Search Results for: procras

Appetite for destruction… and procrastination

Financial markets continue to take into their stride a number of man-made and natural crises and the procrastination of policy-makers in the US, UK and Eurozone.

Global risk appetite remains seemingly well bid despite the still very opaque end-game for rising geopolitical tensions stemming from North Korea and the impact from Hurricanes Harvey and Irma.

In the world of FX, the emerging market carry trade is seemingly enjoying a mini-revival thanks to low yields in developed economies, signs that global GDP growth continues to inch higher and a surge in commodity prices, particularly industrial metals.

Event risk is clearly more acute in September than it was in August but it is not obvious to me that major central banks will deliver the kind of surprises which cause major dislocations in financial markets, including EM currencies.

However, these high-yielding EM currencies’ volatility versus the Dollar remains quite elevated, with perhaps the exception of the Turkish Lira and Indian Rupee.

Chinese policy-makers are seemingly intent, at least for now, on using Renminbi appreciation as a show of strength and I expect further currency gains near-term.

In the UK, the mammoth challenge facing Prime Minister Theresa May is coming into greater focus. Moreover, the Bank of England is unlikely to seriously consider a rate hike before next year, in my view.  With this in mind, I see the risk biased toward bouts of Sterling weakness.

The Euro, which eked out small gains versus the Dollar and Sterling following ECB President Draghi’s Q&A session, is ultimately behaving like a safe-haven currency.

I expect the common currency to benefit, not suffer, from lower interest rates for longer and the associated improvement in economic activity even if future Euro appreciation could be modest rather than spectacular.
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Uncertainty threatens Euro’s safe-haven status, for now

The Euro Nominal Effective Exchange Rate (NEER) appreciated about 8% between 20th April and late-August and outperformed all major currencies. However, since its multi-year high on 28th August the Euro NEER has weakened an albeit very modest 1%.

The question is whether/when the Euro may again find favour and set new multi-year highs or whether a more acute correction looms.

Part of the answer lies in the confluence of inter-related factors which contributed to the Euro’s steady climb in the first place but have recently lost some traction.

Prior to its take-off in April, the Eurozone NEER had been one of the more stable among the majors. The Euro was perceived as neither a “risk-on” nor “risk-off” currency and the ECB tacitly welcomed the Euro’s underperformance versus its key trading partners’ currencies.

While the French presidential election in April-May was an important catalyst for the Euro’s appreciation, the seeds for its rally and accession to “safe-haven” status had arguably been sown in 2015-2016.

However, some of these Euro-positive factors have become prey to far greater uncertainty and lost traction in recent weeks, undermining the Euro’s relative appeal while the Dollar and Sterling narrative has improved somewhat.

Financial markets have in particular reacted negatively to Sunday’s German federal election and uncertainty it has generated, both at a domestic and European level.

The Euro finds itself at a cross-road and I see little scope for rapid and/or sustained appreciation until the ECB announces the modalities of an extended QE program and a new German government is in place, with the risk biased towards bouts of Euro weakness.

Longer-term, however, a number of factors could drive renewed Euro appreciation, albeit at a likely slower pace than in April-August.

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Asymmetric data and event risk

With the August lull behind us, developed central bank monetary policy has taken centre stage, with the focus in particular on the Fed and Bank of England. Both have signalled that they could deliver a 25bp hike before end-year.

Rates markets have adjusted accordingly and the focus as we enter the last leg of 2017 will be on whether macro data and events support this hawkish turn. Accordingly, I have compiled a comprehensive data and event release calendar for major economies (Figure 1).

Markets now have 17bp of Fed hikes priced in for the remainder of the year versus 7-8bp in early September – in line with my view that pricing was probably too skinny for the liking of a Fed keen to keep its options open while minimising any market fall-out.

Markets are pricing an 80% probability of the BoE hiking its policy rate 25bp to 0.5% at its 2nd November meeting and a further 30bp of hikes for 2018 – a very slow and gradual rate hiking cycle which would mimic the Fed’s tightening in 2015-2016.

The Fed and BoE have cried wolf in the past only to then keep rates on hold. Precedent suggests that a combination of very weak domestic and global macro data and significant Brexit-related setbacks (for the UK) could derail these central banks’ aspirations.

But my twin forecasts of the Fed hiking only twice this year and the BoE only starting to hike in 2018 are clearly at risk. Both central banks have, in my view, set the bar pretty low for a Q4 hike or put differently set the bar quite high to keep rates on hold.

The corollary is that financial markets’ reaction function to forthcoming macro data and events could be asymmetric, with bond yields rising and the Dollar and Sterling strengthening further on the back of good data and/or positive event risk but not reacting as much to weak data and/or negative event shocks.

The Fed confirmed at its policy meeting that it would start as of October reducing its $4.5trn balance sheet. The timeline and timescale, which had been flagged at its June policy meeting, is clearly designed to be slow and gradual in a bid not to spook markets and avoid a repeat of the 2013 tapper-tantrum.

I argued in Paradox of acute uncertainty and strong consensus views (3 January 2017) that “German general elections scheduled for September may well lead to a more divided parliament, making it harder to form a majority coalition government. But it is difficult at this stage to see who will realistically challenge Chancellor Merkel who is striving for a fourth consecutive election victory”. Nine months on and with German federal elections scheduled for Sunday my view has not changed materially.

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