MarketWatch: November 8-12, 2010

Domestic and global financial markets are being driven by major cross-currents once again.

On the home front, dust is still settling in the markets from the Fed’s announcement last week that it would launch its second round of quantitative easing (QE2, its purchase of large amounts of government debt to stimulate the economy). Earlier this week, the New York Fed announced its QE2 purchase plans for the near future: the Fed plans to be in the markets nearly every day. Stay tuned.

The Fed’s decision is also having a global impact. The dollar depreciated as global investors adjusted portfolios toward higher yielding currencies in response to the change in monetary policy stance by the Fed relative to that of other countries’ central banks. (Relatively higher yields elsewhere reflected relative strength of those economies and the tightening or neutral stance of their central banks.)

As we saw in the run-up to the G-20 meeting in Korea this week (the Group of 20 consists of the world’s major economies), the shift in the dollar’s direction highlighted existing fault lines within the G-20. After the Fed’s announcement, capital surplus countries like China started to receive increased capital inflows – and they were already considered at risk of overheating by many experts. Fears of destabilizing capital flows into their countries as the US tries to avoid deflation is a major factor behind G-20 battles.

If all this wasn’t enough, the fiscal situation in Ireland spilled over into US and global capital markets. For the dollar, this meant that safe haven sentiment returned yesterday and the dollar gained against the euro.

Yesterday’s play reflected the turn of market sentiment against Ireland and the euro, due to increasing doubts over the Irish government’s ability to manage its debt and the EU’s still pending debt crisis resolution mechanism and fund. Like Greece, Ireland has been increasingly forced to recognized additional – and large – debt problems. For Ireland, the problem is the banks, which – like US banks - were overleveraged in housing. Markets do not like uncertainty, and the government’s credibility is at stake.

Today, EU leaders announced that any bailout fund charges would only affect future investors. The eurozone still has not finalized its fiscal reform plan in reaction to the Greek situation, as the EU legislative wheels turn very slowly. Today, safe haven plays toward the dollar may recede with EU finance leader clarification that investors in bonds purchased through mid-2013 would not be forced to take a hit if the eurozone needs to step in to resolve an Irish (or, presumably, other EU country) financial crisis. Effects on Treasuries have been mixed, with safe haven–related effects diminishing this morning and markets turning their focus to the Fed’s purchases.