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Fed and ECB - A World Apart

Interest-Rates / US Interest Rates Mar 04, 2011 - 11:18 AM GMT

By: Axel_Merk

Interest-Rates

The U.S. Federal Reserve (Fed) and the European Central Bank (ECB) are divided by a common goal: price stability. Fed Chairman Bernanke has made it clear in his recent testimony and speeches that the Fed would react should food and commodity inflation lead to an increase in core inflation. Let's spell this out: the Fed is ready to R E A C T. We are not aware of any central bank that is proud of reacting, but rather acting preemptively to mitigate inflationary concerns; naturally, a central bank may often be forced to react, but to do so by design puts the cynical view that central bankers are too far behind the curve into a new light.


In contrast, in Thursday's press conference, the ECB President Trichet said "risks to the outlook for price developments are on the upside;" and that it "is paramount that the rise in [..] inflation does not lead to second-round effects." He then clarified that the ECB is "in a posture of strong vigilance," and that based on past experience, this suggests an increase in interest rates at the next meeting is possible. Indeed, in ECB parlance, "strong vigilance" has all but once been a codeword for an upcoming rate hike.

Given the most recent developments, the jump in the euro versus the U.S. dollar should not be a surprise, and may be exactly what Bernanke is trying to achieve. Bernanke, unlike his predecessor, embraces the discussion surrounding the dollar. Indeed, we believe Bernanke considers the U.S. dollar a monetary policy tool. Our assessment is based on both words and action by the Fed Chair. Bernanke has argued:

  • Going off the gold standard allowed the U.S. to recover faster from the Great Depression than other countries. Our interpretation: if you devalue your currency, you may boost growth. Note that someone has to be on the other side of the trade: the Eurozone in particular may have lackluster growth because less money is being printed, but a stronger currency.
  • Bernanke believes a weaker dollar may not be inflationary. We strongly disagree and point to the rise in the cost of import prices in the spring of 2008 that went well beyond the soaring price of oil and commodities at the time. Bernanke, however, points to work done by the staff at the Fed highlighting that, in the past, a weaker dollar has not necessarily been inflationary.
  • Bernanke puts his words into actions by purchasing government securities. Those securities are now intentionally over-valued, signaling to rational investors to take their money abroad. As a result, when a central bank aggressively buys government debt, it tends to weaken a currency.

The divergence between the Fed and the ECB has long been in the making. Finally, the market is starting to embrace reality.

Ensure you sign up for our newsletter to stay informed as these dynamics unfold. We manage the Merk Absolute Return Currency Fund, the Merk Asian Currency Fund, and the Merk Hard Currency Fund; transparent no-load currency mutual funds that do not typically employ leverage. To learn more about the Funds, please visit www.merkfunds.com.

By Axel Merk

Manager of the Merk Hard, Asian and Absolute Return Currency Funds, www.merkfunds.com

Axel Merk, President & CIO of Merk Investments, LLC, is an expert on hard money, macro trends and international investing. He is considered an authority on currencies. Axel Merk wrote the book on Sustainable Wealth; order your copy today.

The Merk Absolute Return Currency Fund seeks to generate positive absolute returns by investing in currencies. The Fund is a pure-play on currencies, aiming to profit regardless of the direction of the U.S. dollar or traditional asset classes.

The Merk Asian Currency Fund seeks to profit from a rise in Asian currencies versus the U.S. dollar. The Fund typically invests in a basket of Asian currencies that may include, but are not limited to, the currencies of China, Hong Kong, Japan, India, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Taiwan and Thailand.

The Merk Hard Currency Fund seeks to profit from a rise in hard currencies versus the U.S. dollar. Hard currencies are currencies backed by sound monetary policy; sound monetary policy focuses on price stability.

The Funds may be appropriate for you if you are pursuing a long-term goal with a currency component to your portfolio; are willing to tolerate the risks associated with investments in foreign currencies; or are looking for a way to potentially mitigate downside risk in or profit from a secular bear market. For more information on the Funds and to download a prospectus, please visit www.merkfunds.com.

Investors should consider the investment objectives, risks and charges and expenses of the Merk Funds carefully before investing. This and other information is in the prospectus, a copy of which may be obtained by visiting the Funds' website at www.merkfunds.com or calling 866-MERK FUND. Please read the prospectus carefully before you invest.

The Funds primarily invest in foreign currencies and as such, changes in currency exchange rates will affect the value of what the Funds own and the price of the Funds' shares. Investing in foreign instruments bears a greater risk than investing in domestic instruments for reasons such as volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. The Funds are subject to interest rate risk which is the risk that debt securities in the Funds' portfolio will decline in value because of increases in market interest rates. The Funds may also invest in derivative securities which can be volatile and involve various types and degrees of risk. As a non-diversified fund, the Merk Hard Currency Fund will be subject to more investment risk and potential for volatility than a diversified fund because its portfolio may, at times, focus on a limited number of issuers. For a more complete discussion of these and other Fund risks please refer to the Funds' prospectuses.

This report was prepared by Merk Investments LLC, and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute investment advice. Foreside Fund Services, LLC, distributor.

Axel Merk Archive

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