Month: November 2018

Emerging market currencies enjoyed a reprieve last week as global risk appetite showed some improvement after signs that investors were heading for havens earlier in the week amid rising market volatility and a rout in global stocks.

Higher-yielding currencies like the South African rand; the Turkish lira, Mexican peso and Russian rouble were firmer in trading in London, with the rand leading the pack with a 1.5 per cent rise to R13.884 against the dollar.

The lira edged up by as much as 1.4 per cent against the dollar to a high of TL5.3030, after sliding yesterday on reports that the country’s finance minister was expecting commercial interest rates to fall.

The Mexican peso was third in the ranking mid-week with a 0.8 per cent rise. The Russian rouble gained a modest 0.5 per cent.

Speculation that the Fed would take a less aggressive stance on policy tightening weakened the dollar. The reprieve did not just concern emerging markets. Risky assets like Italian government bonds were also rallying as investors shrugged off the latest iteration of a tug of war between the European Commission and Italy on the country’s draft budgetary plans.

But it is unlikely that demand for risky assets will improve significantly and more importantly in a sustainable way in the coming months unless trade tensions between the US and China ease with particularly close attention being focused on the upcoming Trump-Xi meeting at the G20 summit.

 

Just a few months ago, all looked calm for the Eurozone. Five years into a recovery, though with core inflation still below the European Central Bank’s objective, there was ample potential for broadening the expansion before reaching any significant capacity restraints.

The ECB, which was later than its US counterpart to introduce quantitative easing, warned that it would curtail bond purchases later this year, but only as long as the economy was performing successfully.

Since then, although the Eurozone recovery has not ended, even though it is floundering. The central bank would do well not just to reconsider stopping bond purchases under QE next month, but also to preserve and emphasise the array of weapons for monetary stimulus still at its disposal.

Last week Germany, one of the few reliable generators of Eurozone revealed that growth since the global financial crisis had seen a 0.2 percent fall in GDP in the third quarter after healthy expansion of 0.5 percent in the second.

Indicators of business sentiment show that underlying growth momentum has slowed across the Eurozone. In this context, core consumer price inflation still well below target looks more like an economy striving to generate a solid long-run growth rate than one with plenty of room to expand.

That is even without the potential risks to exports of a hard Brexit or a rapid acceleration in US protectionism. Despite the frothy rhetoric and the drastic across-the-board tariffs that Donald Trump has placed on China, the US administration has so far targeted only steel and aluminium exports from the EU.

If the Eurozone weakens, it will become even more lamentable that reform inside the single currency zone has been so lackluster.

In this context, whatever the ECB does with QE, it is critical it possesses the capabilities developed following the global financial crisis and especially the Eurozone sovereign debt turmoil.

Far from decommissioning its weapons, the ECB should clarify that they are kept in constant repair. It is for the moment unclear whether the blip in growth will become a downturn. The ECB needs to signal that it keeps the capacity to react swiftly and decisively if it does.

 

As the asset most susceptible to Brexit-related news, sterling was hard hit last week by the political deadlock over Theresa May’s proposed deal.

After a mellow summer, one-month and three-month implied volatility for sterling-dollar option contracts jumped to their highest levels since the Summer of the 2016 Brexit vote, as investors rushed for put options and market makers switched to protect their positions.

The move was remarkable. Even investors who had bought call options last week in expectation a deal would push sterling higher still made money, despite the pound’s subsequent fall. That is because the volatility spike made owning options, in general, more valuable.

Investors still seeking safety will now pay up with it becoming continually more costly if you need to buy options, the Brexit endgame having become progressively more obscure. Yet the spectrum outcomes could yet represent a handsome trade with some investors are forecasting a move to as high as $1.35-40 or down to $1.15-20, depending on whether the definite conclusion is regarded as positive or negative.

As the asset most susceptible to Brexit-related news, sterling was hard hit last week by the political deadlock over Theresa May’s proposed deal.

After a mellow summer, one-month and three-month implied volatility for sterling-dollar option contracts jumped to their highest levels since the Summer of the 2016 Brexit vote, as investors rushed for put options and market makers switched to protect their positions.

The move was remarkable. Even investors who had bought call options last week in expectation a deal would push sterling higher still made money, despite the pound’s subsequent fall. That is because the volatility spike made owning options, in general, more valuable.

Investors still seeking safety will now pay up with it becoming continually more costly if you need to buy options, the Brexit endgame having become progressively more obscure.

Yet the spectrum outcomes could yet represent a handsome trade with some investors are forecasting a move to as high as $1.35-40 or down to $1.15-20, depending on whether the definite conclusion is regarded as positive or negative.

Having filtered out much of the Brexit political turbulence in recent weeks, Thursday proved a chastening experience as investors started to at least price in a higher risk that the deal prime Minister Theresa May had hailed outside Downing Street less than 24 hours earlier would fail to make it through parliament.

The pound tumbled almost 2 percent against the dollar for its biggest decline in two years while sliding 1.9 percent against the euro. With investors taking shelter in the gilt market, where the yield on the benchmark 10-year bond dived 13 basis points, a much steeper climb than any other developed bond market.

The tumult of the day was a shock given UK market had spent recent weeks following, rather than reacting to, the Brexit negotiations, but the falls did not drive markets to new lows. Even after Thursday’s slide, the pound is nevertheless almost precisely in the midst of its trading range this year against the Euro.

Thursday’s sell-off, however, may even prove something of a game-changer if it opens the door too much greater Brexit-driven volatility. For investors accustomed to analysing economic data and corporate cash flows, the seeming political impasse appears to throw up a range of outcomes, including a possible second referendum or indeed a general election.

Brexiters opposed to the deal have to determine how much pressure they can put Theresa May under without triggering either outcome or what the impact of a leadership challenge would be.

The challenge in trying to calculate the Brexit risks -and then assessing whether they are priced into UK assets has inclined many investors to steer clear.

Sterling, in particular, has been problematic for investors to trade. Some funds have avoided taking large positions, in the knowledge that the trade is more about predicting a political outcome than crunching technical or economic data.

The euro had another case of the blues last week with the political risk factors it faces darkening as the dollar’s pick up from last week’s lows also gathers pace.

Leaving the shared currency hovering around 17-month lows against its US counterpart, with investors unnerved at the confusion over a Brexit deal and the Italian budget.

It pinned the shared currency under $1.13 early in the week — down 0.6 percent from Friday’s close. Then hit a low of $1.1237 during morning trade, the weakest position since June last year.

It then rebound to $1.1258 after Italian industrial orders data turned out to be stronger than predicted. And there is an apprehension at the rift between Italy and the European Commission over the country’s budget plans, with the Italian government holding to its fiscal plans — setting the stage for a showdown with Brussels.

Furthermore, talk that the European Central Bank could consider extending its proposed package of actions devised to bolster the Eurozone’s banks were again having a continuous toll on the currency.

That would require the use of the Eurozone’s targeted longer-term refinancing operation, which could defy the prospect of a normalisation of interest rates in the Eurozone.

Which is perhaps why we have had such notable Euro weakness since September and why it has persisted alloyed with the potential risk of a new Italy crisis unfolding.

Plenty of investors are still licking their wounds after a bleak October, and with the restoration of market volatility as central banks steadily remove the security blanket of easy money should serve as good news for active managers and macro-based investors.

A world rent with divergences among markets and regions is just the febrile environment that requires paying a higher fee for a more active approach to investing and affording shelter from the tough market turmoil we have experienced recently.

 

The cycle of quantitative easing has been a blessing for passive investing as easy money was a king tide that floated all boats. Now portfolios are being confronted by higher volatility in the form of quantitative tightening.

This year has already been affected by two big drops in equities during February and October and there are enough of storm clouds piling up on the horizon as markets look towards 2019. An economic environment whereby equity and bond prices move together as we have just experienced illustrates the discomfort exacted by the regime change of QT.

And the performance in February and October has prompted an abundance of hard questions from investors and asset allocators. Especially after February when equities slumped 10 percent, the reaction of the Fed was to raise interest rates in March.

That alerted investors to a significant new development: the Fed under Jay Powell was resolute in pushing overnight rates higher, a prospect reinforced by this week’s policy statement. This leads to more market corrections and greater opportunities for stock and credit pickers to shine.

The Federal Reserve stayed on course for further hikes in short-term interest rates, with the next move expected as soon as December, as the central bank attempts to keep the economy on an even keel as the labour market strengthens.

The Federal Open Market Committee kept its target range at 2-2.25 percent on Thursday, and gave a bullish verdict on the US economy, noting that unemployment had dropped further as improvement in economic activity and household spending remained steadfast.

The rates decision by the Fed, chaired by Jay Powell, occurs as the central bank maintains its steady march to tighter monetary policy. Wage growth has sped up to its swiftest pace in almost a decade, job gains are averaging over 200,000 a month, unemployment is hovering at multi-decade lows, and the economy has recorded two consecutive quarters of annualised growth well in excess of 3 per cent.

With inflation close to the target, the central bank last raised its key rate in September and policymakers have clarified that further rises remain in prospect as they move policy to neutral settings. At the same time, the central bank is restricting in the extent of its balance sheet, which was expanded by crisis-era stimulus measures.

The Fed has raised rates eight times in the current cycle, with a further one forecast to come at the December 18-19 meeting. A move was not foreseen at this month’s two-day policy meeting, which takes place in the aftermath of high-stakes midterm elections that saw the Democrats retake the House of Representatives and the Republicans hold the Senate.

Brokers and exchanges have emerged as the main winners in October’s market turbulence, and the futures market suggests investors are braced for further volatility.

Monthly data from the world’s biggest exchanges and trading venues show flows swelled during “Red October” when fears over faster interest rate rises pushed the 10-year US government bond yield towards an eight-year high.

That contributed to substantial falls in equities, led by a sell-off in technology stocks. The surge produced a shot in the arm for the intermediaries such as exchanges and computer-driven market makers, which benefit from daily moves in equities, futures, fixed income and foreign exchange, whatever the direction. After a confident first few months, business languished during the year as markets were becalmed.

Investors remain on alert for further moves that could bring to a more uncertain 2019. These constitute the Federal Reserve raising rates, China’s economy slowing, the European Central Bank unwinding its wide-ranging asset-purchasing programme, Italian budget tussles and congressional gridlock after the midterm elections that may hinder a further fiscal stimulation to the US economy.

Sterling ascended to a two-week high last week, stimulated by optimism about progress on a Brexit deal. With the pound was 0.3 percent higher and back at a two-week high of $1.3085 following reports that the EU was preparing to back a compromise on the Irish border.

The currency has now climbed 3 percent from its a nadir of $1.2694 at the end of October, undeterred by new economic data indicating the UK services activity is slowing down and the manufacturing sector is undergoing its sharpest slowdown in two years.

With the pound looking set to remain driven by headlines regarding Brexit. And optimism regarding a deal has built up in recent trading sessions. But the currency is still down 9 percent from the year’s high of $1.4376, touched in mid-April.

So we have congressional gridlock, the consensus arising from the US midterm elections. With that out of the path can financial markets can go back to fixating on what concerns them? I.e. Federal Reserve policy and US-China trade tension.

These two drivers of market sentiment will demonstrate whether Wall Street and global equities can continue their recent rebound after a brutal performance in October. The election result seems prone to produce a weaker dollar and stable bond yields, which will help.

One profoundly significant result from Tuesday’s split decision— with Democrats taking control of the House of Representatives and Republicans holding a Senate majority — is that the prospect of further fiscal stimulus dims.

When early results on Tuesday night suggested Republicans might carry the House, opening the door to the second round of tax cuts, bond yields jumped and the dollar rallied.

While infrastructure spending may well materialise in the next Congress, one key point to note is that the campaign for the 2020 presidential election now begins. It is debatable that Democrats will further buttress the economy from here on and help Donald Trump’s re-election prospects.

Which means the US economy enters 2019 with a diminishing tailwind from tax cuts. This heightens the chances that the Fed tightening cycle is nearing a conclusion and bond yields are close to a peak.

For international markets, the most prominent reaction is that the dollar’s strong run looks on borrowed time. Whilst for emerging market economies, many loaded with hefty dollar debts, this beckons as good news — and the early response in Asian equity markets and currencies was confident after Tuesday’s election results came in.

In terms of valuations, global equities outside the US look a lot more tempting than those on Wall Street. The first round of Trump tax cuts fuelled great divergence between the US and the rest of the world in terms of economic performance. If Fed tightening slows and the global economy recovers, the gap between the US and the rest of the world may narrow.