February 5, 2013
It's no secret that the U.S. dollar is weak. In fact, we've known it for months, if not years. And the main cause is obvious: Over the past four years, the Federal Reserve has instated three rounds of Quantitative Easing in an effort to shore up financial markets. What's more is that the Fed shows no signs of slowing down bond buying (and by extension, keeping interest rates near zero) until the labor market firms up. So the dollar is very weak and will remain so for the indefinite future.
But what's less discussed is that the several of the world's largest central banks have joined the Fed in playing the "currency limbo." Despite the fact that the G20 (representing 19 countries plus the E.U.) pledged to refrain from competitive currency devaluations, several of these members are doing just that.
And you can believe that is going to have some big consequences for investors. So let's run down which central banks are dead set on devaluing their currencies and see which one "wins" the currently limbo.
The ECB is ready to buy unlimited quantities of short-dated government bonds in an effort to keep the euro-area's struggling members afloat. The only thing keeping the ECB from opening the floodgates is that it needs approval from Germany's Federal Constitutional Court. The ECB currently maintains a benchmark interest rate of 0.75%.
The BOE completed a $600 billion bond buying program late last year. While the central bank currently doesn't have any plans to initiate another round of Quantitative Easing, it remains committed to keeping the benchmark rate at a record low of 0.5%. This low-interest rate policy has kept U.K. inflation at 2.7%, a 7-month high.
The BOJ has a $1.1 trillion asset-buying and lending program in the works and is open to pumping even more money into the economy. On top of this the bank recently doubled it inflation target to 2% and scrapped its 0.1% floor on interest rates.
Right now, it's the Japanese yen. Thanks to the BOJ's unyielding commitment to pull the economy out of deflation, the Yen has fallen 13% against the U.S. dollar in the past three months. And there's no doubt that has helped Japanese financial markets; over the same period, the NIKKEI 225 has rallied over 22%.
Of course, the U.S. dollar is a close second; over the past three months it has retreated 5% compared with the Euro and has remained flat against the British Pound. During that time the S&P 500 has risen 12% and the FTSE 100 has climbed 10%.
So there is a clear connection between currency devaluation and stock price appreciation. Time will tell if these central banks are able to encourage economic recoveries on the scale their looking for, but in the meantime there are plenty of opportunities coming out of this currency limbo.