Change Can Come Fast

There once was a market that soared
With tech stocks quite widely adored
The Fed, for eight years
Suppressed any fears
And made sure that rates were kept floored

But nothing, forever, can last
Now ZIRP and QE’s time has passed
Investors are frightened
‘Cause Powell has tightened
Beware because change can come fast!

Many of you will have noticed that equity markets sold off sharply in the past twenty-four hours, and that as of now, it appears there is more room to run in this correction. The question in situations like these is always, what was the catalyst? And while sometimes it is very clear (think Brexit or the Lehman bankruptcy) at other times movements of this nature are simply natural manifestations of a very complex system. In other words, sometimes, and this appears to be one of them, markets simply move because a confluence of seemingly minor events all occur at the same time. Trying to ascribe the movement to yesterday’s PPI reading, or comments from the IMF meetings, or any other specific piece of information is unlikely to be satisfying and so all I will say is that sometimes, markets move further than you expect.

Consider, though, that by many measures equity prices, especially in the US, are extremely richly valued. Things like the Shiller CAPE, or the Buffet idea of total market cap/GDP both show recent equity market levels at or near historic highs. And while the tax cuts passed into law for 2018 have clearly helped profitability this year, 2019 comparisons will simply be that much tougher to meet. There are other situations regarding the market that are also likely having an impact, like the increase in algorithmic trading, the dramatic increase in passive indexing and the advent of risk parity strategies. All of these tended to lead to buying interest in the same group of equities, notably the tech sector, which has been the leading driver of the stock market’s performance. If these strategies are forced to sell due to investor withdrawals, they will do so with abandon (after all, they tend to be managed by computer programs not people, and there is no emotion involved at all) and we could see a substantial further decline. Something to keep in mind.

But how, you may ask, is this impacting the FX markets? Interestingly, the dollar is not showing any of its risk-off tendencies through this move. In fact, it has fallen against almost all counterpart currencies. And while in some cases, there is a valid story that has nothing to do with the dollar per se, in many cases, it appears that this is simply dollar weakness. For example, the euro has rallied 0.5% this morning, after a 0.25% gain yesterday. Part of this has been driven by modestly higher than expected inflation data from several Eurozone countries (Spain and Ireland) while there is likely also a benefit from the story that the Brexit negotiations seem to be moving to a conclusion. However, despite the positive Brexit vibe, the pound has only managed a 0.15% rise this morning. The big winner in the G10 space has been Sweden, where the krone has rallied 1.5% after it also released higher than expected CPI data (2.5%) and the market has priced in further tightening by the Riksbank.

Looking at the EMG space, the dollar has fallen very consistently here, albeit not universally. We haven’t paid much attention to TRY lately, but it has rallied 1.4% today, and 5.5% in the past month. While yesterday they did claim to create some measures to help address the rising inflation there, they appear fairly toothless and I suspect the lira’s recent strength has more to do with the market correcting a massive decline than investor appetite for the currency. But all of the CE4 are rallying today, albeit in line with the euro’s 0.5% move, and there have been no stories of note from the region.

Looking to APAC, the movement has actually been far less pronounced with THB the best performer, rising 0.7% but the rest of the space largely trading within 0.2% of yesterday’s close. In other words, there is no evidence that, despite a significant decline in equity markets throughout the region, that risk-off sentiment has reached dramatic proportions. Now, if equity markets continue their sharp decline today, my best guess is that we will see a bit more activity in the currency markets, likely with the dollar the beneficiary.

Finally, LATAM currencies have had a mixed performance, with MXN rising 0.5% this morning, but BRL having fallen more than 1% on news that the mooted finance minister for Jair Bolsonaro (assuming he wins the second round election) is being investigated for corruption.

Turning to this morning’s session, the key data point of the week is released, with CPI expected to have declined to 2.4% in September (from 2.7%) and the core rate to have risen to 2.3%, up from August’s reading of 2.2%. With every comment from a Fed speaker focused on the idea of continuing to increase Fed Funds until they reach neutral, this data has the opportunity to have a real impact. If the release is firmer than expected, look for bonds to suffer, equities to suffer more and the dollar to find support. However, if this data is weak, then I would expect that the dollar could fall further, maybe back toward the bottom of its recent range, while the equity market finds some support as fears of an overly tight Fed dissipate.

So there is every opportunity for some more market fireworks today. As I believe that inflation remains likely to continue rising, especially based on the anecdotal evidence of rises in wages, I continue to see the dollar finding support. Of course, that doesn’t speak well of how the equity market is likely to perform if I am correct.

Good luck
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Still Under Stress

As traders are forced to assess
A bond market still under stress
Today’s jobs report
Might be of the sort
That causes some further regress

Global bond markets are still reeling after the past several sessions have seen yields explode higher. The proximate cause seems to have been the much stronger data released Wednesday in the US, where the ADP Employment and ISM Non-Manufacturing reports were stellar. Adding to the mix were comments by Fed Chairman Powell that continue to sing the praises of the US economy, and giving every indication that the Fed was going to continue to raise rates steadily for the next year. In fact, the Fed funds futures market finally got the message and has now priced in about 60bps of rate hikes for next year, on top of the 25bps more for this year. So in the past few sessions, that market has added essentially one full hike into their calculations. It can be no surprise that bond markets sold off, or that what started in the US led to a global impact. After all, despite efforts by some pundits to declare that the ECB was the critical global central bank as they continue their QE process, the reality is that the Fed remains top of the heap, and what they do will impact everybody else around the world.

Which of course brings us to this morning’s jobs data. Despite the strong data on Wednesday, there has been no meaningful change in the current analyst expectations, which are as follows:

Nonfarm Payrolls 185K
Private Payrolls 180K
Manufacturing Payrolls 12K
Unemployment Rate 3.8%
Participation Rate 62.7%
Average Hourly Earnings (AHE) 0.3% (2.8% Y/Y)
Average Weekly Hours 34.5
Trade Balance -$53.5B

The market risk appears to be that the release will show better than expected numbers today, which would encourage further selling in Treasuries and continuation of the cycle that has driven markets this week. What is becoming abundantly clear is that the Treasury market has become the pre-eminent driver of global markets for now. Based on the data we have seen lately, there is no reason to suspect that today’s releases will be weak. In fact, I suspect that we are going to see much better than expected numbers, with a chance for AHE to touch 3.0%. Any outcome like that should be met with another sharp decline in Treasuries as well as equities, while the dollar finds further support.

Away from the payroll data, there have been other noteworthy things ongoing around the world, so lets touch on a few here. First, there is growing optimism that with the Tory Party conference now past, and PM May still in control, that now a Brexit deal will be hashed out. One thing that speaks to this possibility is the recent recognition by Brussels that the $125 trillion worth of derivatives contracts that are cleared in London might become a problem if there is no Brexit deal, with payment issues needing to be sorted, and have a quite deleterious impact on all EU economies. As I have maintained, a fudge deal was always the most likely outcome, but it is by no means certain. However, today the market is feeling better about things and the pound has responded by rallying more than a penny. The idea is that with a deal in place, the BOE will have the leeway to continue raising rates thus supporting the pound.

Meanwhile, stronger than expected German Factory orders have helped the euro recoup some of its recent losses with a 0.25% gain since yesterday’s close. But the G10 has not been all rosy as the commodity bloc (AUD, NZD and CAD) are all weaker this morning by roughly 0.4%. Other currencies under stress include INR (-0.6%) after the RBI failed to raise interest rates as expected, although they explained there would be “calibrated tightening” going forward. I assume that means slow and steady, but sounds better. We have also seen further pressure on RUB (-1.3%) as revelations about Russian hacking efforts draw increased scrutiny and the idea of yet more sanctions on the Russian economy make the rounds. ZAR (-0.75%) and TRY (-2.0%) remain under pressure, as do IDR (-0.7%) and TWD (-0.5%), all of which are suffering from a combination of broad dollar strength and domestic issues, notably weak financial situations and current account deficits. However, there is one currency that has been on a roll lately, other than the dollar, and that is BRL, which is higher by 3.4% in the past week and 8.0% since the middle of September. This story is all about the presidential election there, where vast uncertainty has slowly morphed into a compelling lead for Jair Bolsonaro, a right-wing firebrand who is attacking the pervasive corruption in the country, and also has University of Chicago trained economists as his financial advisors. The market sees his election as the best hope for market-friendly policies going forward.

But for today, it is all about payrolls. Based on what we have heard from Chairman Powell lately, there is no reason to believe that the Fed is going to adjust its policy trajectory any time soon, and if they do, it is likely only because they need to move tighter, faster. Today’s data could be a step in that direction. All of this points to continued strength in the dollar.

Good luck and good weekend
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Goldilocks Ain’t Dead Yet

The Chairman said, no need to fret
Our low unemployment’s no threat
To driving up prices
And so my advice is
Relax, Goldilocks ain’t dead yet

Chairman Powell’s message yesterday was that things were pretty much as good as anyone could possibly hope. The current situation of unemployment remaining below every estimate of NAIRU while inflation remains contained is a terrific outcome. Not only that, there are virtually no forecasts for inflation to rise meaningfully beyond the 2.0% target, despite the fact that historically, unemployment levels this low have always led to sharper rises in inflation. In essence, he nearly dislocated his shoulder while patting himself on the back.

But as things stand now, he is not incorrect. Measured inflationary pressures remain muted despite consistently strong employment data. Perhaps that will change on Friday, when the September employment report is released, but consensus forecasts call for the recent trend to be maintained. Last evening’s news that Amazon was raising its minimum wage to $15/hour will almost certainly have an impact at the margin given the size of its workforce (>575,000), but the impact will be muted unless other companies feel compelled to match them, and then raise prices to cover the cost. It will take some time for that process to play out, so I imagine we won’t really know the impact until December at the earliest. In the meantime, the Goldilocks economy of modest inflation and strong growth continues apace. And with it, the Fed’s trajectory of rate hikes remains on track. The impact on the dollar should also remain on track, with the US economy clearly still outpacing those of most others around the world, and with the Fed remaining in the vanguard of tightening policy, there is no good reason for the dollar to suffer, at least in the short run.

However, that does not mean it won’t fall periodically, and today is one of those days. After a weeklong rally, the dollar appears to be consolidating those gains. The euro has been one of today’s beneficiaries as news that the Italian government is backing off its threats of destroying EU budget rules has been seen as a great relief. You may recall yesterday’s euro weakness was driven by news that the Italians would present a budget that forecast a 2.4% deficit, well above the previously agreed 1.9% target. The new government needs to spend a lot of money to cut taxes and increase benefits simultaneously. But this morning, after feeling a great deal of pressure, it seems they have backed off those deficit forecasts for 2020 and 2021, reducing those and looking to receive approval. In addition, Claudio Borghi, the man who yesterday said Italy would be better off without the euro, backed away from those comments. The upshot is that despite continued weakening PMI data (this time services data printed modestly weaker than expected across most of the Eurozone) the euro managed to rally 0.35% early on. Although in the past few minutes, it has given up those gains and is now flat on the day.

Elsewhere the picture is mixed, with the pound edging lower as ongoing Brexit concerns continue to weigh on the currency. The Tory party conference has made no headway and time is slipping away for a deal. Both Aussie and Kiwi are softer this morning as traders continue to focus on the interest rate story. Both nations have essentially promised to maintain their current interest rate regimes for at least the next year and so as the Fed continues raising rates, that interest rate differential keeps moving in the USD’s favor. It is easy to see these two currencies continuing their decline going forward.

In the emerging markets, Turkish inflation data was released at a horrific 24.5% in September, much higher than even the most bearish forecast, and TRY has fallen another 1.2% on the back of the news. Away from that, the only other currency with a significant decline is INR, which has fallen 0.65% after a large non-bank lender, IL&FS, had its entire board and management team replaced by the government as it struggles to manage its >$12 billion of debt. But away from those two, there has been only modest movement seen in the currency space.

One of the interesting things that is ongoing right now is the fact that crude oil prices have been rallying alongside the dollar’s rebound. Historically, this is an inverse relationship and given the pressure that so many emerging market economies have felt from the rising dollar already, for those that are energy importers, this pain is now being doubled. If this process continues, look for even more anxiety in some sectors and further pressure on a series of EMG currencies, particularly EEMEA, where they are net oil importers.

Keeping all this in mind, it appears that today is shaping up to be a day of consolidation, where without some significant new news, the dollar will remain in its recent trading range as we all wait for Friday’s NFP data. Speaking of data, this morning brings ADP Employment (exp 185K) and ISM Non-Manufacturing (58.0), along with speeches by Fed members Lael Brainerd, Loretta Mester and Chairman Powell again. However, there is no evidence that the Fed is prepared to change its tune. Overall, it doesn’t appear that US news is likely to move markets. So unless something changes with either Brexit or Italy, I expect a pretty dull day.

Good luck
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Too Arcane

The Fed took the time to explain
Why ‘Neutral’ they’ll never attain
Though theories suppose
O’er that rate, growth slows
Its measurement is too arcane

If one needed proof that Fed watching was an arcane pastime, there is no need to look beyond yesterday’s activities. As universally expected, the FOMC raised the Fed funds rate by 25bps to a range of 2.00% – 2.25%. But in the accompanying statement, they left out the sentence that described their policy as ‘accommodative’. Initially this was seen as both surprising and dovish as it implied the Fed thought that rates were now neutral and therefore wouldn’t need to be raised much further. However, that was not at all their intention, as Chairman Powell made clear at the press conference. Instead, because there is an ongoing debate about where the neutral rate actually lies, he wanted to remove the concept from the Fed’s communications.

The neutral rate, or r-star (r*) is the theoretical interest rate that neither supports nor impedes growth in an economy. And while it makes a great theory, and has been a linchpin of Fed models for the past decade at least, Chairman Powell takes a more pragmatic view of things. Namely, he recognizes that since r* cannot be observed or measured in anything like real-time, it is pretty useless as a policy tool. His point in removing the accommodative language was to say that they don’t really know if current policy is accommodative or not, at least with any precision. However, given that their published forecasts, the dot plot, showed an increase in the number of FOMC members that are looking for another rate hike this year and at least three rate hikes next year, it certainly doesn’t seem the Fed believes they have reached neutral.

The market response was pretty much as you would expect it to be. When the statement was released, and initially seen as dovish, the dollar suffered, stocks rallied and Treasury prices fell in a classic risk-on move. However, once Powell started speaking and explained the rationale for the change, the market reversed those moves and the dollar actually edged higher on the day, equity markets closed lower and Treasury yields fell as bids flooded the market.

In the end, there is no indication that the Fed is slowing down its current trajectory of policy tightening. While they have explicitly recognized the potential risks due to growing trade friction, they made clear that they have not seen any evidence in the data that it was yet having an impact. And given that things remain fluid in that arena, it would be a mistake to base policy on something that may not occur. All told, if anything, I would characterize the Fed message as leaning more hawkish than dovish.

So looking beyond the Fed, we need to look at everything else that is ongoing. Remember, the trade situation remains fraught, with the US and China still at loggerheads over how to proceed, Canada unwilling to accede to US demands, and the ongoing threat of US tariffs on European auto manufacturers still in the air. As well, oil prices have been rallying lately amid the belief that increased sanctions on Iran are going to reduce global supply. There is the ongoing Brexit situation, which appears no closer to resolution, although we did have French President Macron’s refreshingly honest comments that he believes the UK should suffer greatly in the process to insure that nobody else in the EU will even consider the same rash act as leaving the bloc. And the Italian budget spectacle remains an ongoing risk within the Eurozone as failure to present an acceptable budget could well trigger another bout of fear in Italian government bonds and put pressure on the ECB to back off their plans to remove accommodation. In other words, there is still plenty to watch, although none of it has been meaningful to markets for more than a brief period yet.

Keeping all that in mind, let’s take a look at the market. As I type (which by the way is much earlier than usual as I am currently in London) the dollar is showing some modest strength with the Dollar Index up about 0.25% at this point. The thing is, there has been no additional news of note since yesterday to drive things, which implies that either a large order is going through the market, or that short dollar positions are being covered. Quite frankly, I would expect the latter reason is more compelling. But stepping back, the euro has traded within a one big figure range since last Thursday, meaning that nothing is really going on. The same is true for most of the G10, as despite both data and the Fed, it is clear very few opinions have really changed. My take is that we are going to need to see material changes in the data stream in order to alter views, and that will take time.

In the emerging markets, we have two key interest rate decisions shortly, Indonesia is forecasts to raise their base rate by 25bps to 5.75% and the Philippines are expected to raise their base rate by 50bps to 4.50%. Both nations have seen their currencies remain under pressure due to the dollar’s overall strength and their own current account deficits. They have been two of the worst three performing APAC currencies this year, with India the other member of that ignominious group. Meanwhile, rising oil prices have lately helped the Russian ruble rebound with today’s 0.2% rally adding to the nearly 7% gains seen in the past two plus weeks. And look for the Argentine peso to have a solid day today after the IMF increased its assistance to $57 billion with faster disbursement times. Otherwise, it is tough to get very excited about this bloc either.

On the data front, this morning brings the weekly Initial Claims data (exp 210K), Durable Goods (2.0%, 0.5% ex transport) and our last look at Q2 GDP (4.2%). I think tomorrow’s PCE data will be of far more interest to the markets, although a big revision in GDP could have an impact. But overall, things remain on the same general trajectory, solid US growth, slightly softer growth elsewhere, and a Federal Reserve that is continually tightening monetary policy. I still believe they will go tighter than the market has priced, and that the dollar will benefit accordingly. But for now, we remain stuck with the opposing cyclical and structural issues offsetting. It will be a little while before the outcome of that battle is determined, and in the meantime, a drifting currency market is the most likely outcome.

Good luck
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Doves Will Despise

Come two o’clock later today
The Fed will attempt to convey
How high rates may rise
Though doves will despise
The idea that more’s on the way

Ahead of the conclusion of the FOMC meeting today, very little has happened in the FX markets, and in fact, in most markets. At this point, given the fact that the Fed remains one of the key drivers to global monetary policy, and the still significant concern that the ongoing divergence in Fed policy with that of the rest of the world can have negative consequences, pretty much every investor is awaiting the Fed statement and Chairman Powell’s press conference. It is a foregone conclusion that they will raise the Fed Funds rate by 25bps to 2.00% – 2.25%.

So the big question is just what the dot plot will look like, especially since today is the first time we will see their 2021 forecasts. Economists and analysts have slowly accepted that the Chairman is on a mission here, and that rates are going to continue to rise by 25bps every quarter at least through June 2019. That would put Fed Funds at 2.75% – 3.00%, a level that is currently seen as ‘neutral’. But what is still uncertain is how the Fed itself expects the economy to evolve beyond the end of the previous forecast period. Any indication that their models point to faster growth would be quite surprising and have a market impact. In fact, the most recent Fed forecasts have been for the economy to peak soon and begin to slow back to a 2.0% GDP growth rate by 2020. It is changes in this trajectory that will be of the most interest. That and Chairman Powell’s comments and answers at the press conference. But at this point, all we can do is wait.

Looking around the rest of the world, we see that central banks everywhere continue to have their policy dictated by the Fed. Two examples are Indonesia and the Philippines, both of whom are expected to raise rates this week (Indonesia by 25bps, Philippines by 50bps) as both of these nations continue to run current account deficits and have seen their currencies erode in value faster than any of their Asian peers other than India. The nature of these two countries, which is quite common in the emerging market sphere, is that currency weakness passes through quickly to higher inflation, and so the dollar strength that we have seen since the beginning of Q2 has already had a significant impact. It is this issue that has prompted a number of emerging market central bankers to caution Chairman Powell of the negative consequences of the current Fed policy trajectory. However, Powell has dismissed these out of hand and the Fed continues on its course.

The other notable movement in the EMG bloc was in Argentina, where the central bank president resigned after just three months on the job. Luis Caputo was both liked and respected by markets and the FX market responded by pushing the peso lower by 2.5% on the news. Of course, in the broad scheme of things, this is not very much compared to the currency’s 50% decline this year.

Pivoting to the G10, FX movement has been modest overall, with the biggest movers AUD and NZD, both of which seem to be benefitting from the recent revival in commodity prices. There has been no new Brexit news and so the pound remains relatively unscathed. Meanwhile, after Monday’s excitement in the euro following Signor Draghi’s “relatively vigorous” comments, it seems that ECB member Peter Prâet was trotted out to explain that there was no change in the committee’s view and that rates would not be rising until much later next year. Ultimately, however, the euro is essentially unchanged on the day, with the market having drawn that conclusion shortly after the comments were made.

Yesterday’s US data showed that Consumer Confidence was approaching all time highs but House prices seemed to display some weakness. This is the perfect mix for the Fed, lessening price pressures along with optimism on economic growth. I assure you this will not deter the Fed from continuing on its path. Before the FOMC meeting ends this afternoon, New Home Sales data will print, expected to be 630K, which looks right about in line with the longer term trend, albeit showing some softness from the situation earlier this year.

I see no reason to expect that the market will move significantly before the FOMC, and of course, can only watch with the rest of the market to see what actually comes from the meeting as well as what the Chairman says. Until then, look for a quiet session.

Good luck
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Just How He Feels

On Wednesday the Chairman reveals
To all of us, just how he feels
If dovish expect
Bulls to genuflect
If hawkish, prepare for some squeals

This is an early note as I will be in transit during my normal time tomorrow.

On Friday, the dollar continued its early morning rebound and was generally firmer all day long. The worst performer was the British pound, which fell more than 1.0% after Friday’s note was sent. It seems that the Brexit story is seen as increasingly tendentious, and much of the optimism that we had seen develop during the past three weeks has dissipated. While the pound remains above its lowest levels from earlier in the month, it certainly appears that those levels, and lower ones, are within reach if there is not some new, positive news on the topic. This appears to be an enormous game of chicken, and at this point, it is not clear who is going to blink first. But every indication is that the pound’s value will remain closely tied to the perceptions of movement on a daily basis. Hedgers need to be vigilant in maintaining appropriate hedge levels as one cannot rule out a significant move in either direction depending on the next piece of news.

But away from the pound, the story was much more about lightening positions ahead of the weekend, and arguably ahead of this week’s FOMC meeting. The pattern from earlier in the week; a weaker dollar along with higher equity prices around the world and higher government bond yields, was reversed in a modest way. US equity markets closed slightly softer, the dollar, net, edged higher, and 10-year Treasury yields fell 2bps.

The big question remains was the dollar’s recent weakness simply a small correction that led to the other market moves, or are we at the beginning of a new, more significant trend of dollar weakness? And there is no easy answer to that one.

Looking ahead to this week shows the following data will be released:

Tuesday Case-Shiller House Prices 6.2%
  Consumer Confidence 312.2
Wednesday New Home Sales 630K
  FOMC Decision 2.25%
Thursday Initial Claims 208K
  Goods Trade Balance -$70.6B
  Q2 GDP 4.2%
Friday PCE 0.2% (2.3% Y/Y)
  Core PCE 0.1% (2.0% Y/Y)
  Personal Income 0.4%
  Personal Spending 0.3%
  Chicago PMI 62.5
  Michigan Sentiment 100.8

So clearly, the FOMC is the big issue. It is universally expected that they will raise the Fed funds rate by 25bps to 2.25%. The real question will be with the dot plot, and the analysis as to whether the sentiment in the room is getting even more hawkish, or if the CPI data from two weeks ago was enough to take some of the edge off their collective thinking, and perhaps even change the median expectations of the path of rate hikes. I can virtually guarantee you that if the dot plot shows a lower median, even if it is because of a change by just one FOMC member, equity markets will explode higher around the world, the dollar will fall and government bond yields will rise. However, my own view is that the data since we have last heard from any Fed speaker has not been nearly soft enough to consider changing one’s view. Instead, I expect a neutral to hawkish statement, and a little pressure on equities.

But the big picture narrative does seem to be starting to change, and so any dollar benefit is likely to be short lived. Be ready to hear a great deal more about the structural deficits and how that will force the dollar lower. One last thing, tariffs on $200 billion of Chinese imports go into effect on Monday, which will only serve to add upward pressure to inflation data, and ultimately keep the FOMC quite vigilant. I remain committed to the idea that the cyclical factors will regain their preeminence, but it just may take a few weeks or months for that to be apparent. In the meantime, look for the dollar to slowly slide lower.

Good luck
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Investor Frustrations

There once was a wide group of nations
Whose growth was built on weak foundations
Their policy actions
Are seen as subtractions
Increasing investor frustrations

Boy, I go away for a few days and world virtually collapses!!!

Needless to say, a lot has happened since I last wrote on Thursday, with a number of emerging market currencies and their respective equity markets really coming under pressure. It was the usual suspects; Turkey, Argentina, Indonesia, Brazil, Mexico, Russia and China, all of whom had felt significant pressure at various times during the year. But this new wave seems a bit more stressful in that prior to the past few days, each one had experienced a problem of its own, but since Friday, markets have pummeled them all together. This appears to be the contagion that had been feared by both investors and policymakers. The thing is, the unifying theme to pretty much all these markets is the stronger dollar. As the dollar resumes its strengthening trend, both companies and governments in those nations are finding it increasingly difficult to handle their debt loads. And given the near certainty that the Fed is going to continue its steady policy tightening alongside consistently stronger US economic data, the dollar strengthening trend seems likely to remain in tact for a while yet.

Could this be one of the ‘unexpected’ consequences of ten years of QE, ZIRP and NIRP? Apparently, despite assurances from esteemed central bankers like Ben Bernanke, Janet Yellen and Mario Draghi (as dovish a triumvirate as has ever been seen), there ARE negative consequences to dramatically changing the way monetary policy is handled, massively expanding balance sheets and driving real interest rates to significant negative levels. While there is no doubt that developed economy stock markets have benefitted generally, it seems like some of those risks are becoming more apparent.

These risks include things like the central bankers’ loss of control over markets. After all, markets around the world have basically danced to the tune of free money for the past decade. As that tune changes, investor behavior is sure to change as well. Another systemic risk has been the increasing inability of investors to adequately diversify their portfolios. If every market rises due to exogenous variables, like zero interest rates, then how can prudent investors manage their risk? Many took comfort in the fact that market volatility had declined so significantly, implying that systemic risk was reduced on net. However, what we have observed in 2018 is that volatility is not, in fact, dead, but had merely been anaesthetized by that free money.

The worrying thing is there is no reason to believe that this process is going to end soon. Rather, I fear that it may just be beginning. There are a significant number of excesses to wring out of the markets, and however much central bankers around the world try to prevent that from happening, they cannot hold back the tide forever. At some point, and it could be coming sooner than you think, markets are going adjust despite all the efforts of Powell, Draghi, Carney, Kuroda and their brethren. Never forget that the market is far bigger than any one nation.

We are already seeing how this can play out in some of the above-mentioned countries. Argentina, for example, has short-term interest rates of 60%, inflation of ‘only’ 31%, and therefore real interest rates are now +29%! But the economy is back in recession, having shrunk 6.7% last quarter, and the current account deficit remains a significant problem. So despite jacking rates to 60%, the currency has fallen 22% this week and 120% this year! And they are following orthodox monetary policy. Turkey, on the other hand, has been unwilling to bend to orthodoxy (when it comes to monetary policy) and has kept rates low such that real interest rates are near zero and heading negative as inflation continues its climb (17.9% in September) while rates remain on hold. So the fact that the lira is down 9% this week and 95% this year should be less surprising.

The point is that the market is losing its taste for discrimination and is beginning to treat all currencies under the rubric ‘emerging markets’ as the same. And they are selling them all. As long as the Fed continues its grind higher in rates, there is no reason to believe that this will end. And if these declines are steady, rather than sharp crashes, it will go on for a while. Chairman Powell will have no reason to stop if a few random EMG markets trend lower. If, however, the S&P 500 starts to suffer, that may be a different story, and one we will all watch with great interest!

In the meantime, turning to G10 currencies, the dollar is stronger here as well this morning, although it has fallen back from its best levels of the morning. In fact, while the pound has been consistently undermined (-0.3% today, -1.5% since Thursday) by what seems to be a worsening saga regarding Brexit, the euro has stabilized for now, although it is down about 1% since Thursday as well. Apparently, CAD is not taking the ongoing NAFTA negotiations that well, as it has fallen 2% since Thursday amid pressure on PM Trudeau to cave into US demands. The BOC meets today and while there had been previous expectations that they may raise rates, that has been pushed back to October now in view of the NAFTA process. This is despite the fact that inflation in Canada is running at 2.9%, well above target.

In the end, as long as the Fed continues along its recent path, expect market volatility to increase further, with more and more dominoes likely to fall.

As to today, the only noteworthy data is the Balance of Trade, where expectations are for a $50.3B outcome, not exactly what the president is hoping for, I’m sure. And as far as the dollar goes, there is no reason to believe that its recent strength is going to turn around anytime soon.

Good luck
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