The Federal Reserve’s policy-setting committee meets this week to discuss the outlook for the U.S. economy and for rates. It’s something of a shame for Janet Yellen & Co that the event will be mostly overshadowed by the outcome of the Scottish independence referendum two days later. The dollar is around its highest in over a year and logic would dictate that this is a function of the growing expectations for the Fed to signal its first rate rise in almost a decade. At least that’s the theory.
The practice is a lot less dollar-centric, according to BNY Mellon chief currency strategist, Simon Derrick. The dollar has gained more than 5 percent so far in 2014 against a basket of currencies, putting in track for its largest increase in a year since 2008, the year the financial crisis exploded. But this has a lot less to do with the Fed gradually inching towards tighter monetary policy and a lot more to do with just about everything else. “It seems to me that expectations about Fed have actually been least important element in USD performance over past month,” Simon said. “Look over the past month and each USD move has really been about external factors Mid-August – that was about Japan and (its pension fund); early September – that was about the ECB and then Scotland. It feels very much as if the dollar has been the funding currency of choice over past 12 months and that what we are really seeing is a variety of factors that are denting confidence in carry trade.”
We decided to take a break from Scot-fever today and take a long hard look at how the European Central Bank’s latest lifeline will have an impact on the euro zone economy, which seems to be sinking into dangerously deflationary territory, and what it means for the euro, which is rapidly looking like the last child to be picked for the school sports team. The euro has borne the brunt of investor desire for yield and the bears are now prowling around it. The ECB last week cut interest rates to just 0.05 percent and pledged to buy asset-backed securities and covered bonds as a means of thawing out long-frozen credit flows to small- and medium-sized businesses in the euro zone. The bank stopped short of unveiling full-blown quantitative easing – where it would purchase sovereign bonds – but government bond yields have hit record lows and the euro has lost ground against every major currency bar the rouble, the Polish zloty and the New Zealand dollar over the last month as a result. But will it be worth it? Our guest today, Professor Reto Foellmi of the University of St. Gallen, said he wasn’t sure it was a price worth paying. “Concerning the ECB, I doubt whether these additional measures work. It is more of the same,” he said. ECB president Mario Draghi did the right thing by promising two years ago to do “whatever it takes” to save the euro and the commitment to buy the sovereign bonds of any euro zone nation in need of an emergency financial lifeline that met a series of conditions. “ This bought time for “real politics” but they did not use it,” Reto said, on the pressure from the ECB on the more indebted nations to bring their houses in order and implement serious structural reforms, rather than relying on handouts from the central bank. “The imbalances in the euro zone are still present and I fear more and more that we resemble the Japan experience two decades ago,” Reto added. Japan spent years trying to exit deflation and only now, having thrown trillions of yen at the economy, has started to do so. Bank of France governor Christian Noyer, who is also a member of the ECB’s governing council, said the central bank had achieved its aim of bringing the euro lower, but the currency needed to fall much further in order to raise inflation, currently running at around 0.3 percent, closer to the ECB’s threshold of near 2 percent. How much lower is “lower”? A Reuters poll taken last week showed most traders believe the euro will rise to around $1.31 in a month before falling to $1.28 by the end of the year, below its current level of around $1.29. In an informal straw poll in the forum, members were split over whether the euro’s next move over the coming week would be up or down, but in the longer run, it seems the single European currency doesn’t have that many friends out there right now.
Apple’s hotly-awaited iWatch smartwatch has featured on the front page of virtually every major news outlet and blog today, eclipsing the company’s new iPhone 6 model. The all-singing, all-dancing gadget will receive phone calls and messages, play music and monitor heart rates via special sensors. But almost more interestingly, it will incorporate Apple Pay, the company’s new mobile payments system that it unveiled at the iPhone 6 launch last night. One of the obstacles that a lot of fledgling digital payments systems face is not the unwillingness of consumers to embrace e-cash, but that of the retailers. But perhaps not for long, according to our guest today. who founded asset manager Altana Wealth, runs an alternative currency fund and is something of a digital money convert. He said this trend among consumers to conduct more and more of their transactions electronically poses one the biggest threats the traditional retail banking model has ever faced. Lee said the banks’ grim reality is that of the ever-changing demands of their customers and this could ultimately cause retail banking to go the way of the dodo. “Surveys that say 18-35 year olds would rather bank with Google/apple than a normal bank,” he told us. Sources of credit that totally exclude the banks, such as peer-to-peer lending or crowd-funding, digital currencies like bitcoin and electronic payment systems such as PayPal, all raise the possibility that banks may become extinct, Lee said. “Does anyone really care who lends them money as long as the rate is good?” Lee said. “Banks are entering a competitive commodity space. It’s very bad for profits especially levered companies like banks,” he said. “We are living in very exciting times. more going on today than late 90s in my opinion in tech world … supermarkets are just warehouses with bright lights and shelves (although) there are exceptions … Similarly banks.”
Any complacency about the outcome of the Scottish independence vote on Sept. 18 was knocked out of the UK markets today after a pre-election survey over the weekend gave the “yes” campaign a lead for the first time. Sterling has fallen to its lowest in 10 months against the dollar, having suffered its largest week-on-week fall in nearly three years, while the FTSE100 has lagged behind the rest of the major European benchmarks. A YouGov survey for the Sunday Times newspaper was the first this year to give the “Yes” to independence campaign a lead, putting it on 51 percent against the “no” camp on 49 percent, overturning a 22-point lead for the unionist campaign in just a month. “My own view is that media spin is intended to frighten soft Noes to the polls,” Reuters analyst Neal Kimberley told us today. “Sterling could conceivably go below $1.60 if the polls stay tight.” All very dramatic stuff. Online peer-to-peer betting platform Betfair said today on its blog this was “easily the biggest UK political market of recent years. With the result on a knife-edge, expect much more over the final fortnight of the campaign, with each poll prompting further market volatility.” Indeed, as “#indyref” fever has broken out, short-term option volatility on sterling is at its most expensive – indicating that traders believe the currency could move sharply in one direction for another after the vote – for two months. The pound is one of several contentious issues in an increasingly heated Scottish referendum debate. Pro-independence leader Alex Salmond says Scotland will share the currency while Westminster has ruled this out, leading to uncertainty about valuations, debt and the sharing of North Sea oil revenues. Neal said so much uncertainty will weigh on the pound, but any weakness goes beyond the Scottish vote. “With the spin on the YouGov poll, rather than the poll itself, being the story, the pound is set to stay soft,” Neal said. “But let’s understand what’s really going on… this is not so much a market getting short of sterling, but one getting out of a structural long position,” He said. “The … mentality has been to focus on the Bank of England and a possible rate hike, and better UK data than being seen elsewhere it was ill prepared for the tightening of the polls north of the border, a fact realised in the lack of movement in volatility until last week.”
All hail the dollar/yen! The greenback gained nearly 4 percent against the Japanese yen in the space of just 6 weeks and is now close to its highest since the start of the year. It doesn’t look like it will stop there either, thanks to a heady mix of geopolitical and macroeconomic uncertainty, according to our guest today, IFR technical analyst Martin Miller. Even with the confusion over today’s mixed messages from Kiev and Moscow about a potential ceasefire in Ukraine’s war-torn east, there is enough risk appetite out there to give the dollar another lift and against what better currency to fund such a position as the low-yielding yen?
“The overall scope is for eventual gains through towards 105.45, which was the 2014 high posted back in January,” Martin said. “It might well struggle for the rest of this week to get through this level, but eventually, perhaps next week, we should see a daily close above 105.45 which will unmask 106.00.” The dollar hasn’t caught a whiff of 106.00 since the depths of the financial crisis in late 2008, when Lehman Brothers collapsed. Aside from any lingering geopolitical risk, there’s plenty of macro risk this week as well, with the European Central Bank set to release its policy decision on Thursday and then the all-important monthly U.S. jobs report and dollar/yen is reacting accordingly.
Martin noted one-month at-the-money implied volatility for dollar/yen – a short-term gauge of how active traders expect this currency pair to be – has risen to its highest in three and a half months today, having topped 6 percent and beating its three-month average of closer to 5.1 percent. “I would stick to USD/JPY if you are looking for more vol,” he said, adding that volatility could rise even further, especially given the scope for the unexpected.
Financial markets have got it into their collective head that the UK economy is recovering and that a rate rise is imminent. But is Bank of England governor Mark Carney on the same page? Almost certainly not, according to Ian Campbell, our guest today from Breakingviews, who says the UK may continue to see low rates until 2016, a year later than markets are currently pricing in, after Wednesday’s quarterly inflation report. “I’m not sure he is deliberately trying to confuse the markets,” Ian said of Carney. “His ‘Mansion House’ speech sounded more hawkish—perhaps more hawkish than he intended. One thing he is saying is that markets should look at the data.” Depressed UK wage growth, the prospect of softer inflation as the oil price barely holds above $100 a barrel and the eurozone – the UK’s key export market – struggling to fend off deflation as many of its key economies falter are some of the factors that could well stay the BoE’s hand. Sterling as a result has dropped to its lowest in four months against the dollar, which some of our GMF members believe is something of a welcome development, after cable touched a five-year high above $1.70 just a month ago. “I’m with you on the pound. In the U.S., earnings are rising by close to 2 percent. Labour participation has dropped and the inflation rate is pushing up—though not very different to the UK’s for now,” Ian said. “However, I think the Fed will need to raise rates next year. The U.S. economy has grown by a lot more than the UK since 2008 and has recovered for more. The delay there could be inflationary,” he added.
Can you guess which major asset has gained the most so far in 2014 and looks set to gain further? The S&P 500 is hovering just shy of record highs, while emerging markets have gained some 20 percent since the worst of the market turmoil in February. But it is not a major stock market, not even the mighty German DAX, which gained close to 30 percent in both 2012 and 2013, that tops the league tables. Rather, it is gold and it’s no coincidence given the extent to which investors have been unnerved by the outbreak of the crisis between Russia and the West over Ukraine, as well as by their dubiousness over the resilience of the recoveries in both the United States and China. Granted, U.S. interest rates look more likely to rise than fall over the coming year as the data is coming in stronger, but even the hardiest gold bear would do well to allocate some of their hard-earned cash to bullion, our guest today, Mark O’Byrne, from online bullion dealer Goldcore said. “It is all about diversification and not a question of ‘either or’ regarding major assets,” he said.“ It is not absolutely safe – nothing is, but a significant body of academic research and history shows it acts as hedging instrument and safe-haven asset. At the same time, it should only be an allocation in a portfolio of some 5 to 20 percent.”
The gold price saw an epic 12-year bull run – something not even the mighty S&P 500 has been able to achieve – come to an end in 2013, when investors grew confident enough about the outlook for the global economy to move into more risk-sensitive assets such as equities, thereby boosting the dollar. Since then, the gold price has risen by nearly 8 percent to just above $1,300 an ounce. That said, it is still worth just over half of its inflation-adjusted record high in the 1980s of some $2,400. The grim reality is that sentiment in the gold market is close to its worst in living memory, as miners and refiners deal with a price that has fallen by more than 30 percent from its peak just three years ago and investment banks jettison their precious metals and broader commodities businesses for fear of falling foul of new U.S. trading regulations.
It looks like there will be no avoiding austerity for Ghana, which has just gained the agreement of the International Monetary Fund to help the sub-Saharan nation with its economic challenges, but this might be what the country needs to stabilise its currency and restore its image as rising regional star, our guest today said. Ghana’s growing budget deficit, fuelled by government spending outpacing revenue, and stubbornly high inflation are just two of the factors that have pushed the cedi currency into what can only be described as free-fall, with a 60-percent drop against the dollar in the year to date, its worst yearly fall since its value halved over the course of 2000. The government’s reluctance to seek outside help has cost it precious time, but our guest today says the fact that President John Mahama has engaged with the IMF will serve as reassurance to investors. And with a $1.5 billion Eurobond due to come to market later this month, it’s not a moment too soon.“The immediate reaction has been a near 7 percent appreciation in the cedi last week compared to the week before, so we are beginning to see the benefits come through. In Ghana’s case a dose of austerity will be needed as the flipside of a cut in government spending,” Angus Downie, head of research at pan-African lender Ecobank, said during a visit to GMF. “An IMF loan would help comfort many investors, as it would bolster the policy reforms to be implemented. But the government would probably be keen to take the policy advice only, as a loan might signal weakness or failure of their own efforts,” he added. Indeed, Ghana was the first sub-Saharan African country outside South Africa to tap the Eurobond market in 2007 and as Reuters Breakingviews pointed out last week, the country’s problem isn’t inadequate economic growth. Real GDP rose 7.3 percent in 2013, only modestly below the 8 percent target and one of the highest increases in Africa. Even in the first quarter of 2014 real GDP rose at a 6.7 percent annual rate. But taking the IMF’s advice, which most market-watchers agree will be austerity-shaped, will send a more powerful signal than anything else. “ The technical advice is the key issue for me as FX reserves are not yet at a critical low level,” Angus said.
So you think the summer is a quiet time for the markets? Think again! Using the VIX index, which tracks changes in the implied volatility of options on the S&P 500 index, as a gauge, markets are far more likely to be choppy in the months of July, August and even into September. In the last 20 years, the VIX rises by an average of 10.2 percent in July, making this its most volatile month, followed by an average of 5.8 percent in August and another 8 percent in September, the second-most volatile month of the year.
Implied volatility in the currency market has hit multi-year lows, sparking some concern in GMF about complacency, but even that is picking up as the northern hemisphere summer goes on. Looking at the average change in one-month implied volatility for both the yen and the euro, the month of May sees the largest increase in the two, right in time for the start of the summer.
The euro has taken a lot of flak this week in the GMF. From its billing as most unloved currency in the G10 space for a number of our analysts and traders, to the bane of the big European corporates, many of which this week have complained of a hit to their balance sheets from the currency’s relative outperformance earlier in the year.
Big Paris-listed names such as automaker Renault, construction rivals St Gobain and Lafarge, as well as German luxury carmaker Daimler have all pointed to the headwinds created by the euro’s strength against the dollar, as well as against a lot of key emerging currencies such as the Chinese yuan, the rouble or the Brazilian real.