventually. And when they do many investors will look elsewhere, to cash or bonds.

If not now, when?

There was a point this year where many believed the central bank policy reversal would start in 2015. It hasn’t, and it’s not likely to. You can thank the Fed for that.

On Thursday, the Fed meets again for its penultimate summit this year. Few expect it to make any move this week. Not in the wake of the dovish comments coming out of European, Chinese and Japanese central banks.

Even December is likely to prove a damp squib. Why? Because the US economy isn’t making the kind of progress expected of it. Corporate America warned that quarterly profits are on the decline. And the industrial sector cautioned spending was waning too. Sales are forecast to fall by 4%. That would represent the third straight quarter of decline.

And with other central banks loosening credit, why would the Fed increase rates now? It’s as much a part of this global currency war as everyone else. Just like other central banks, it has no desire to boost the US dollar’s value. Not when everyone else is devaluing. A strong dollar is part of the problem for the Fed. One that threatens to derail any permanent US economic recovery.

The US, EU, China and Japan the four largest economic blocs in the world. And, outside the US, they’re all easing. Don’t bet on the Fed bucking the trend when it meets this week. All of which shapes up as a strong November for global markets.

ASX to gain from RBA cuts

On the domestic front, inflation figures are on the agenda this week. These will be key in the lead up to the Reserve Bank’s meeting next Tuesday.

What will the figures show? Inflation should come in higher according to estimates. Somewhere around 1.8% for the quarter to September. That’s up on the previous quarter, when inflation was at 1.5%.

The RBA will be particularly keen on underlying inflation though. This is a measure of inflationary pressures in the economy. Yet these are pressures that affect price changes as a result of market forces, like supply and demand. Underlying inflation is expected at 2.5%, falling in the RBA’s preferred 2–3% range.

In other words, inflation numbers won’t make a lick of difference. They’re too dull to weigh on the RBA’s decision next week.

The recent spate of bank home loan rate hikes should be up for discussion though. Each of the big four banks have now raised home lending rates by at least 0.15%. That, more than anything, is raising prospects of an imminent rate cut.

The RBA may feel it must lower rates to offset the effects of this on households. In doing so, it’d put mortgage holders back to square one. Household monthly repayments would fall back just as quickly as they rose.

Or the RBA may decide it won’t do anything. If that’s the case, households will end up feeling the pinch. That threatens to derail consumer confidence over the medium term. And it could damage any service driven economic recovery.

As an aside, one in three Bloomberg economists expects the RBA to lower rates next week. As always, stock will be the big winners from any potential cuts.

But central banks are merely delaying the inevitable. The currency war shows no sign of fading. But you’ll know exactly the moment the game is up. The second the Fed starts reining in its monetary policy…

That’s the only clue we’ll get. It’s the only central bank with enough global influence to rock the boat. With other central banks still mired in the global currency war that time isn’t coming yet. Not for another six months at the least. After that, all bets are off.

When that happens stocks will be less attractive. Until then, central banks will continue propping up markets. But they’ll pull the plug eventually. Those with inside knowledge will make a killing. As for the rest of us? You can make your own mind up.

Mat Spasic,

Contributor, Markets and Money


PS: When the great monetary policy reversal begins in earnest, stock markets will take a hammering. Markets and Money’s Vern Gowdie expects the ASX will lose as much as 90% of its value. And with the banking sector accounting for almost half of the ASX, it’ll be one of the worst hit.

Vern is the award-winning Founder of the Gowdie Family Wealth and The Gowdie Letter advisory services. He’s ranked as one of Australia’s Top 50 financial planners.

Vern wants to help you avoid this coming wealth destruction. That’s why he’s written this free report ‘Five Fatal Stocks You Must Sell Now’. As a bonus, Vern will show you which five blue chip Aussie companies could end up destroying your portfolio. You’ll be surprised to learn which banks make Vern’s list…

To find out how to download the report, click here.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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