The Fed Effect – Impacting The Value Of Currencies And Assets Across The World

Fed speak seems to impact the value of currencies and assets across the world! With the US economy continuing to be sluggish, the US Fed seems to be all set to take further measures to stimulate the US economy. The Fed seems to be in the mood to undertake quantitative easing by purchasing government paper. Quantitative easing is likely to lead to an increase in the money supply in the economy. More money chasing less goods or the same number of goods will put an upward pressure on prices. This measure is likely to reduce the chances of deflation setting in, something that has been haunting the US economy for some time. Pumping in more money into the economy is also likely to put a downward pressure on interest rates, which can help grease the wheels of the economy by making loans for investments and other purposes cheaper.

The Fed’s move though aimed at propping the US economy is impacting the values of currencies and other assets across the globe. The quantitative easing and an increase in the money supply means the value of the US dollar vis-à-vis other currencies should drop. The same would be true as the US interest rates ease. On the other hand, lower interest rates should fuel investment and galvanize the US economy. This should increase demand in the US economy and as the US is the largest importer in the world, production in other parts of the world should receive a boost.

The Fed announcement seems to have had exactly the same effect. The Canadian dollar strengthened against the US dollar and came close to parity. The Euro and the Yen also strengthened against the greenback. At the same time the Toronto Stock Exchange moved up led by commodity stocks on the expectation of increasing demand from the US. There was a twin effect here, with the commodity prices firming up due to a weaker US dollar and the expectation that the demand for commodities would increase due to the fresh stimulus in the US, both of which affected prices of commodity stocks. Similar was the effect on the Tokyo Stock Exchange, with select stocks including that of commodities and car makers strengthening.

The Fed’s move to stimulate the economy is in the face of expectations that it could slip back into recession if left to itself. The move of quantitative easing also implies that the Fed is signaling a weaker dollar regime. A weaker dollar should make exports from the US cheaper and prop the US industry. However, a massive quantitative easing program could make it difficult for the US to reverse the process quickly, once the economy picks up, and is likely to result in a subdued US dollar in the medium term. As and when the US economy picks up and the US Fed starts to reverse its monetary policy stance and sucks out liquidity from the economy the dollar should begin to stabilize and move upwards. However, how quickly this will happen is an answer that has been elusive, with the US economy remaining sluggish for an elongated period of time. Hopefully, an early turnaround in the economy should bring cheer to the dollar and the global economy in general.