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.
Read MoreSometimes it is best just to sit back and do nothing, and perhaps, watching the World Cup isn’t such a bad way to spend your time at the moment. Last week, I laid out what I consider the two main economic and market themes. First, real narrow money and liquidity growth is slowing, which is usually a bad sign for risk assets and second, monetary policy divergence is being stretched to new extremes. I surmise that most of the key macro-trading trends can be derived from these two stories. All other important themes are just crammed into the box labelled political uncertainty, a box which incidentally is increasingly full to the brim. The consensus is that political risk is the dog the never barks; this true on a headline level. But I can’t help but think that markets are a like deer caught in the headlight. Everyone is waiting for one of the political land mines to blow up, but no one knows what to do about it. In the U.S., Mr. Trump has escalated the global trade wars, though markets are not exactly pricing-in the end of the globalised world order as we know it. Rather, they seem to have settled on the idea that the U.S. is winning. Small cap U.S. equities have soared, and the dollar is bid. The latter effectively is an equaliser. If the dollar rises as U.S. imposes import tariffs, the real economic impact of Mr. Trump’s policies will be curbed, perhaps even neutralised altogether.
Read MoreThe market always tries to distract investors from what the obvious themes, a bit like a good striker selling a dummy to a goalkeeper, before he tugs it away. I’ll try my best to avoid that mistake here. Seen from my desk, the state of play in the global economy currently can be boiled down to two stories: First, the intensifying slowdown in real narrow growth in the major economies, and second, the fact that monetary policy divergence between the Fed and the rest of the world is being stretched to hitherto unseen extremes. This doesn’t mean that other stories—EM wobbles, Italian bond market woes, and trade wars—aren’t important. They are, especially for macro traders who have deservedly re-gained their mojo this year. But no matter how much joy investors have in the murky world on emerging market currencies, they will, sooner or later, have to take a view on the two themes highlighted above. Using money supply as part of global business cycle analysis is a controversial topic. For some analysts, it is the holy grail, while others will walk out of the room if you even mention it. Many economists prefer the credit impulse—the second derivative of loan growth—but if you actually draw the charts, you will find that this indicator very often is closely aligned with M1 growth.
Read MoreI have two objectives with this week’s missive. I want to contrast what I think are the two prevailing narratives used to explain markets in the first half of the year. And then I want to have a look at the durability of large-cap equity earnings because it seems to be crucial to what happens next. The first story pits the storm chasers against the connectors. The former primarily sees events such as the equity volatility surge in February, the widening LIBOR/OIS spread and the leap in Italian two-year yields as a result of a change in market structure. The ratio of liquidity-providing market makers to crowded trades has shrunk dramatically, creating the condition for face-ripping reversals in consensus and complacent positioning. The storm chasers sees this, and are trying to exploit it. They don’t necessarily ignore the big picture, but they are sufficiently confident in its stability to believe that storms can arise independently of it. Proponents of this view would argue that it is the combination of 15-sigma events and a stable overall environment that is the central story. For example, the fact that the February blow-up of the short vol trade was linked to a bigger story—that the market as a whole would crash—is what makes the initial trade, and the rebound, so attractive.
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