I said my peace on global growth and EM currency crises last week, so I won’t belabour those here. I am struggling, however, to square the circle on the dollar and U.S. bonds. The story for the greenback appears simple; interest rate differentials suddenly matter again. The Fed is on the move, but expectations for tighter monetary policy elsewhere has been pushed back, especially in the U.K. and in the Eurozone. Even in Japan, few believe that the BOJ will do anything, anytime soon. HSBC’s FX Chief, David Bloom, does an admirable job explaining this in a recent segment on Bloomberg TV. By this account, the rout in EM is as much about a shift in G4 central bank expectations as it is about the lagged effect of higher short-term rates in the U.S. and structurally-vulnerable balance sheets. As long as European and Asian central banks drag their feet, and the Fed keeps going, the dollar will continue to rally; its simple. The problem with this story is that it assumes that the combination of a hawkish Fed and higher U.S. bond yields persists. Almost all my models are telling me to fade this story. For starters, the curve continues to lurk as the proverbial elephant in the room.
Read MoreTwo questions, at least, are on investors’ mind at the moment. Is the synchronised global upturning turning into a synchronised slowdown? Will the dollar rally be sustained, and if so, will it spark further stress in emerging markets and in the global economy? You would be hard-pressed to argue that the global economy is slowing dramatically, at least based on the most recent headline data. My estimates suggest that global GDP growth was unchanged at 2.9% year-over-year in Q1, thanks mainly to a slight 0.3 percentage point rise in U.S. growth to 2.9%. That said, this number includes the 6.8% headline in China, which no one believes, and we still don’t know what happened in Japan. Finally, this number masks the fact that momentum in Europe slowed across the board. Growth in the euro area is still solid, but it slowed sharply in Q1. And the first indications for Q2 do not promise much in the way of a rebound. After growth of nearly 3% last year, all evidence so far points to somewhat slower growth of 2% in 2018. The picture is even grimmer in the U.K. where growth slid to a five-year low of 1.2% in Q1. Looking beyond the GDP numbers, leading indicators are discouraging, but not yet in panic territory.
Read MoreChurn is probably the best way to describe equity markets at the moment. Inter- and intra-day volatility have increased, which is great news for the traders—and investment banks, apparently—but it isn’t much help to the rest of us. It reduces the signal-to-noise ratio, which has already been stung by the persistent cloud of political uncertainty, the threat of trade wars and related themes. Everyone likes to talk about this, but these events have, so far, been of no consequence whatsoever to markets as far as I can see. All that moaning notwithstanding, I am happy to report that the portfolio had its first decent month of the year in April. I was beginning to wonder whether I could be that bad at picking my horses. My confidence is now restored slightly, although I am still behind the mighty Spoos. Also, the next calamity is never far away. Equity strategists are now telling me to worry about another thing: The multiple-crushing rise in oil prices. Looking beyond the idea that a higher oil price ought to result in divergence between energy and the rest of the market, the idea is simple. A sharp rise in oil prices drives up inflation expectations and bond yields, both of which are poison for valuations. Multiple-expansion turns into contraction, and equities struggle.
Read MoreFor all the talk about a flattening U.S. yield curve, it is ironic that it steepened last week, albeit slightly. The trend, though, is clear enough. The 2s5 and 2s10s have flattened 27 and 32 basis points in the past year, respectively. Another 12 months at this rate and the curve would invert by the middle of next year. This wouldn’t be odd. It’s normal for the curve to flatten as monetary policy is tightened, and it is also normal for the Fed to keep going until the curve inverts. If you believe that an inverted curve is a good recession indicator—which is debatable—this is tantamount to saying that the Fed will keep going until something breaks, consistent with what almost always happens at the tail-end of policy tightening cycles. This probably won’t prevent investors and analysts from continuing to pay close attention to the yield curve. I have sympathy for that, for two reasons. Firstly, it is not clear to markets whether the Fed cares about a flattening curve or not. Some members of the FOMC do, some don’t. Secondly, if the shape of the curve is important to the Fed, the recent pace of curve flattening challenges the prediction by economists and markets that the Fed funds rate will be hiked by 25 basis points three-to-four times in 2018 and 2019.
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