A Couple Ominous Signs

There is quite a bit of economic data out this week, along with some US Treasury auctions.  However, there are two sort of ominous signs I see that are overhanging on the market.  One is obvious, the European situation.  Wednesday, Portugal has a bond auction.  They don’t want to accept the terms of an EU bailout.   This is something to keep an eye on.  Additionally, bond yields are being driven by inflation fears.  Inflation is never bullish for stocks.  China and India are combating inflation problems, with food prices in India having touched a high of 18.32%!  Much of this is due to bad weather that destroyed some Indian crops. However, capital flows are affecting it too.

Capital flows are what lead the Brazilian Finance Minister to call a spade a spade over the week end.  In the FT, “This is a currency war that is turning into a trade war,” Mr Mantega said. His comments follow interventions in currency markets by Brazil, Chile and Peru last week and recent sharp rises in the Australian dollar, the Swiss franc and other currencies amid an exodus of investment from the sluggish economies of the US and Europe.”

This is more fall out from the US Federal Reserve QE2 policy.  Because the Fed is actively trying to push the value of the dollar down, it sparks reactions from other countries seeking to keep stable values for their currencies relative to the US dollar.  At the same time, the Chinese renminbi is pegged to the dollar. So, when the dollar loses value, the Chinese currency loses value.  This causes consternation among finance ministers world wide.

China not only has an undervalued currency, but it’s government actively subsidizes exports.  So do other governments.  These subsidies throw off trade equilibriums.  China has been more active than other governments, and Brazil will be bringing up the issues this year at World Trade Organization summits.

Trade wars and currency wars are never positive.  Tariffs almost certainly ensue, as governments feel populist pressure to erect an artificial fence around a particular industry.  There were other signs this was beginning to happen before the US decided to pursue QE2.  But the QE2 policy has provoked an equal amount of reaction around the world.  Plus, since Bernanke began aggressively easing, the dollar has actually risen in value and interest rates have increased.  Exactly the opposite effect of his intentions.

Over at Notes From the Underground, they have a similar take and ask a lot of great questions.  As Yra says, “for those nations that have criticized QE2…the data does not prove out.”   While data in the form of dollar/other currency valuations has not changed much, perceptions and how to act/react to crisis have.  With QE2, the Fed gave the green light for every country to try and manipulate its currency, and subsequent to that their trade policies.  The US is supposed to be a leader and above that.   QE2 has not put us any closer to economic prosperity.

The sages on the street aren’t buying what Bernanke is selling.

Read more at Points and Figures