The Plan for the Chairman’s Succession

The markets are starting to question
The plan for the Chairman’s succession
Is Yellen the plan?
Or Summers the man?
Regardless, we’ll get indigestion

It seems that my thoughts on Friday were prescient as the payroll data was better than forecast and the dollar rallied while the bond market fell sharply. Equities performed well, but as we head into earnings season and the market starts to accept the idea that the Fed is not going to print money forever, I wonder if they can maintain their gains. In fact, I am short the market (long the SDS) as I believe recent equity performance has been entirely based on the Fed’s QE process. Once that goes, it is not clear to me that equities represent such a good value at current levels.

Now, back to FX. This morning the dollar is modestly weaker against the major currencies, but that is merely a reaction to Friday’s sharp gains. The euro has found support at the 1.2800-1.2850 level for now, but I expect that to give way this week. While the weekend press was not terribly exciting, the information at hand was how difficult things were in Portugal and how Greece is back at the end of its financing abilities. As I type, the Troika is meeting in Brussels to determine if the next tranche of Greek aid should be released despite the fact that the Greeks have not met their deficit cutting goals; not reduced the government payroll by the requisite amount; nor been able to generate anywhere near the expected value in asset sales. In other words, the Greeks have failed to show the ability to remain on the bailout program. But I am sure that within hours, the Troika will release the funds while saying something like, ‘Greece has shown it is on track to pass the programs necessary to continue the economic corrections within the nation’ or some such nonsense as that. It has become abundantly clear that until the German elections in September, Chancellor Merkel has instructed everyone to prevent any problems from becoming visible. So the question really is, will the ECB and Troika be able to prevent the next flare-up of economic tragedy for almost 3 months? I am not so sure, and if I am right, then the euro will be much lower sometime soon. I think the risks are highly asymmetric here, with only a potential modest rally if things work out well and a significant decline if things go pear-shaped. I bring this up for the benefit of euro receivables hedgers, as my concern remains that the euro has much further to go during the rest of 2013. A move toward 1.20 or below is not out of the question at this point. Remember, ECB President Draghi promised no tightening for a very long time, which will be quite the contrast to the FOMC. And real US 10 year yields are up near 1.7%, the highest in the G4 nations, which adds to the attractiveness of the dollar as an investment.

In Japan, campaigning for the Upper House election is in full swing and the polls are showing that PM Abe and the LDP are leading handily. While in May his announcement of the third arrow was a disappointment, if he captures the Upper House and the LDP controls the entire legislative branch of government, I expect that we will see more aggressive actions on his part resulting in the next wave of yen weakness. Spot is little changed today and USDJPY remains about 2% below the highs we saw in May, but as I have written several times, once the election is past, I expect the next leg of yen weakness to manifest itself. This should take us through 105 and it is not unreasonable to see 110 by autumn. Certainly my call for 110 in December remains right on track.

The story in China is one of analysts and economists trying to determine if the PBoC’s recent liquidity actions are going to be beneficial in the long run, and perhaps even more importantly, if Premier Li’s plans to rebalance the economy toward more consumption are going to work while maintaining the 7.5% pace of GDP growth currently forecast. Personally I doubt he will be able to do both. My sense is that Li believes the rebalancing of the economy is a critical long term goal, and that if growth suffers for a period in the interim, he will accept that. I read of one economist calling for 6.0% GDP growth in China in 2014. That would be a significant adjustment for China as well as for global markets, notably commodities. While I do not believe they would report such a low number, simply the fact that analysts are thinking that way indicates a sea change in the underlying views of the market. It was always impossible to believe that an economy as large as China’s could grow at an 8%-10% pace for any extended period of time. It appears to me that China is going to start behaving more like a developed nation than an emerging one in terms of growth rate. Keep that in mind when looking for global engines of growth.

Today there is no US data of note and this week brings very little of consequence on the data front. So, earnings and foreign stories will be the key drivers, as well as the ongoing discussion as to who will replace Bernanke in January. While Yellen remains the odds on favorite, apparently, Larry Summers is making a push. Either way, an uber dove is likely to be in the chair.

Good luck
Adf