What the Coming Global Tightening of Money Supply Might Mean

Includes: FXB, FXE, UDN
by: Simit Patel

Right now, the world is seeing a fair amount of price inflation. One of the clearest indications of this is the global rise in food prices. This is leading many central banks to consider raising rates. The FT.com emerging markets blog, Beyond BRICs, recently suggested emerging markets will be the most aggressive. And for traders, this is an important question: Which central bank will blink first?

I tend to agree with Beyond BRICs -- I think emerging markets will raise rates first. Brazil already has, the Monetary Authority of Singapore (MAS) has stated a willingness to allow its currency to appreciate, Russia its willingness to allow the ruble to float more freely, and China its desire to have the yuan play a greater role in international trade.

The situation is a bit more uncertain among the major Western central banks -- namely the Bank of England, the Federal Reserve, and the European Central Bank. Based on all the comments thus far, I believe ECB and BOE will tighten monetary policy before the Federal Reserve does. This may lead to bullishness in EURUSD and GBPUSD, although some informed traders have noted the abundance of bearish technical signs on EURUSD in particular -- see here and here. A tightening of monetary policy in the Western world may still be months away, so these views are not necessarily incompatible.

Tightening of monetary policy may have some or all of the following impacts:

  1. Decline in global equities.
  2. Decline in commodities.
  3. Decline in precious metals.
  4. Appreciation of emerging market currencies relative to G4 currencies.

Of the aforementioned items, I consider the last point -- appreciation of emerging market currencies -- to be the most likely scenario.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.