Fed's Treasurys Purchase to Impact Stocks This Week

A significantly different market landscape greets investors this week, courtesy of the Federal Reserve's decision to buy up Treasurys.

Oliver Quillia for CNBC.com The New York Stock Exchange

For one thing, market players will have to deal with a rapidly declining dollar. For another, commodities have started rising for the first time in nine months.

If that is not enough, equities have been putting in a rally that had the MSCI all-country world stock index flirting last week with its best monthly gain in a decade.

It has prompted researchers at Swiss bank UBS to recommend increasing exposure to so-called risk assets, in this case, Asian and Japanese equities and U.S. high-yield bonds.

The catalyst for much of the change was the Fed's move last week to purchase U.S. Treasuries and agency debt-- a so-called quantitative easing, or QE, that pumps money into the system without an interest rate cut.

"(It) should help to reduce economy-wide financing costs and moderate some of the more pernicious de-leveraging pressures. It is no "silver bullet', but a useful step nonetheless," the UBS researchers said.

The Fed is not alone. The Bank of England said last week it was going to buy corporate bonds on top of its purchases of gilts, and the Bank of Japan has been conducting QE for some time.

Eyes will be on the European Central Bank now to see if it too will start buying assets.

For financial markets, it is all about inflating the economy and unleashing money that has been held back by cautious commercial banks and nervous investors.

"Commodity prices ... are signalling a return of inflation over the long term," said Sarah Hewin, senior economist at Standard Chartered, "suggesting that people thing that quantitative easing is going to work ultimately."

The Reuters-Jefferies CRB index, a global commodities benchmark, gained more than 5 percent the day after the Fed's move and is working on its first positive month since June.

Dollar Doldrums

Perhaps the biggest change that investors will have to come to grips with this week is a newly weakening dollar.

After climbing for much of the year, the U.S. currency has been hit by a huge sell-off as a result of the Fed move and its implications for riskier global assets.

The dollar index, which tracks the greenback against a basket of major currencies such as the euro and yen, had one of its biggest weekly slides in decades, at one point testing the steepest slide since 1973 before recovering.

In an interview with Reuters Insider television last week, strategists Jeremy Stretch at Rabobank and Ashraf Laidi of CMC Markets both said they expected the dollar to continue weakening over the medium term. For example, they saw the euro strengthening to $1.38, compared with Friday's $1.36, and then perhaps rising to $1.40.

But beyond giving currency investors a new trend to deal with, a weakening dollar may also upset a number of other markets. U.S. assets such as those on Wall Street, for example, become less attractive to investors when the dollar is falling.

U.S. investors also may find rising currencies abroad bring them back to overseas assets.

Emerging market stocks, for example, are expected to benefit. They have already risen more than 10 percent this month.

The weak dollar, meanwhile, is providing a longer-term worry to many countries because of its role as the world's reserve currency, held by central banks. It has been the most convincing store of value, but this is now changing.

A panel of experts is expected to recommend to the United Nations this week that the world shift to use a basket of currencies as the global reserve. There will be no change in anything like the short term, but the mere fact it is being discussed points to the greenback's current weakness.

Bear or Bull?

For many investors, however, the big question remains whether world stock markets have reached the bottom and are now headed for a new bull market. The trend has begun to be positive, not just because of the gains of recent weeks but also because stocks appear cheap.

Financial services group State Street, for example, calculates that U.S. stocks have been cheaper in terms of the price-to-earnings ratio on only five occasions dating back to 1870.

They include the nineteenth century Long Depression, the aftermaths of the World War One and Two, and the Great Depression.

Such valuations, along with the commitment of the Fed and others to pump money into the system, have turned some investors--UBS , for one--more bullish.

But it all remains bracketed by caution. Global stock as measured by MSCI rose nearly 27 percent between December and January, only to see it all wiped out to a new low.

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