Currency Wars, Deflation, Inflation, Rising Interest Rates & Falling Oil Prices

We have seen both surprising and expected events in the first two months of 2015.   The European Central Bank (ECB) decided to move forward with their QE plan to print 1.1 Trillion Euros, which has driven down the value of the Euro.  The Federal Reserve Chair, Janet Yellen, testified in Congress that the US central bank’s “patience” with holding interest rates near zero has limits and suggested the central bank might drop its pledge to be patient, due to low oil prices stifling inflation.  Yellen strongly criticized a proposal to allow congressional audits of the Fed’s monetary policy, saying it would curtail central bank independence and expose it to political meddling: “Audit the Fed is a bill that would politicize monetary policy, would bring short-term political pressures to bear on the Fed,” said Yellen.  While opposing regulatory scrutiny on the Fed, she also called for more scrutiny of large Wall Street banks, as many banks like Morgan Chase, Citigroup and Bank of America have recently paid out record fines to settle civil investigations.

ECB Seeks to Inject Up to 1.1 Trillion Euros Into Economy in Deflation Fight (1-21-15)

Yellen Signals Feds Patience With Zero Interest Rate Has Limits (1-24-15)

Yellen Says Effective Supervision of Big Banks One of Fed’s Top Priorities (3-4-15) WSJ

Fed to Continue to Err on Side of Caution Says Zentner (2-27-15)

Raising Interest Rates
Former manager of PIMCO Total Return Fund, Bill Gross, is concerned that the job creation we’ve seen over the past decade is not what it seems, because real wages have declined. “We can create jobs, but can we create profitable jobs and productive jobs that pay money to elevate labor back into the old middle class?  … I don’t think we’ve done that and that’s what we need to do.  Wages need to increase at least 3 percent to help offset the impact of lower commodity prices and get to the Fed’s inflation target of 2 percent,” Gross said.

Bloomberg columnist Matthew Boesler wrote:
“The Group 20 finance ministers this week urged the Federal Reserve to “minimize negative spillovers” from potential interest-rate increases, they omitted a key figure: $9 trillion.  That’s the amount owed in dollars by non-bank borrowers outside the U.S., up 50 percent since the financial crisis, according to the Bank for International Settlements. Should the Fed raise interest rates as anticipated this year for the first time since 2006, higher borrowing costs for companies and governments, along with a stronger greenback, may add risks to an already-weak global recovery.”

Here’s a $9 Trillion Question (2-13-15) by Matthew Boesler

Gross Says Fed Must Be Very Careful in Raising Rates (2-6-15)

Deflation & Inflation
Deflation played a role in two of the worst economic disasters we’ve seen, the Great Depression and more recently, Japan’s lost decades with almost no economic growth.  We’ve all heard that inflation was bad, but because of deflation and the desire to expand exports, central banks are setting inflation goals and doing everything they can to ignite inflation.  Bloomberg columnist Mark Gilbert does a great job of defining inflation and deflation using comments from one of the readers of his column:  “Inflation rewards borrowers and punishes savers and people on fixed incomes. Deflation rewards savers and people on fixed incomes and punishes borrowers. I’m tired of being on the losing team because I’ve been frugal, instead of a borrowing spendthrift.”

Deflation is a prolonged period of falling consumer prices; rational consumers will defer purchases because they expect to be able to buy goods and services cheaper in the future. That drives prices into a tailspin and the economy into a funk.  Many other people aren’t buying that theory. “If you expect food prices to drop, will you stop eating?” he asks. “If you expect housing prices to drop, will you start living in a cardboard box? If you expect clothing prices to drop, will you walk around naked?”  We certainly don’t want a starving, homeless Steve wandering around in the altogether. But that’s what the most recent inflation figures from around the world suggest might be coming.

Deflation The Trouble With Falling Prices (1-21-15) By Simon Kennedy

Will Deflation Make You Naked, Homeless and Hungry? (1-21-15) By Mark Gilbert

Currency Wars
One of the tools being used by central banks to combat deflation and improve exports is the de-valuing of currency, because a strong currency means that a nation’s export products are more expensive and a weaker currency means their exports are less expensive.  David Woo, head of global rates and currencies research at Bank of America Merrill Lynch in New York said:

“There is a growing consensus in the market that an unspoken currency war has broken out … The reason why this is a war is that it is ultimately a zero-sum game — someone gains only because someone else will lose … The standard view on war-mongering is that by easing monetary policy, central banks from Asia to Europe are hoping to weaken their currencies to boost exports and import prices. Trade rivals then retaliate, creating a spiral of devaluations as witnessed in the 1930s … A weak currency might provide a short-term boost to the countries engaging in currency devaluation, however, if everyone is playing the same game, what we all will end up with is more and higher FX volatility. This in turn will likely exact a toll on global trade and capital flows.” 

Currency Devaluations Are an Undeclared War (2-6-15) Simon Kennedy

Did the Fed Just Enter the Currency Wars? (2-18-15) Rachel Evans

Is America Losing the Global Currency Wars? (2-3-15) Bloomberg Video

Swiss Central Bank De-pegs from Euro
The Swiss Central Bank de-pegged the Swiss Franc from the Euro and lowered its interest rate to negative 0.75%.  The Swiss are reacting to the European Central Bank (ECB) plans to print 1.1 trillion euros.  They could no longer hold down the value of the Swiss Franc and keep it pegged to the rapidly de-valuing Euro.  Swiss markets are all down because the de-pegging will drive up the value of Swiss products in international markets and hurt Swiss exports.  This, however, likely now makes the Swiss Franc the top safe haven currency.  This was a very significant event and financial commentators and professionals are all saying nothing like this has ever happened before.  No country has ever purposefully raised the value of their currency, nor has a respected central banking system ever fully embraced negative interest rates to combat deflation in an attempt to ignite inflation.  After this decision, the Swiss Franc gained 15 cents on the US Dollar in one day.

What Made the SNB End the Minimum Exchange Rate? (1-15-15) Bloomberg Video

SNB Ends Minimum Exchange Rate, Cuts Interest Rate (1-15-15) Bloom berg Video

SNB Ends Franc Floor, Cuts Interest Rate to -0.75% (1-15-15) Bloom berg Video

FX Strategists on SNB’s Surprise Removal of Franc Cap (1-15-15) Bloom berg Video

SNB Franc Move a `Major Deflationary Shock’: Halpenny (1-15-15) Bloomberg Video

SNB Had to Act Ahead of QE From the ECB: Sri-Kumar (1-15-15) Bloomberg Video

The drop in oil prices is being characterized as a bad thing for international markets and economies because of the high percentage of oil companies in mutual fund portfolios, weighted market measures and loss of tax revenues from oil profits.  The drop, however, it’s great for consumers, farmers, factories, transportation providers and other businesses.  Bloomberg columnist Michael Snyder, explains the problem this way:

“The oil sector has added over a half million jobs — many of them high paying — since the recession ended in June 2009. That’s 13% of all US job growth over that period.  Now energy companies and related sectors are laying off thousands. Expect that trend to continue, bears say.  But losing good jobs is just the tip of the iceberg of this oil crisis.  At this point, the price of oil has already dropped to a catastrophically low level. The longer it stays at this level, the more damage that it is going to do. If the price of oil stays at this level for all of 2015, we are going to have a complete and total financial nightmare on our hands… For the first time in 18 years, oil exporters are pulling liquidity out of world markets rather than putting money in.”

Birth Pangs of The Coming Great Depression (1-29-15) by Michael Snyder

The reduction in oil prices is also creating great concerns in international bond markets.  In a Bloomberg article Lisa Abramowicz wrote, “An accident could be on its way.  The stage is set for another financial crisis to unravel years of relative calm in debt markets.  At least that’s how firms from UBS Group AG to Invesco Ltd. see it. Here’s why: Prices in the world’s biggest bond market are swinging and the plunge in oil is sinking the economies of nations from Venezuela to Nigeria.  To top all that off, the fundamental structure of the bond market has changed in a way that makes it difficult for regulators to gauge exactly where risks are building.  As stresses grow, we believe the probability of an ‘accident’ increases.”

Invesco analyst Rob Waldner, wrote in the firm’s February fixed-income outlook: “The overall environment for risky assets, and particularly for credit, is deteriorating.”  “Oil, which has plunged to below $50 per barrel from $107 in June, may cause more energy companies to default on their billions of dollars of debt than many investors are expecting,” according to UBS analysts.

Major Firms Are Saying the Stage Is Set for Another Crisis in the Bond Market (2-27-15)

The Obama administration wants more regulations and restrictions on brokers who manage retirement accounts.  This is creating another confrontation with the financial services industry over rules affecting trillions of dollars in 401ks and other savings accounts.  The Associated Press wrote, “The change would put brokers — who sell stocks, bonds, annuities and other investments — under the stricter requirements for registered financial advisers when they handle clients’ retirement accounts.”  SEC Commissioner Daniel Gallagher, a critic of the Labor Department proposal, said in a speech Friday, “This is something the nanny state has a hard time comprehending.”  Along with the government IRA plan already in place, keep an eye on the administration as it continues to position itself to get its hands on the estimated $5T in retirement accounts so it can be placed in US debt securities.

Obama to Propose Tighter Restrictions on Retirement Brokers (2-23-15) Associated Press

US Banks are coming under more and more scrutiny and Janet Yellen doubts our largest ones will be able to pass the first stress test.  The Federal Reserve will meet again later this month, but we will not hear about what happened at the meeting until chairman Yellen testifies again at the end of April.  We will continue to watch the events in Russia and Greece.  Putin has an agenda and he doesn’t seem to care about sanctions which are also causing many financial problems for the EU.  Greece has been given a little more time, but most do not expect them to follow through.  So stay tuned and keep watch.  Between now and then you can check out my blog at:

Below are few additional articles of interest.

Fulton Sheen


Fed Officials Voiced Doubts First Bank Stress Test Would Succeed (3-5-15) Yalman Onaran

Yellen Says Effective Supervision of Big Banks One of Fed’s Top Priorities (3-4-15) WSJ

Strange World of Russian Sanctions Levies Uneven Penalties (2-18-15)

Russia Gets Second Junk Rating From Moody’s on Ukraine, Oil (2-20-15)

Germany Rejects Loan Request Saying Greece Must Meet Conditions (2-19-15) Bloomberg Video

Why Austerity Won’t Save Greece (2-19-15) Bloomberg Video

Where is Germany’s Gold? (2-2-15) Bloomberg Report

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