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from Global Investing:

Strong dollar, weak oil and emerging markets growth

Many emerging economies have been banking on weaker currencies to revitalise economic growth.  Oil's 25 percent fall in dollar terms this year should also help. The problem however is the dollar's strength which is leading to a general tightening of monetary conditions worldwide, more so in countries where central banks are intervening to prevent their currencies from falling too much.

Michael Howell, managing director of the CrossBorder Capital consultancy estimates the negative effect of the stronger dollar on global liquidity (in simple terms, the amount of capital available for investment and spending) outweighs the positives from falling oil prices by a ratio of 10 to 1. Not only does it raise funding costs for non-U.S. banks and companies, it also usually forces other central banks to keep monetary policy tight, especially in countries with high inflation or external debt levels. Howell says:

If you get a strong dollar and intervention by EM cbanks what it means is monetary tightening...The big decision is: do they allow currencies to devalue or do they defend them? But when they use reserves to protect their currencies, there is an implicit policy tightening.

The tightening happens because central bank dollar sales tend to suck out supply of the local currency from markets, tightening liquidity.   That effectively drives up the cost of money, as banks and companies scramble for cash to meet their daily commitments.  Central banks can of course offset interventions via so-called sterilisations - for instance when they buy dollars to curb their currencies' strength, they can issue bonds to suck up the excess cash from the market. To ease the tight money supply problem they can in theory print more cash to supply banks.  But while many emerging central banks did sterilise interventions in the post-crisis years when their currencies were appreciating, they are less likely to do so when they are trying to stem depreciation, says UBS strategist Manik Narain.  So what is happening is that (according to Narain):

from Morning Bid with David Gaffen:

Simple Tricks and Nonsense

Heading into the end of a violent week and ahead of a slew of earnings reports, the market has swung from one extreme to another, as the average daily move in the S&P 500 rises dramatically, as futures promise another big drop at the open Friday, and as investors try to take stock of what's happening here in their beloved stock market.

The U.S. economic growth situation hasn't changed all that much - after all, jobless claims continue to fall and the expectation again is for another strong earnings season. And, as awful as Europe is right now, there's only so much damage its economy can do to the U.S. The extent of that should be known before long if recent German data is any guide.

from Morning Bid with David Gaffen:

Speak softly, and carry a big helicopter

Days like Wednesday are the ones that remind investors why the Federal Reserve is what it is, and how some believe the other world central banks cannot compete, even as some expect the European Central Bank and Bank of Japan (to an extent) to take up the slack the Fed will leave behind when it ends quantitative easing in the next weeks and prepares for its first interest-rate hike some time in the third quarter.

The odds on that hike, by the way, shifted late Wednesday after the Fed's minutes showed there was concern about moving policy too quickly. It’s the pace of increases that worries the Fed, not the idea of doing it at all. The Fed is likely to push rates to about 50 basis points either in July or September (the market is betting on September now, the Fed is probably thinking July), but it’s important to keep in mind that the monetary policy committee is not going to then start doing the one-move-per-meeting thing they did in the last rate-hiking cycle back in the Pre-Cambrian Era.

from Morning Bid with David Gaffen:

Five and Five

Just when the market thought it was out, it got pulled back in. The Federal Reserve will release its minutes later in the day that details what it was thinking during its most recent September policy meeting, but of late, the markets have been of a mind that the expectations for higher rates ought to be tempered a bit.

On Tuesday, New York Fed head William Dudley suggested in remarks that the chances of economic growth in the long-run coming in faster than anticipated is a fantasy that people should get shut of - and so that helped take down the market and not ironically contributed to a further decline in the five-year/five-year forward spread that serves as one of the market's best barometers of inflation expectations.

from Morning Bid with David Gaffen:

Dollar bulls, equity bears

The preparation for tighter U.S. monetary policy is showing up in markets in a number of areas, most notably through the appreciation of the dollar which has a greater affect on GDP growth than people sometimes realize. Rising strength in the greenback, which would be expected to continue given the dovish monetary policies being pursued in Europe and Japan, turns into notable weakness in a number of U.S. sectors tied to exports like autos and energy.

US assets 2014

Citigroup's William Lee dives into this by pointing out that substantial rallies in the dollar have the power to brake GDP in a way that Fed tightening even doesn't, saying GDP growth could decline by a percentage point if the rapid move in the dollar continues through early 2015.

from David Gaffen:

MORNING BID – For a few dollars more

The dollar is now running a 10-week streak of strengthening (using the dollar index, which is a basket of currencies but mostly the euro and yen), and while that streak will end at some point, the overall trend does not look likely to abate in the near-term. That presents some interesting opportunities in markets, trends that have already been playing out but are likely too to persist as investors concentrate more on companies less exposed to areas like Europe and more exposed to the United States.

The weakness in the euro eventually is going to undermine sales there from U.S. companies - even though the euro is still on balance stronger than the greenback, it's threatening to continue to slip against the dollar, with Goldman Sachs strategists believing that it will eventually hit parity as the tendencies of the major central banks pass like ships in the night. For the year so far, Goldman's basket of S&P stocks that are mostly exposed to the U.S. economy is up 13 percent on the year, with a 3 percent gain in the last month; its basket of companies exposed most to Western Europe is up 6 percent on the year, and flat on the month. What's concerning is that the domestically-oriented names are sporting overall higher price-to-earnings ratios at 19 compared with 16 for the Europe group, and so these companies - the likes of Intuit, UnitedHealth and a few other major health insurers, a few brokerages, AT&T, and a bunch of others - could be overvalued. It's also possible that the dominance by the health companies in that growing area is overwhelming any weakness in any of the other sectors.

from Counterparties:

MORNING BID – Apres Fed, le Deluge

The Kremlinologists turned out to be right, and the Federal Reserve left its "considerable time" language in its statement to assure the markets that it would be around for a while longer with rock bottom rates. It's the divergent (to a point) reaction out of the markets themselves that is interesting to parse, and will be key to watch in coming weeks and months. The action in the stock market was to suggest the entire exercise was a snooze-fest, with stocks ending marginally higher (yes, the Dow at a new record) but not too far from where the major averages were trading just before the news. Which is to say the equity market, always the most optimistic of U.S. markets, has it in mind that low rates stay for now, and until "now" is "then," it's time to party.

Bond markets, inflation-protected securities and the currency markets saw things differently, and it's those markets that may be more instructive to watch as the days and months go on and on. The five-year TIPS note saw its yield break above zero for the first time in ages, a sign that investors are starting to worry more about inflation, or higher Fed rates, which is interesting as consumer price data showed year-over-year inflation fall to a 1.7 percent rate earlier in the day. The dollar put together another strong rally, meanwhile, with the dollar index hitting highs not seen in 14 months and big rises against its main companions, the euro and the yen. And this is where the dot matrix comes in.

from Counterparties:

MORNING BID – European Deflation

Never say the Europeans aren’t cautious. The dollar has been on a roll of late, in part because of the market’s growing expectation for more stimulus from the European Central Bank before long that would include some kind of larger-scale quantitative easing program after a speech last week from Mario Draghi that European markets seem to still be reacting to several days later. Reuters, however, reported that the ECB isn’t quite likely to do move quite so fast (heard this one before) and that took some of the wind out of the dollar’s sails and boosted the euro a bit.

Some of the move in the euro will depend on the trend in European yields, where everything is going down – German Bunds continue to make their way rapidly toward zero, and Bund futures remain in an overwhelming bullish trend, per data from Bank of America-Merrill Lynch. Analysts there also anticipate the dollar is going to experience some kind of medium-term correction – but remains in rally mode otherwise. There’s a headwind there for equities from that – rising greenback makes U.S. goods more expensive, but the gains are still only in earlier stages, and haven’t pushed into territory that would otherwise indicate surprising strength that we haven’t seen in some time.

from Breakingviews:

“Seller beware” when profiting from market calm

By Swaha Pattanaik

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Seller beware. That is an unusual warning, but it applies right now to the options market. Sellers of protection against large price moves have been pocketing gains. But many will suffer losses if markets become less calm.

from Expert Zone:

Currencies and the collapse of globalisation

(Any opinions expressed here are those of the author and not of Thomson Reuters)

We live in stirring times. The president of the European Central Bank, Mario Draghi, crossed the monetary policy Rubicon and cut one of the euro area’s key interest rates into negative territory. This is dramatic stuff, as even the most economically oblivious are likely to recognise that negative interest rates are a radical policy.A picture illustration of Euro banknotes and coins taken in central Bosnian town of Zenica

At the same time, the United States Federal Reserve is gracefully gliding out of its quantitative policy position - and by October that money printing process is likely to be effectively at an end. The question from most investors is therefore “what next for U.S. monetary policy?”.

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