Posts in US Economy
Agreeing to disagree about the DXY

One of the more interesting stories in markets last week was the disagreement about whether investors are bullish or bearish on the dollar. On the face of it, this is a silly debate. Clearly, sentiment has become significantly more positive on the dollar in the past three months, lifting the DXY index up by nearly 6% to a nine-month high of just under 95.0 at the start of Q3. On occasion, I nail my colours to the mast and try to come up with short-term ideas in equities and bonds, but I am generally loath to do it in FX markets. Currencies have a tendency to the exact opposite of what macroeconomists predict that they will. Usually, the stronger the conviction of economists, the stronger the countermove. With that warning in mind, I think it’s worthwhile looking at the stories which currently are propelling the dollar. The macroeconomic argument for a stronger dollar is simple. The synchronised global recovery has become de-synchronised since the beginning of the year, and the U.S. economy has emerged head-and- shoulders above the rest. Not only that; Europe and China have slowed while the U.S. economy appears to have gathered strength in the second quarter. 

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#Tradewars

Markets were mulling familiar themes last week. Will a wider U.S. twin deficit change the rules for the dollar and treasuries and is elevated volatility here to stay in equities? Judging by last week, the answer would be: probably and yes. The contemplation over these stories, though, were interrupted by politics. Mr. Trump announced his intention to apply tariffs on steel and aluminium—25% and 10% respectively—and Mrs. May attempted to give clarity on the U.K. government’s Brexit position.* I was unimpressed with both. Before I have a dig at Mr. Trump, I ought to provide an example of someone who supports it. I have great respect for Stephen Jen, but his argument here is like endorsing the idea of a diet by advising someone to eat nothing but kale and carrots for a decade. The analysis of Mr. Trump’s tariffs requires a distinction between the principle and the concrete measures. I concede that China is bending the rules of global trade, but Mr. Trump is stretching the fabrics of macroeconomic policy if he starts imposing tariffs on industrial goods. He is presiding over an economy close to full employment, a low domestic savings rate, and a medium-sized twin deficit. To boot, he is about to let fly with unprecedented fiscal stimulus.

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As if I was never away

It’s been a while since I had a look at financial markets. But I am happy to report that the laws of the natural world, inhabited by investors, are undisturbed. Volatility across most asset classes remains pinned to the floor, equities have pushed on—with the annoying exception of the majority of the portfolio’s holdings—and short-term rates in the U.S. also have crept higher. In this environment, the DXY has regained its footing, although it still looks vulnerable relative to many of its G7 sisters, and the yield curve in the U.S. is still not sure whether to steepen or flatten. It seems to have settled in the middle; a small rise across the curve. Political risks have returned to Europe—did it ever go away?—but I am unimpressed with the bears’ attempt to kick up a fuss. In Germany, I am reasonably certain that a government is formed, eventually. In Spain, I think the Catalan separatists are on the road to nowhere. Their leader Carlos Puidgemont is caught between a rock and a hard place, and I think they will need to have regional elections to settle what precisely the mandate is. Finally, we are supposed to worry about Italy leaving the Eurozone. Break-up risks in the euro area, however, is the dog that never barks. The periphery wants to use the euro, not jettison it for their own.

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What if the Fed doesn't matter?

Markets were focused on one of their favourite pass-times last week; fed watching. The FOMC underlined that it considers recent softness in core inflation to be transitory, and also defied uncertainty over two hurricanes which battered the U.S. earlier. Mrs. Yellen informed markets that the run-off of the Fed’s balance sheet will begin in October and that the Fed believes the economy is strong enough to warrant a continuation of the so far slow, but steady, hiking cycle. The peanut gallery saw this as a moderately hawkish statement, but this was because markets had been pricing out a December rate hike going into Wednesday’s meeting. Fed funds futures and front-end rates have since corrected to reflect a near certainty that the Federales will raise rates one more time this year, likely in December. In effect, though, the Fed merely confirmed the path that it set out 12-to-18 months ago. Last week’s signal to markets from the Fed led punters to re-evaluate a vexing question; does the market lead the Fed or the other way around? The vibe I am getting from the veterans on FinTwitter is that the Fed laid down the gauntlet, signalling that it intends to push on. If that is true, trades are there for the taking. 

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