You would almost think that nothing had happened over the last few weeks.. almost! The volumes tell us a story, and it’s not a good one. At the peak of this mini crisis we saw moves in the treasury bond futures market, the like of which we’ve rarely seen before, and on the face of it it’s somewhat surprising. After all, we’ve had trillions of dollars of global liquidity foisted on us, surely supply and demand should easily match in a correction that amounted to a 10% decline in the benchmark S&P 500 index? But that wasn’t the case. This was… merely a dress rehearsal to what we will eventually have to face.. policy normalisation. I don’t know about you, but it makes me shudder, and it does force us to call into question the unintended consequences of central bank policy in recent years.
But let’s get to the nitty gritty.. the dollar rally paused, and appears to be trying to reassert itself again. Oil is technically in a bear market and prices hover just above levels that should make oil majors question the viability of further investment in exploration, and expansion, we are certainly far below levels that have been used in the fiscal calculations of certain oil dependent countries – Russia, Venezuela etc. Instability still simmers in the Middle East; the Ebola threat is not going away; Russia-Ukraine; Israel-Palestine; China faces a 3 pronged minority protest (3, if you can call the denizens of Hong Kong a minority!); in addition Xi’s anti-corruption effort gathers pace even as the latest Communist Party plenum has just commenced; and last but not least we have multiple slow burning crisis in the European Union with Draghi battling the German council member Weidmann to effect an ECB version of QE while the UK, France and Italy each separately pose sovereignty questions that challenge the primacy of EU laws. There’s a lot going on!
Despite the complexities I’ve listed, or perhaps because of them, we remain comfortable in our belief that the dollar will continue to rally. It is, after all, the path of least resistance. Let’s not forget why we recently experienced market turmoil… the US economy is doing relatively well.. fact. Policy will need to be normalised in the next year or two.. fact. This is the foundation on which our conviction of dollar strength sits. Meanwhile the case for a weaker euro is no less strong. EUR/USD has GOT to weaken further, this simply has to happen at a bare minimum. It is entirely within the realm of possibility that we will move from todays 1.27 levels to 1.20 by the end of the year. But if the dollar is the solar mass around which other currencies orbit, the euro is most certainly Jupiter. It exerts a tremendous gravitational influence, particularly on the neighbouring European currencies like sterling and Swedish Krone, and so while I believe the UK economy is doing at least as well as the US, I am less confident about where GBP/USD goes from here. What I will say with strong conviction is that I believe EUR/GBP has a very strong case to continue lower. There may well be bumps on the road, even as we await the BOE minutes today where an implied pause in the policy normalisation debate in Britain could knock sterling temporarily. And it would be temporary, as.. and I repeat.. the UK economy is doing very well indeed. Clearly a weakening Eurozone economy has a huge impact on future growth prospects in the UK, but normalisation may occur more quickly from the BOE than the Federal Reserve. It’s tough to make a case for anything other than a weakening GBP/USD rate due to the Jovian gravitational impact of EUR/USD’s descent and the relatively larger impact Eurozone recession has on Great Britain.
Even as the case for a weakening euro remains strong, we see similar support for depreciation in most Emerging market currencies. However it is worth pointing out that the recent falls in treasury yields have lessened the pressure somewhat. It would be a mistake to look at Emerging Markets as a distinctive asset class where all read from the same script. The world as it is presents different markets with different threats and opportunities. For example, even without sanctions, Russia will be under pressure from the decline in oil prices, and the rouble will have to reflect this. However economies like India and Turkey will be beneficiaries of lower energy import costs, thus the Indian rupee and Turkish lira should benefit.. and so it goes on. If you have any specific currencies you’re exposed to, please don’t hesitate to contact us. We would be only too happy to discuss our specific currency views with you.
I’ve mentioned the BOE minutes today. We are also anticipating retail sales out of Canada and inflation numbers from the US, both important pieces to clarify our view of the macro-scope. The recovery in risk sentiment continues, but we’ve moved so far, so quickly. It wouldn’t shock me if we take a breather here.