Inflation Drives a Shift in Markets..... April 9 article...

• APRIL 9, 2011

Inflation Drives a Shift in Markets

By TOM LAURICELLA And JUSTIN LAHART

After being pushed and pulled this year by tumult in the Middle East and the quake in Japan, the world's financial markets are increasingly being driven by economic fundamentals, including inflation and interest rates.

The winners in the shift have been precious metals and emerging-market currencies such as the Brazilian real and the Korean won—a sign of the growing split between healthier and still-sluggish quarters of the global economy such as Japan, the U.S. and parts of Europe.

The shift is roiling markets around the world. Several currencies and precious metals hit all-time or multiyear highs Friday. Some Asian governments intervened in the currency markets on two different days this week, buying billions of dollars to drive down the value of their soaring currencies, traders said.

Gold hit a new record and posted its biggest weekly gain in a year. Silver closed above $40 an ounce Friday for the first time in 31 years and has more than doubled over the past year.

Rising inflation is a key factor driving the emerging market currencies and precious metals. "For the longest time, people were concerned that inflation would start to build to levels where central banks are moved into action," says Mark Enman, head of global trading at Man Investments (USA) LLC. "That point was somewhere on the horizon, and now the horizon is here."

Investors who believe inflation can be tamed are buying currencies in countries where central banks are raising interest rates to control prices. So far this year, central banks in at least 18 developing economies have raised interest rates, according to RBC Capital Markets. That diverse list includes China, which raised rates this past week, along with Israel, Poland and Uruguay. Brazil and India were virtually alone in raising rates last year.

Those higher rates make the currencies more attractive, leading to big flows of capital into those countries. Brazil, after months of fighting the tide of money into the country, this week allowed its currency to rise sharply to help its own fight against inflation. Other central banks, especially in Asia, continue to battle investors who are bidding up the value of their currencies in order to protect the competitiveness of export industries.

The impact of rates was a focus this week when the European Central Bank raised interest rates by one-quarter of a percentage point, becoming the first central bank among the world's three major currencies to boost rates. The euro rose just over 1% against the dollar Friday, its biggest one-day gain since the start of the year, and is up 1.65% over the past week.

Bloomberg News

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• Asian Central Banks Intervene as Currencies Rise

The U.S. currency also lost 1.4% against the Australian dollar and was even weaker against the Brazilian real, falling 2.7%.

The moves in gold and currencies come as economic officials are about to convene in Washington late next week for the annual spring meetings of the International Monetary Fund and World Bank. Officials from the Group of Seven developed economies meet Thursday, and the broader Group of 20 talks Friday.

High on the agendas is how the rest of the world will help Egypt and Tunisia revamp their economies. But currencies are always part of the conversation in these meetings, both in private and public comments. The wording of communiques is seen by officials and markets as a way for governments to send smoke signals to investors and to pressure each other.

The dollar and yen are weakening against nearly all global currencies because the relatively slow economic recoveries of America and Japan mean their central banks are unlikely to raise interest rates in coming months. After spiking to a record high after last month's Japanese earthquake, the yen has fallen more than 5% against the dollar in the past three weeks—a significant move for a major currency—and fell more against other currencies.

U.S. investors are worried about the Federal Reserve's "quantitative easing" plan of bond buying, which ends in June. In anticipation of lower demand for bonds from the Fed, they have been driving up the yields on U.S. Treasurys, which rose to their highest level in a month. The possible shutdown of the U.S. government over the budget impasse added to the anxiety.

The past few weeks have been a contrast to previous months, when worries about the European governments defaulting on their debts or of upheaval in Middle Eastern countries had assets moving in lock-step. When fear was the prevailing emotion, the dollar rose, and when investors were less worried, riskier assets ranging from the euro to oil to stocks took off.

Now, all different assets are moving based on their own fundamentals. U.S. stocks have continued to rise—even as the dollar sinks—because American corporations are profitable, strong and growing.

—Carolyn Cui and Matt Whittaker contributed to this article.

Write to Tom Lauricella at tom.lauricella@wsj.com and Justin Lahart at justin.lahart@wsj.com

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