20141223 – PONDERING 2015

The S&P 500 hit its record high again into the close last night, even as EUR/USD made a new year to date low. The paradigm of equities going up as the US dollar strengthens appears to remain in force. This is reinforced by USD/JPY going back up above 120. As we approach the end of the year the markets look set to maintain the trends which have dominated the global macro this year.

This morning we have seen a lacklustre French GDP report, with 0.3% growth which was in line with expectations and bang in line with the previous quarterly number. Certainly not enough to get that pesky public sector deficit moving in the right direction – public debt has risen in Q3 to 95.2% of GDP… ouch! Shortly we’ll see Italian retail sales, with UK and US GDP numbers to follow. We also have durable goods and core PCE price data in the United States as well. Economists expect 3% growth in the UK and 4.3% in the US, so it’s not surprising at all that these are the economies most likely to begin the process of rate normalisation next year, and naturally it’s not surprising that the Eurozone in which France is the 2nd largest economy is looking to ease further. So much to ponder about 2015.

These growth differential macro forces will continue to drive currencies next year, and we at ParityFX continue to maintain that the US dollar will trend higher versus its major rivals, and developing markets to boot. It is also our expectation that we will see more developing markets under pressure with the main risk being corporate debt. As we’ve mentioned in these blogs in recent months, corporates in developing markets have borrowed heavily, primarily in US dollars, over the last 5 or 6 years, the data is sketchy, but when you consider known debt issuance, and the fact that the foreign subsidiaries of a lot of these corporates have also borrowed and sent money back home, it raises the question of exactly what component of foreign direct investment has really been… foreign in the last half decade. Which western banks have exposure to over-leveraged businesses in at risk economies? These are the types of risks that look likely in the new year. The story is always the same, collectively humanity must be insane, because we really do keep doing the same things over and over. But perhaps not, perhaps you’re only insane if you expect a different result!?

We would expect the strength of the US dollar to start weighing on US large cap earnings, both from translation effects and also from price competitiveness, therefore I wouldn’t be shocked to see US small cap stocks outperform their larger brethren as they benefit from robust domestic growth. We would, however, only expect an accelerated decline in the euro if Mr Draghi is somehow able to convince Mr Weidmann of the merits of purchasing sovereign debt, or if the stresses of stagnating growth and rising debt levels force some sort of EU wide political crisis. Any of these things are possible, but the middle path points to a continuing gentle decline in EUR/USD with bouts of sharp corrections. As the linkage between positive global growth and strong US economic performance is maintained, we would expect periods of negative risk sentiment to strengthen the euro in particular.

Finally we don’t expect the base for oil prices base to be too far from the current $60 level (Brent), and we would not be surprised to see a ranging market next year, after all the excitement in 2014. Commodity focused developing currencies are likely to continue to suffer. The likes of Korea, India, and Mexico look to be in prime position to benefit from the present situation, as strong US growth should benefit Korea and Mexico, while lower energy imports as well as a reforming Modi should benefit India. Net global liquidity should be reduced as I don’t believe that the ECB’s promises and Japan’s intentions will be sufficient to counteract Federal Reserve tightening. I guess the really big question is… have legislators left the financial system in a sufficiently robust condition to handle the rise of volatility that is sure to happen as financial repression recedes? We shall see..