Currency Markets: Beware: Words of Cautionary Wisdom from Glenn Stevens

In a recent speech the Reserve Bank of Australia Governor[1] cautions on following counts:-
(Excerpt Extracts only) 

QUOTE

• Policy rates in the major advanced jurisdictions have been near zero for six years now. In fact, official deposit rates in the euro area and some other European countries are now negative.

• Central bank balance sheets in the three large currency areas have expanded by a total of about US$5½ trillion since 2007, and the ECB and Bank of Japan will add, between them, about another US$2½ trillion to that over the next couple of years.

• Recovering from a financial crisis is an especially long and painful process

• The direct effect of this unprecedented monetary easing has been to lower whole yield curves to extraordinarily low levels, and that process is continuing.

• The most pronounced effects can be seen in Europe. If one were to invest in German government debt for any duration short of nine years, one would be paying the German government to take one’s money. The same can be said for Swiss government debt.

• Even some corporate debt in Europe has traded at negative yields.

• European developments are also affecting long-term interest rates in the United States.

• Fiscal constraints on governments much less binding than they would otherwise have been.

• A striking feature of the global economy, according to World Bank and OECD data, is the low rate of capital investment spending by businesses.
• Listed companies seems to have remained where it has historically been for a long time, even as the return on safe assets has collapsed to be close to zero. This seems to imply that the equity risk premium observed ex post has risen even as the risk-free rate has fallen and by about an offsetting amount. Perhaps this is partly explained by more sense of risk attached to future earnings, and/or a lower expected growth rate of future earnings.

• Whether this is best seen as a temporary increase in risk aversion, a genuine dearth of investment opportunities, evidence of monetary policy “pushing on a string”, a portent of secular stagnation, or just unusually long lags in the effects of policy, will probably be debated for some time yet.
• In capital markets some valuations are stretched, credit spreads are compressed, there has been significant cross-border capital flow and liquidity may be less available than investors are assuming. That raises the risk that a sell-off, were it to occur, could be abrupt.
• What might trigger such an event? The usual trigger people have in mind is a rise in US interest rates.   
• Growth has already weakened in some economies, several of which have been bruised by falling commodity prices. Capital that flowed into emerging markets could flow out again, perhaps when interest rates begin to rise in the United States.
• That would probably occur alongside an appreciating US dollar. So the distribution of credit risk and foreign currency risk will be of considerable importance. One can easily see why investors could become less forgiving of borrowers on a shaky footing, be they corporates or sovereigns.
• A complicating factor here is that the rise in US interest rates looks set to occur while the central banks of Japan and Europe are continuing an aggressive easing of monetary policy via balance sheet measures.
• The combined Japanese and European “QE” will be very substantial.  

UNQUOTE

Author's Comment: Exhortation to buy the US Dollar? 

Without any risk or responsibility 

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[1] Address by Mr Glenn Stevens, Governor of the Reserve Bank of Australia, to the American Australian Association luncheon, hosted by Goldman Sachs, New York City, 21 April 2015.
Source: Reserve Bank of Australia