Good morning

While the markets globally have seen a respite today after the recent sell off, I think we have NOT seen the end yet. While the US is powering ahead, the commodity/energy/precious metal markets have been obliterated as the slowdown in China continues to bite. I have noted on MANY previous occasions that the Renminbi (CNY) is ripe for FURTHER DEVALUATIONS.  Trading around 6.36 at the time of writing I truly believe that the PBoC will “surprise” us yet again (following the deval in August) with further devaluations to improve exports and kick start the economy.

Michael Mabbutt, manager of the Liontrust Global Strategic Bond fund, noted recently “China has opened a Pandora’s box by allowing the currency to depreciate modestly. This, combined with the social impact [of a slowing economy], leads us to believe it will go much further. Typically you need a drop of between 15 per cent and 20 per cent for it to have an effect. That would take us to about 8.00 as an exchange rate [against the dollar]. I suspect we’ll have a few more devaluations.” Mr Mabbutt noted this drop would take the renminbi close to the level at which it was pinned to the US dollar between 1997 and 2005. I think there are many strategist and FX dealers who are thinking the same thing and the FX options market has seen an increasing number of options traders buy USD CALLS vs CNY (low delta strikes). With volatility levels creeping up the market is waking up to the realisation the reward is worth the “risk” of shelling out the premium.

The fallout from weaker stock markets has played into the hands of a stronger EUR as we have seen in recent days despite the crisis at VW. FX traders have waded into the EUR despite the “threat” from the FED that rates are on the up this year. With the backdrop of a weaker China, FX traders are betting that the FED might have to sit this one out and look to hike only in 2016 as growth in China continues to fall. Truth is you have to think the rate hike rumours are well priced in so that if it does happen (say in December) we won’t be surprised and thus the USD is unlikely to see a jump to 1.0462 – sadly that means my prediction for EURUSD at PARITY before year end is losing its shine. Under normal trading circumstances I would probably have been spot on (like predicting EURUSD would fall from 1.3770 to 1.2000 by 31 Dec 2014), however what I never took into account was the severity of the economic situation in China and the collapse in energy and commodity prices. Still I can hold my head up high and say at least we got close (1.0462 back in March 2015).

UBS has also come out in favour of a stronger EUR, joining HSBC, Morgan Stanley, BOA/Merrill Lynch and Citibank in raising forecasts for a stronger EUR(USD). UBS commented, ” the argument that an expected hike can benefit the dollar partly relies on ‘carry’ as a driver, and although there is empirical evidence that higher yielding currencies outperform lower yielding currencies over time, we don’t think EUR/USD is likely to become a carry trade. Rate differentials between the US and Euro area are not large, with the two right in the middle of the G10 pack. Even when the Fed starts hiking, the cycle is unlikely to widen the differential enough to make it much of a carry trade. Even if the Fed were to hike enough to make carry in the USD worthwhile, this would imply a macro backdrop that is even less conducive to carry trades than the current one, as higher US rates would likely increase volatility, and decrease global liquidity.” In other words just like I have noted above a US rate hike is UNLIKELY to see a rush to buy USD as the rate differential is already so close. For now it appears then that EURUSD will remain “range bound” with the prospect of further appreciation. The GBP however is unlikely to enjoy such respite and my prediction is the GBP will continue to FALL vs the USD and EUR over the coming months despite the HEALTHY (don’t tell Corbyn this) GDP growth numbers in the Western world (2nd behind the US).

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