Many investors understandably remain focused on the rally in equities, probably with a mix of satisfaction and astonishment. As interesting as the virus-defying rise in equities is, though, the real story this week has been in U.S. rates, Let me explain. It started with analysts suddenly remembering that trying to shield the economy from the Covid-19 induced lockdowns is going to cost money. Markets’ memory was stirred by the U.S. Treasury announcing that it is planning to place $3T worth of debt in Q2 alone, a cool 14% of GDP, and that’s probably just the beginning. The initial response by many analysts was to extrapolate to a depreciation of the dollar. After all, that’s an awful lot of currency that Uncle Sam will need to produce, assuming that is, that the Fed is going to stand up and be counted. As I argued in my day-job, that reaction was surprising to me. After all, it’s not as if European governments won’t have to dig deep either, and it’s not clear to me that the race to throw money at Covid-19 favours a bet against the dollar. In any case, before we get to currencies, the incoming tsunami of U.S. debt issuance is also, obviously, important for fixed income, and in a world of uncertainty, I am happy to report that the movie currently on offer is one that we have seen before.
Read MoreI said my peace on what I consider to be the big market stories last week, so I won’t belabour bonds and equities too much this week. FX markets, however, could well be the driver of the NarrativeTM in the next few months, at least judging by the rustling of the grapevine. This story starts with the notion of the “global Fed,” which is not a new idea at all. Fed watchers tend to pivot between two extremes in their analysis of, and forecasts, for U.S. monetary policy. In one end, Fed conducts itself according to the reality of a relatively closed U.S. economy, without regard to the impact of its policy on the rest of the world, and the value of the dollar. At the other end, the Fed acts according to its role as a warden of the global reserve currency, taking into account the impact of its policy on the rest of the world. A more cynical version of this story is the idea that the Fed, in a world of free capital mobility, is constrained by the fact that other major central banks, in economies with large external surpluses, are stuck at the zero bound. This could happen in practice as tighter monetary policy in the U.S. drives the value of the dollar higher and/or leads to an increase in capital inflows. Both likely would drive up the external deficit, which would probably be counterproductive in an environment when the Fed would otherwise want to raise rates to curb inflation pressures.
Read MoreThe flow of goods and capital across borders and between nations has featured in human storytelling and economic relations since the beginning of time. The biblical protagonists traveled and traded with each other, and often fought over the dominion of resources. The protagonists in modern historical tales of trade and war since the turn of the millennium continue the habit in similar ways. You would be hard-pressed to find a better historical account of that than in Ronald Findlay and Kevin H. O’Rourke’s Power and Plenty. The book is as much about the wars that divided empires and nations as it is about the exchange of goods and capital that bound them together, though it is reasonable to say that these two perspectives are joined at the hip. Economics plays a specific role in the study of global trade and empire-building. The exchange of goods, capital, and services across borders gives rise to transactions as the ownership of resources shifts. Over time, these processes lead to the accumulation of wealth and debt on the part of nations and economic actors—assets and liabilities, in the jargon of modern finance. It is the economist’s job to trace, identify, and record the nature and value of these transactions.
Read MoreOne 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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