Bank Credit Analyst

Measures Of Reflation

November 11, 2008

Aside from various spreads, we advise clients to look to gold prices and currency volatilities for evidence that policymakers are winning the battle over debt-deflation.

Additional monetary and fiscal support will be needed before the easing cycle ultimately comes to an end. Still, global policymakers are aggressively pulling out all the stops to shore up both investor and banking sector confidence and limit downside in their various economies (China's announcement of a massive $US586 billion fiscal package was the latest example). Correspondingly, we continue to watch various bond spreads closely for evidence that the credit logjam is starting to unfreeze.

So far, there are encouraging signs that U.S. Libor/OIS spreads have adjusted lower (even at longer maturities), although this measure of banking sector risk has not yet narrowed much throughout Europe and both corporate bond yields and mortgage rates are still near their peaks across the globe. Aside from these conventional measures, we are also watching gold prices and currency volatilities. In our opinion, gold is a great barometer of excess liquidity and a sustained rise across a broad range of currencies would suggest that reflation measures are starting to work.

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Similarly, a dramatic reduction in currency volatility may indicate that we are returning to a world of 'competitive' currency devaluation as policymakers seek external support for weakness in their domestic economies. In this environment, no currency adjusts lower versus the others (an advantage all would be seeking), but significant monetary stimulus is provided, nonetheless.

Bottom line: Further evidence in the weeks ahead that policymakers are finally getting ahead of the curve would prove supportive of risky assets.