So far this year some of the top performing currencies against the dollar are the offshore and onshore Chinese renminbi, and the Japanese yen. At the time of writing, the offshore renminbi is up ~2.5% and the yen has gained 1.45% against the greenback. On the other side of the spectrum the Argentine peso, Turkish lira and Brazilian real are amongst the worst performers year-to-date; having fallen roughly 23.5%, 16.5% and 10%, respectively.
Over the last week the International Monetary Fund (IMF) has been pushing the EU to agree a debt relief programme for Greece so to ensure that the fund has enough time to start giving the country money. The IMF director for European affairs, Poul Thomsen, warned ‘Time is running out’, however, he did go on to say ‘but if there is an agreement in the Eurogroup meeting in May, then there will be enough time for us to activate the program and for it to coincide with the remainder of the ESM (European Stability Mechanism) program’ Not that EU seem to be taking much notice of the call for urgency, believing the decision on any Greek debt relief is up to two months away according to Valdis Dombrovskis, who has the impressive title of European Commission Vice-President for the Euro and Social Dialogue.
I envision at least three serious long-term consequences of current policy blunders for the US economy. First, at some point, public deficits will crowd out the nascent recovery in private investment – perhaps not this year but by 2019 the burden of financing public debt will begin to interfere with private financing, especially if the private sector is expected to finance public infrastructure projects. Over a longer horizon, the burden of debt will shift to the younger generation whose earnings prospects already are below those of their parents
Extract from Bob Gay’s piece ‘Policy Blunders and Currencies’
The Near-Term View – A Shrinking Supply of US Dollars
Herein lies the Fed’s current dilemma. A monetary regime of negative real policy rates and asset purchases is not sustainable. Pressures to exit these policies are growing in the US now that economy has reached full employment with the attendant risks for inflation. Those conditions call for a neutral monetary stance or perhaps something sterner. That means the Fed has little choice but to continue normalise rates and to unwind its bloated balance sheet. In doing so, however, the Fed is unintentionally constricting the global supply of US dollars.
Extract from Bob Gay’s piece ‘Policy Blunders and Currencies’
Let us apply this simplified framework to today’s circumstances: a synchronised expansion in which most central banks are normalising monetary conditions toward what they believe to be a neutral policy stance. Granted, the BoJ and ECB are lagging behind, but the gradual trajectory of the Federal Reserve coupled with its reduced estimate of the new neutral rate (now less than 3%) have left both current and expected real interest rate differentials relatively small. As a result, lucrative carry trades now require a lot of leverage and have withered in the increasingly uncertain financial landscape.
Extract from Bob Gay’s piece ‘Policy Blunders and Currencies’
A simplified way of thinking about a directional (unhedged) carry trade is to presume interest rate parity will hold over an intermediate period with some extra bells and whistles for inflation and expectations. The objective of the carry trader is to find a currency with a higher yield than elsewhere and with a good chance of remaining that way for long enough to earn a significant arbitrage. In short, the arbitrageur is looking for an interest rate differential that is likely to persist.
For the next 5 days we feature extracts from our macro-economist Bob Gay’s latest piece ‘Policy Blunders and Currencies’
In December 2015, I wrote a commentary entitled “The Illusion of Policy Divergence” which expressed my concerns on the longevity of the so-called ‘reflation trade’ that was in fashion at the time. The consensus of opinion was that US monetary and fiscal policies were poised to diverge from those of the rest of the world because the Federal Reserve had embarked on a pre-programmed exodus from quantitative easing and zero interest rates, while President Trump was promising to undertake a major fiscal stimulus with a massive infrastructure program. That policy mix – tighter monetary conditions and loose fiscal policy – tends to be a classic prescription for currency appreciation, at least as long as it generates a domestic economic cycle that is asynchronous with what is happening elsewhere.
The ‘neutral hold’ yesterday from the Bank of England shows how fast the economic situation can change. Just four weeks ago the market was pricing in a continuation of tightening with a May 25bps rise priced at around 96% but after disappointing economic data (especially CPI and GDP data) a rise in August is now priced in at a less than 50% chance with some calling for 10-year Gilt yields at 1% by year-end; a fall of 43bps from this morning’s level.
Earlier this year China launched a renminbi-denominated crude futures exchange in Shanghai as a means to internationalise the renminbi by delivering international investors a means by which to trade oil futures contracts without the need for offshore operations and dollar denominated transactions. With the Trump-administration looking inward, China has been taking the opposite approach and with this and its more recent venture could indirectly help commodity based nations like Venezuela and Iran overcome some sanction pain, and itself mitigate possible trade conflict effects with the US.
#prayfortheoiltraders appeared on Twitter yesterday as they were taken on a rollercoaster ride with Brent oil prices whipsawing down from 76 dollars to near 73 dollars per barrel even as all those holding $200bn of long oil futures contracts got what they were anticipating - Trump nixing the Iran Nuclear Deal. The expected price reaction eventually came 5 hours later when oil prices moved back up to where they started (the market having mostly priced in Trump’s braggadocio). At the time of writing, Brent prices have pushed above 77 dollars a barrel setting new highs – that is since the paradigm shift of oil markets in late 2014 (prices would still have to rise a further 50% to approach where they were in the first half of this decade).
There is an interesting piece from Bloomberg Economics out today which ranks the emerging market economies according to their vulnerability to President Trump’s policies, as they see them. Three major factors are measured and scored. The first is Protectionism Vulnerability, the second Rates Vulnerability and the third Oil Vulnerability. Fifteen countries are scored with South Africa and Thailand coming in the last two places with an overall score of just one and two respectively, whilst in the top two places are Russia with a score of fifteen and Brazil with a score of fourteen.
Today’s April non-farm payroll release showed 164,000 jobs added which was below expectations of 193,000 jobs created and the previous month’s figure was revised up by 32,000 to 135,000. The unemployment rate came in at 3.9% versus the prior month’s reading of 4.1% and the participation rate edged lower to 62.8% from 62.9%. Importantly, average hourly earnings were weaker than expected at 2.6% yoy, and the previous month’s figure was revised down to 2.6% yoy. Broadly speaking, a positive set of numbers for bond markets.
Last night’s FOMC statement was a “mark-to-market” of sorts that did not give any clear indications about future policy. Since the FOMC last met, inflation has risen on a 12 month basis due to base effects and first quarter GDP showed that the pace of growth had moderated relative to the previous quarter. This has led to slight changes in the statement regarding the categorisation of growth and inflation, including a removal of a previous phrase that noted the Fed would monitor inflation developments closely.
The month of May looks to be somewhat challenging for Prime Minister Theresa May. Although she recently polled more popular (or more accurately less unpopular) than Jeremy Corbyn for the first time in a year - she now faces a new Brexit ‘ultimatum’ from MPs within, further dogged Brexit pessimism from various EU officials without, and following tomorrow may be answerable if any disappointment and losses across local council elections transpire.
As Abu Dhabi continues to move to consolidate its government-related industries (GRIs), we heard that the scale of the “integrated portfolio” of the Mubadala and IPIC merger in January 2017 saw revenues grow by 17% last year. The company reported that revenues were driven by “the strong performance of all four global platforms, with major contributions from upstream & integrated, petrochemicals and the semiconductor business sectors”, adding that the sovereign wealth fund (SWF) took advantage of “reducing leverage while maintaining appropriate liquidity to deploy capital in new investments… we took the opportunity to monetize some of our mature assets which provided a significant return on our original investments, in line with our mandate to deliver financial returns to our shareholder.”
With the UK, this week announcing a £1 billion combined public (£400m + £300m new) and private (£300m) drive into artificial intelligence: understanding the benefits this will bring to long- and short-term growth is complicated and very much uncharted territory. It won’t simply provide the 'limitless opportunities' that Business Secretary Greg Clark purported. We were reminded of a report in 2017 from the consultancy firm PwC in which it stated that up to 30% of all the jobs in the United Kingdom were at risk from both breakthroughs in artificial intelligence (AI) and automation.
It will be interesting to listen to the reports of Trump versus Merkel, after three days of meetings with French President Macron and lots of touchy feely politics combined with fine pruning and a real ‘good chaps united ambiance’. Now let’s see how discussions over tariffs on European aluminium and steel, Germany’s new Russian pipeline, small scale defence spending and very large trade surplus get reported. Well they plan a two hour meeting today, not enough time to do the ‘bonding thing’ then.
Europe’s reliance on Russian gas is a good illustration of the important trading relationship between Russia and Europe. Gazprom estimate they supplied up to 34.7% of the gas consumed in Europe in 2017; Germany is the largest individual market. This it implies Europe’s approach to sanctions is necessarily different to the US. Although it is a different industry, last week the US eased the recent sanctions on Rusal, given the knock-on effects on European businesses, by extending the deadline to October for compliance. US Treasury Secretary Steven Mnuchin commented: ‘Given the impact on our partners and allies, we are issuing a general license extending the maintenance and wind-down period while we consider RUSALs petition.’
Attractive from a distance, but disappointing close-up… It's such a let-down when – after catching a glimpse of some sparkling earnings – markets were hoping to see some ‘healthy assets’ and a confident outlook. But it wasn’t to be, and the market quickly lost interest in Caterpillar (CAT) yesterday after a flash of favourable earnings was followed by a slightly more muted earnings call. Notably, outgoing Group President and CFO Brad Halverson stated that, “The outlook assumes that first quarter adjusted profit per share will be the high-water mark for the year.”
With many nations at odds both internationally and domestically, China has taken it upon itself to use the opportunity to strategically amass what it can as soon as it can across the globe. China, who already has its fingers in Asian, African and Latin American pies now appears to be rapidly taking ownership of Europe too. According to data published by Bloomberg, the world’s largest economy in PPP terms has attained and invested in European assets totalling USD 318bn over the past decade; with activity calculated at ~45% higher than that from the US, in dollar terms. Said assets range from airports, seaports and energy farms to football teams, and of course we must mention China’s huge funding in infrastructure projects across the region and investment in the European tech sector.