In addition to gold, investors began to chase emerging markets. The depreciation of the dollar is taking capital away from the United States. Since the capacity of the US financial market is twice that of all emerging markets combined, this shift has a significant impact on emerging markets. For example, after the Federal Reserve cut interest rates, the Hang Seng Index in Hong Kong rose by about 20%.
Even the US stock market is still strong, with the Dow Jones index and the Standard & Poor's 500 index hitting record highs, despite people's worries about the losses caused by the economic recession and the subprime mortgage crisis. Wall Street financial institutions announced losses. However, despite the bad news, their share price has gone up. The excuse is that the bad news is finally exhausted, which means good for the future. This is almost certainly wrong.
In times of inflation, stocks may not be the best haven. Theoretically, enterprises are all in net debt, so they will benefit from inflation. But inflation will push up bond yields and increase financing costs. In the 1970s, the global stock market was weak. Because the bond market still doesn't believe the story of high inflation, the bond yield is still not high. Both sides of the stock market please: I am afraid that inflation will lead to the transfer of funds to the stock market, and these funds are not expensive. But this situation will not last long.
The weak dollar and the fear of inflation drive investors to take risks. Speculative capital in the global financial system generally enters the market first, then creates violent fluctuations and empties the wallets of other investors. The sharp rise in the stock market after the Federal Reserve cut interest rates on September 18, 2007 was probably driven by speculative capital. As the dollar weakens and inflation intensifies, ordinary investors will also take action. However, they have to face higher prices than a few weeks ago. Speculative capital is like a mobile toll collector. No matter where investors smell their movements, they take the lead in opening positions and then make a fortune before leaving.
The best indicator to observe risk or speculative preference is the euro/yen exchange rate. Because the benchmark interest rate of the European Central Bank is 4%, while that of Japan is 0.5%. As long as the exchange rates of the two currencies remain stable, investors can make profits by borrowing yen to buy euros. When everyone does this, it pushes up the exchange rate of euro/yen. Therefore, bettors can make money from both spreads and exchange differences. This so-called arbitrage transaction attracts a lot of capital. Both the euro and the yen are highly liquid currencies. If the euro/yen exchange rate fluctuates greatly, it means the emergence of large-scale capital.
Since the United States cut interest rates, the exchange rate of the euro against the Japanese yen has risen by more than 10% to 16%. Only two years ago, since the weak dollar entered the minds of investors, euro/yen trading has created most of the profits in the foreign exchange market. The market turned a deaf ear to analysts' optimistic expectations of the yen. People who are optimistic about the yen think it is cheap, but it is still not cheap enough. The carry trade will not end until Japan's interest rate catches up with the euro zone. This is because Japan is experiencing negative population growth and needs to import inflation through a weak currency. When the Japanese yen is cheap enough (such as 160 JPY 1 USD), Japan may experience 2% inflation, and the Bank of Japan will raise the interest rate to 3%, which will prevent carry trade. As long as there is a big inflation gap in major economies such as the United States, the euro zone and Japan, there is room for arbitrage trading.
Speculators always feel that cheap and accessible capital is on their side. The popular saying is that cheap and accessible capital can prevent the United States from falling into recession. I don't agree. The US real estate market is overvalued by $8 trillion. The return of value may require half inflation and half house price decline. The evaporation of a large amount of book wealth will severely hit American consumption, and more debt problems will break out. Credit card debt in the United States is also rising, which supports American consumption. Since the interest rate of credit card loans is at least twice that of housing mortgage loans, this trend is unsustainable. When the credit bubble finally bursts and the debt crisis comes, the source of funds that have been supporting American consumption will be cut off.
If people generally accept the expectation that the American economy will decline in 2008, the risk appetite of the market will be reduced and most of the risky assets will be adjusted. However, inflation and dollar weakness will not end. After the impact of the US recession, financial markets will pay more attention to those "inflation havens", such as gold.
Obviously, when the dollar returns to a strong trend, the weak dollar bubble will end. This will only happen when the yield of US Treasury bonds is enough to reflect inflation expectations, forcing the Fed to raise interest rates again. Therefore, if investors take great risks in the market, such as investing in stocks, commodities and real estate, they must pay close attention to US Treasury bonds and pay attention to the departure signals released by them.