This Phenomenon Can No Longer Be Ignored - That is what ECB policymaker Lorenzo Bini Smaghi said today in a speech in Bologna, Italy. He was referring to "permanent and repeated increases in prices of imported products" and their impact on inflation in advanced countries. These statements highlighted the policy divergence between the U.S. and not only Europe, but the rest of the world, causing the Euro to reach another two month high against the USD. The Euro's gains come after yesterday's Fed statement that gave no indication that it may back away from its loose monetary policy and Tuesday's State of the Union address which further outlined loose fiscal policy. The irony here is that the Fed's QE2 program is causing excess liquidity to flow to the commodity sector, thus the U.S. is exported inflation to the rest of the world. In Asia, the big news was the S&P downgrade of Japan to AA-minus due to the country’s political leaders lack a coherent strategy to address its debt dynamics. This caused the Yen to fall across the board calling into question the Yen's status as a safe-haven currency, boosting the appeal of the USD and the CHF. I think the effect on the Yen will be short lived because firstly, the S&P downgrade simply brings them in line with Fitch, which it cut back in May 2009; and secondly, most of the debt is held domestically so the downgrade will not lead to a bond sell off. Elsewhere, the AUD weakened across the board because the government announced a one-time tax to help pay for damage caused by recent floods. The flood will cost an estimated A$5.6 billion ($5.58 billion) and shave around 0.5% off gross domestic product growth. In Canada, the CAD was little changed despite a rise in risk aversion due to Japan's downgrade and lower oil prices.
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