Category Archives: Big Picture

Plan B

Global and US equity markets are hitting new all-time highs at an almost metronomic rate while the VIX continues to hover around a historically-low 11. Moreover, major currencies have remained within narrow ranges in the past couple of months.

Rising global economic activity, still accommodative central bank monetary policy, a historically average crude oil price and increasingly realistic prospect of US tax cuts, among others, continue to buoy global financial markets and tame asset price volatility.

Financial markets have seemingly largely ignored macro, political and geopolitical risks which include 1) monetary policy uncertainty and risk of central banks “getting it wrong”, 2) the impact on emerging markets from higher rates and stronger funding currencies, 3) the shaky underpinnings of global economic growth and 4) political uncertainty in Europe.

The question is whether governments and central banks have a Plan B to reflate their economies and/or support financial markets in the event of an exogenous shock to global growth and/or sharp correction in global financial markets.

The willingness of the private sector in developed markets to borrow more in order to fund economic activity would likely be greatly tested given already high levels of indebtedness and I would not expect corporates or households to be the main source of reflation.

Similarly, the ability and willingness of developed central banks to cut policy rates further and re-start QE programs would be limited in my view.

Precedent suggests that central banks in emerging markets, including China, would likely use considerable FX reserves of around $8trn to slow, if not stop, any shock-induced, rapid and/or sustained depreciation in their currencies.

However, aggregate data mask significant country-side variations while large percentage changes in FX reserves tell us little about their absolute size.

Governments in developed economies could ultimately take over from central banks in a more pivotal role while the governments of China and other Asian economies have repeatedly shown their willingness and scope to use a broad arsenal of measures. Read more

My Top Currency Charts

My macro & FX analysis is premised on both a detailed qualitative assessment of Emerging and G20 fixed income markets and economies and a rigorous quantitative analysis of data, trends, policy decisions and global events too often taken at face-value.

A picture can say a thousand words and a well-constructed and timely chart can shed light on often complex economic and market developments and challenge engrained assumptions.

Ideally, a chart will be forward-looking and a valuable tool in helping forecast economic and market developments and ascertain whether possible market mis-pricing may trigger turning-points or corrections.

There are of course limits to what even the best chart can do, with in particular the line between correlation and causation sometimes blurred. One should also be weary of reading too much into sometimes limited or patchy data sets and underlying data sources can add to or detract from the chart’s credibility.

Moreover, a chart can lose its potency over time, so while on average my research notes include about a dozen charts and tables I am constantly adding new ones.

I have re-published and updated below a small cross-section of the currency-specific charts which continue to play a central part in my narrative and forecasts, including:

  1. Global Nominal Effective Exchange Rates (NEERs)
  2. Euro and government bond yield spreads
  3. Sterling NEER
  4. Sterling NEER and annual pace of appreciation/depreciation
  5. The Renminbi NEER
  6. Renminbi NEER and monthly pace of appreciation/depreciation

 

I will in coming weeks expand on other notable charts and for a more detailed analysis I would refer you to my previously published (hyperlinked) research notes.

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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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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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Broken Records

The past year has been remarkable with political precedents set in the US, UK and France, still record-low central bank policy rates in most developed economies and financial markets and macro data at all-time or multi-year highs (and lows).

The US presidency is fraught with problems but markets are turning a blind eye…for now. The UK is still on course to be the first ever member state to leave the European Union come 29th March 2019, at least on paper. French elections have repainted the political landscape and present many opportunities but old (fiscal) hurdles still need to be cleared.

Central bank policy rates remain at record lows in the majority of developed economies, including the Eurozone, UK, Japan, Australia and New Zealand and I expect this to remain the case for the remainder of the year. Loose global monetary policy is likely to continue providing a floor to risky assets, including equities and emerging market currencies.

A number of central banks have hiked 25bp in recent months, including the Fed, BoC and CNB, in line with my year-old view that rate hikes would gradually replace rate cuts. But in aggregate the turnaround in developed central bank monetary policy is proceeding at a glacial pace and I see few reasons why this should change.

The Bank of England has not hiked its policy rate for 526 weeks – a domestic record – and I continue to believe that this stretch will extend into 2018.

In contrast to the Dollar and Sterling, the Euro – by far the most stable major currency in the past seven years – has appreciated over 7% since early April.

While the ECB may want to slow the current rapid pace of Euro appreciation, it is unlikely to stop, let alone reverse, the Euro’s upward path at this stage. For starters, Eurozone growth and labour markets continue to strengthen. The German IFO business climate index hit three consecutive record highs in June-August.

Perhaps the most obvious record which financial markets have broken is the continued climb in US equities to new highs and volatility’s fall to near-record lows.

Emerging market rates continue to edge lower in the face of receding inflationary risks and I see room for further rate cuts, particularly in Brazil given the pace of Real appreciation.

Non-Japan Asian (NJA) currencies continue to broadly tread water, in line with my core view that NJA central banks have little incentive to materially alter their currencies’ paths.

Year-to-date emerging market equities have rallied 24%, twice as fast as the Dow Jones (12%) which has rallied twice as fast as EM currencies versus the Dollar (6%). Read more

H2 2017: Something old, something new, something revisited

As we head towards the second half of 2017 and the one-year anniversary of the UK referendum on EU membership, many themes which have pre-occupied financial markets in the past 12 months are likely to continue dominating headlines.

These include Donald Trump’s US presidency and its longevity, merits and scope for tax reforms and infrastructural spending, Brexit negotiations which officially started on 19th June and the resilience of the ongoing recovery in global GDP growth.

Global GDP growth rose modestly in Q1 2017 to around 3.12% year-on-year from 3.06% in Q4 2016 and a multi-year low of 2.8% yoy in Q2 2016, according to my estimates.

But the global manufacturing PMI averaged 52.7 in April-May, down slightly from 52.9 in Q1 2017, suggesting global GDP growth may not have accelerated further in Q2. This could in turn, at the margin, delay or temper policy rate hikes and/or unwinding of QE programs.

Non-Japan Asian currencies have in the past month been even more stable than in the preceding month, in line with my expectations, but a more pronounced policy change – particularly in China – remains a possibility.

Other themes, such as the timing and magnitude of higher policy rates in developed economies and falling international oil prices, have recently come into clearer focus and will likely be of central importance in H2.

For the UK, I am sticking to my view that a 25bp policy rate hike this year is still a low probability event and I see little chance of an August hike.

The uncertainty over the MPC’s interest rate path and the government’s stance on Brexit complicate any forecast of Sterling near and medium-term but I continue to see the risks biased towards further depreciation.

In France, the hype surrounding Emmanuel Macron’s presidential and legislative election victories is already giving way to whether, when and how smoothly the LREM-MoDem rainbow government can push through its reformist agenda.

Finally, while most European elections are now thankfully behind us, European financial markets are likely to attach great importance to the outcome of Germany’s general election on 24th September.

Conversely, the burning topic of rising European nationalism and future of the eurozone/EU has lost traction following recent presidential and/or legislative elections in France, the UK, Netherlands and Austria. Read more

The Ultimate Guide to the 2017 French Elections – Part IV

The outcome of the first round on 23rd April remains a close call and I am once again reminded of President de Gaulle who, in a nod to the French electorate’s heterogeneity, asked how it was possible to govern a country where 258 varieties of cheese exist[1].

This granular political landscape has come into focus in recent weeks. Polls show that in the first round National Front candidate Marine Le Pen and the centre-left independent Emmanuel Macron are still slightly ahead of far-left candidate Jean-Luc Mélenchon and Republican François Fillon but the margins are barely statistically insignificant.

Moreover, a large share of voters – up to 45% of the registered electorate – remain undecided on whether and how they will vote. These voters will likely swing the election.

Nevertheless, I am sticking to my core scenario that Macron will make it to the second round which he would win regardless of whom he faces given his strong cross-party political support and reasonably high popularity amongst voters.

While all the main candidate advocate some kind of reform of the EU and eurozone, Le Pen is campaigning on the premise that France needs to leave the eurozone and has promised to hold a referendum on France’s EU membership if elected.

Implied euro volatility has surged – a trend partly attributed to markets pricing in a higher probability of either Mélenchon or Le Pen being elected president. But actual euro volatility remains subdued and the fall in the euro and 2 and 5-year French government bond prices in recent weeks has been modest.

The consensus forecast, which I share, is that the Euro and French government bonds will rally if Macron or Fillon is elected president while the Euro would weaken sharply and French yields rise significantly should Le Pen or Mélenchon become president.

However, with an almost infinite number of scenarios to consider, any forecast of where European financial markets may end up and how they get there remains tentative at best.

There has been little focus on the elections for the French National Assembly, to be held over two rounds on 11th and 18th June and yet they will decide the composition of one of France’s law-making institutions and dictate from which party hails the Prime Minister.

Unless Fillon becomes President, it is likely that for the next five years the President and Prime Minister will not come from the same party or share the same political agenda – a period of “Cohabitation” which would clip the authority of Le Pen, Mélenchon and to a lesser extent Macron, and is usually associated with political instability. Read more

The Ultimate Guide to the 2017 French Elections – Part III

The first round of the French Presidential elections is due to be held in 17 days (on 23rd April), with the likely second round two weeks later on 7th May. The eleven presidential candidates yesterday took part in the final televised debate before the first round.

Weighing their performances remains fraught with difficulty and the key question remains whether the centre-left candidate Emmanuel Macron and National Front leader Marine Le Pen are still likely to make it to the second round.

This in-depth four-part Election Series examines all core elements of the upcoming presidential and legislative elections and takes a quantitative and qualitative approach.

In Part III, I tackle five questions, looking at past presidential elections where appropriate:

Q1: At this stage can we predict with any accuracy the eventual winner?

The media would suggest that we cannot and there is certainly scope for surprises. At the very least opinion polls could be under or over-estimating candidates’ chances. But if Macron and Le Pen make it to the second round, Macron looks set to be elected President based on opinion polls.

Q2: Are French presidential opinion polls reliable?

They accurately predicted the outcome of the 2012 and 2007 presidential elections and the eventual winner of the 2002 election. But opinion polls under-estimated support for Jean-Marie Le Pen in the first round in 2002.

Q3: What are French opinion polls currently predicting?

Macron and Le Pen are neck and neck in the first round on about 25% but these polls do not account for undecided voters and turnout.

Q4: Do French regional elections tell us anything about candidates’ chances?

The December 2015 regional elections suggest that while Marine Le Pen will do well in the first round, she will struggle in the second round in the face of concerted political opposition.

Q5: What are the odds of a left-wing candidate becoming President?

While Mélenchon is likely to come a credible fourth, based on current opinion polls, neither him nor Socialist Party candidate Hamon are likely to get even close to making it to the second round.
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The Ultimate Guide to the 2017 French Elections – Part II

The first round of the French Presidential elections is due to be held in 25 days (on 23rd April), with the likely second round two weeks later on 7th May. In many ways this is proving to be a unique election campaign but the centre-left Emmanuel Macron still comfortably leads National Front candidate Marine Le Pen in second round polls.

This in-depth four-part Election Series examines all core elements of the upcoming presidential and legislative elections and takes a quantitative and qualitative approach. In Part II, I tackle seven questions, looking at past presidential elections where appropriate:

Q1: Who are the presidential candidates?

Eleven candidates, spanning the breadth of the political spectrum, will officially contest the first round in a bid to capture the 46 million or so votes up for grabs. However, Emmanuel Macron and Marine Le Pen remain comfortably ahead in the polls on around 25%.

Q2: What are their relative strengths and weaknesses?

The recent televised debate between the top five candidates was high calibre, in my view, and the front-runners have in recent months shown clear strengths…but also weaknesses.

Q3: What are the odds of a candidate winning an absolute majority in the first round?

No candidate has ever obtained more than 50% of the popular vote in the first round. This time looks no different and a second round is a near certainty based on latest polls.

Q4: Does the number of sponsors have a bearing on first round results?

The relationship is tenuous but does suggest that Le Pen will fail to win the presidency.

Q5: Does the number of candidates have a bearing on first round results?

The large number of candidates points to the winner and runner-up of the first round winning only just over half of the votes, broadly in line with recent opinion polls.

Q6: Does the first round result have a bearing on the outcome of the second round?

Precedent suggests that a small margin of victory in the first round makes the second round outcome harder to predict. This year’s election could prove a break with the past.

Q7: Does it matter who came third or fourth in the first round?

It has on a few occasions but assuming that Fillon comes third and the left-wing candidates fourth and fifth, polls point to a convincing Macron win versus le Pen in the second round.

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