The Daily Update - Policy Blunders and Currencies (Part I)

The Daily Update - Policy Blunders and Currencies (Part I)

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 Daily Update - 2018 Outlook

So, here we are at the last daily of 2017. Looking back at last year’s last daily we forecast two Fed hikes in 2017 and we got three, twelve months on and here we are again, forecasting out expectations for US rate hikes over the next 12 months.

Groundhog day. So, here we go:

Broadly we expect 2 or 3 Fed rate hikes (depending on outcome of the US tax cuts package), bringing the Fed Funds Rate to a 2-2.25% range (a bit of hedging here then). We also expect the yield on longer-dated US Treasuries to continue to fall, thus flatten; with 10 and 30 year debt moving towards a 2.25% yield level and possibly lower. Inflation expectations are key to our strategy; whilst a small rise is expected short term, we believe this is already priced into the market. Longer-term the outlook for inflation remains positive for longer dated high quality bonds; we will continue to monitor inflation and react accordingly.

So we are optimistic for 2018 looking for a continuation of spread tightening in better rated credits hence our stance is to retain our longer duration profile and our higher average credit positioning across all our funds.

Our offshore Guernsey based Renminbi Bond portfolio, having just seen out its tenth year since launch has seen stellar performance and currently is up about 15%c ytd on the USD class, 14% on the sterling class and 13.5% on the euro class; very pleasing. We do expect the Chinese currency to continue to add value when overlaid across our bond portfolio as we actually get paid to buy the renminbi from all three of the above quoted currencies adding to returns. Of course, this also helps alleviate some of the risk associated from currency exposure but we do expect further renminbi appreciation over the coming years as further deregulation and acceptance of the Chinese currency as a core holding grows from a heavily underweight investor base.

As usual a last daily needs some humour and so here goes:

What is it called when Santa gets stuck in the chimney…….Claustrophobia,

What do you call an Elf that sings…….A wrapper,

Why was Santa’s little helper depressed…….he had low elf esteem,

What’s the difference between snowmen and snowladies…….snowballs,

What do you call a blind reindeer……..No eye deer,

What do you call the Head of Sales wearing ear muffs…….Anything you want he can’t hear you.

Have a great holiday and may Santa be kind. The team will be back writing more insightful dailies the week of the 8th January.

Jingle bells, jingle bells, jingle all the way…

The Daily Update - FED NFP

On Tuesday evening Federal Reserve governor Lael Brainard, a well-established dove, who of late has been rather more centralist than dovish, added her thoughts on the current situation the FOMC finds themselves in. On the funds rate she said that 'it will likely be appropriate soon' to adjust the Funds rate. She did add that if soft inflation data persists that it 'would be concerning and, ultimately, could lead me to reassess the appropriate path of policy.' So still data dependent but the concerns for the inflation outlook have helped US Treasury yields lower.

The Daily Update - FED / Sir Winston Churchill

Last night Fed Governor Lael Brainard warned against moving too fast on any rate rises, cautioning that there were still concerns about the global economy that could impact the US. In a speech to The Chicago Council on Global Affairs she highlighted inflation concerns and global uncertainty saying this "counsels prudence in the removal of policy accommodation," adding that she “believed this approach has served us well in recent months, helping to support continued gains in employment and progress on inflation."

Wealthy Nations Daily Update - Fed

So tomorrow evening we get the latest update on the Fed’s thoughts on whether the economy is recovering as expected. The data dependent Fed has quite a lot of ammunition to judge the next rate rise, although the futures market is still pricing the chances of a rise in the funds rate on Wednesday evening at less than ten percent. So is the data dependency just to obfuscate the market while waiting for a clearer economic trend?

Fed official concerns around the tight financial conditions appear to have dissipated, with junk yields having fallen over 150bps from the peak this year, sitting 50bps tighter than at year-end. The US dollar is also around 2.15% weaker during this period, according to the DXY index and so the pressure here has also been alleviated. Also, the US equity markets are up between 1.25% and 1.9% since year-end, call it 1.5% on average and so annualised over 6% per annum, again a comfortable reading given the economy continues to average growth around 2% which it has for the last five years and so nothing here to hold back any Fed hawks.

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