As we head into the new week towards the critical meeting of the FOMC, the speculation around the FED’s decision continues to dominate the press, together with the ramifications of all the possible outcomes. But there is a new and worrying Global Macro concern emerging against that background, which contains many more serious implications; the question of the numerous QE programs and Supply issues.
The major macro themes of interest are:
Additionally, this past week, we have seen the election of Jeremy Corbyn in the UK, as the new leader of the Labour party. As a representative of the more extreme political Left this holds its own implications for the UK and for the GBP, as the future unfolds. Greek elections will be upon soon and the Emerging Markets crisis continues apace, so there is plenty of potential catalysts along-side the FED.
Currently, Wall Street is deeply divided in its predictions and opinions about the outcome of the FOMC’s decision on the beginning and pace of the hiking cycle. Both sides debate convincingly on the merits of tightening and as well as delaying such a decision and both can justify their stance. Of course we understand that a rate rise will exacerbate the downward pressure on commodities and particularly worsen the emerging market crisis and worsen conditions in China. However, there are many now who point to the global deflationary trends, as reason enough to delay the process of hikes until December or even into 2016.
Predicting the outcome does not take us far. Predicting the effects implied by a rate hike and its timing is essential.
What Happened To Markets The Last 15 Times The Fed Tightened…
In an article, “What Happened To Markets The Last 15 times The Fed Tightened”, that was published in Business Insider in Jan 2013, we can see an analysis by Deutsche Bank’s Chief US Equity Strategist David Bianco. Even if we take the last three hiking cycles the consequences were very different. Compare for example, 1992 when a bond sell off was triggered causing flows away from the USD and the inevitable weakening of the Greenback, to 1999, as rates started rising from 5% and when Clinton policy was to strengthen the Dollar, the demand was there and the USD gained ground. In 2006, there was a bull market in both commodities and equities and a different political background. The S&P500 added 6.3% from the beginning of the tightening but the dollar lost ground.
And what of this time? If the FED does move on rates what should we expect? One thing is certain; we have to look behind the volatility and short term movements for clues as to how the USD may behave. This is not a binary event!
The topic of “what moves international stock and bond markets”, was explored in a BOE working paper with the same title in June, written by Gino Cenedese and Enrico Mallucci. It makes interesting reading in the light of current events. Their conclusions were that international bond returns are mainly driven by inflation news. They also reached the conclusion that bond flows to emerging markets are sensitive to revisions in expectations about future interest rates relative to equity flows.
There has been a good deal of doubt cast over the question of Chinese data and how reliable it is in the context of manipulation but if we instead consider data from South Korea we can be in no doubt of the implications of export data which last month plunged -14.7%.
Images courtesy of www.businessinsider.com
Global Macro Analysis
In China, Industrial output was weaker for August confirming the slowdown in growth and particularly in the manufacturing sector. This brings us to the one simple question that we must continue asking: where will growth be coming from on a global basis? How much is the global deflationary trend going to be affected by the data? If those statistics persist then, how can we possibly move into a higher interest rate environment?
In the Eurozone Mario Draghi has hinted on a possible extension of the QE with the admission that the measures are not working as they would expected. Extensions are now likely but what they can achieve is now in doubt. In the UK as inflation data fell back towards zero, the drop in commodities were cited. The truth is if commodities continue downward and particularly oil, higher rate environments become even more unlikely.
There is a further grave problem highlighted by an IMF’s paper titled: “Portfolio rebalancing in Japan: Constraints and Implications for QE”. This is a major concern! The IMF have in effect warned of a situation where the BOJ will have to taper even against their wishes due to a shortage of sellers. There are suggestions that BoJ may need to taper in 2017 or 2018. The same risk presents itself to the ECB, already admitting failure of the current program.
The Chinese have their own ways of controlling their challenges. For their currency protection and limiting volatility, they are going to introduce from October 2015 putting aside 20% in FX Reserves making it more expensive to bet on currency fluctuations.
This is important to note as accumulation FX Reserves will not be enough to protect China or emerging markets from a currency crisis. When we say that China holds $1.7 trillion in FX reserves or that Brazil for example holds $380 billion, what exactly does this mean? Do they actually have so much money in dollar bills and US bonds stored in a safe somewhere?
What kind of reserves do central banks hold in emerging markets and China?
The concern over diminishing reserves is not new. The twist is that the reserves held in the form of forwards, swaps and other securities will not help them to protect their currency. The cash is simply not there in the quantity it may be required. In such an environment FX reserves become a liability rather than an insurance against a potential devaluation.
The Week Ahead/ Opportunities
MSWorld; very bearish, accumulating below 200EMA / FXI (ChinaFTSE) Very bearish, also below 200 EMA
images courtesy of www.stockcharts.com
BUND; zone to watch, 155.41 to 155.81. Strong moves possible from the Value Area. Also watch for break and acceptance below 154.60 to move lower.
US Bond 10yr; Balanced as Wall Street is balanced. Price currently inside value area; watch 127.10
EURUSD; watch for consolidation back below 1290, all depends on the news and there are better opportunities in Bonds and Equities.
US Dollar Index; bottom of balance, staying below Value is bearish but again news dependant. Use balance for reference.
EUROSTOXX50; Another balance and a possible short below;
This is a week to expect increased volatility . There is an increasing use of Algorithms and a lack of liquidity which can cause unexpected swings. We maintain our focus on the big picture and await post meeting opportunities.