Currency wars boost your stocks

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Via FTAlphaville comes this splendid truth from Citi:

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One defining feature of JPY is its negative correlation with Japanese equities. The negative correlation intensified considerably in the wake of the BoJ aggressive QE in April 2013. Investors were buying Nikkei but selling JPY because of QE (Figure 1). Most recently, both Japanese growth and inflation have bounced and the prospects for QE abated somewhat. All that has weakened the negative correlation between stocks and JPY.

1/ ECB’s actions have created a safety net for risk-correlated assets – the euro-funded carry trades – that should continue to support European stocks while weighing on EUR.

2/ More ECB policies in the form of outright QE are expected to come before long as Eurozone growth remains weak and inflation precariously low. That should enhance EUR-underperformance and Eurostoxx outperformance, making their correlation even more negative.

3/ ECB could succeed in re-introducing euro downside risks. This could encourage foreign investors to hedge their long-euro exposure more aggressively not the least because EUR hedging costs have dropped sharply following the introduction of negative deposit rates. EUR would underperform even if we see continuing foreign inflow into the Eurozone asset markets.

4/ ECB measures should ultimately support domestic demand and growth in the Eurozone. As argued in ‘Can ECB be a game-changer for EUR?’ the policies should over time weaken currency block’s external imbalances especially if productivity remains low. That could erode the attractiveness of the single currency.

Inflating asset prices is bad idea, period. But if you must do it then equities are a far more attractive option in the long run. Higher prices mean more corporate activity and potentially higher investment as well. They also help boost wealth and demand and when the whole baby busts again it doesn’t leave your banking system in a generational hole. Equity markets can adjust more swiftly and easily than can housing assets. Australia is busy inflating the wrong market.

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About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.