ECU's Investment Blog

By Neil Staines on 16/10/14 | Category - Comment

"If I panic, everyone else panics”             Kobe Bryant

Over recent months we have raised questions of the risks of an overtly dovish bias at the Fed, despite the increasingly strong economic momentum. We have stressed on a number of occasions that while this Fed bias may be keeping long end interest rates subdued, it also risks undermining confidence in the economic recovery. After all if the Fed are continually stressing the downside risks, should we not be worried?

"…sinking like stones”                  - Don’t Panic, Coldplay

Yesterday, financial markets experienced some evidence of those downside risks, at least in the unwinding of positions in equity (and broader) markets. The Dow Jones index dropped by around 600 points from high to low in around half an hour only to regain its composure shortly afterwards. Equity market spill over into FX was, however, not a linear function. The impact of the seeming collapse of the AbbVie / Shire M&A saw a sharp decline in GBP against the USD, however, weaker than expected consumer data out of the US instigated a sharp unwinding of long USD positions against a number of currencies, most notably (and aggressively) against EUR, JPY and CAD.

"…we live in a beautiful world”                                - Don’t Panic, Coldpay

In reality, however, the US economic data was nowhere near bad enough to warrant the kind of sell off that we saw in US yields. In fact, with US 2 year yields reaching a low of less than 25bps, and 10 year yields falling below 1.87%, the balance of risks for US yields and the USD has likely shifted back to the topside.

Comments later in the session from US Treasury Secretary Jack Lew that "it is a mistake to look at hour-by-hour movements in markets to get a picture of where the core is” and that "US core economic growth is very strong” were clearly intended to calm the concerns of the market.

On Tuesday, we warned of the rising uncertainty in financial markets and argued for a correction in EURUSD as a function of lower US yields (making specific reference to the significant decline in the 2 year forward point spread over recent sessions), as the spread of deflation seemingly induced a wave of panic about growth prospects (despite a sharply lower oil price?) in the global economy. Falling equity markets continued to drive investors into the relative safety of Government securities (most notably US treasuries) driving yields sharply lower across the curve.

"There is nothing here to run from”                        - Don’t Panic, Coldplay

Following the clear out of positions in FX (and to a certain extent equity and bond markets), there is now a case to be made for a resumption of the broader trend. If equity markets continue to decline, which we feel is possible (albeit at a slower pace) then there is an increased likelihood of a continued unwinding of USD funded carry trades. In addition to this, we see no signs or rationale for US economic momentum to be materially affected by recent events, in fact, sharply lower bond yields and oil prices should be a significant economic positive.

In the Eurozone, the picture is perhaps not so rosy and if there is cause for concern globally then it should be most acutely felt in the Eurozone. News last night that Italian PM Renzi has proposed a Budget that will cause a jump in next year’s deficit "to within a whisker of breaching EU deficit rules” (FT), has accelerated an increased focus on risk premium in the Eurozone periphery. It is notable that peripheral yields are rising again this morning.

To complete the square (so to speak), Eurozone yield spreads at current levels are no longer supportive of a weaker EUR. However, recent moves in the US and UK (supported by the hawkish references of BoE Weale overnight) yields provide a starting point where the risks are increasingly biased to the hawkish side for Rates and the bullish side for USD and GBP.

"Here we go, here we go.”          - Don’t Panic, Coldplay

For today, the major focus is likely to be on the US equity market open, with data limited to weekly jobless claims data from the US. With reference to our point above (and on many previous occasions) that the Fed dovish bias was at risk of (has?) undermining confidence in the US recovery, it is also likely that the rhetoric of Fed speakers has greater influence on sentiment that would be the case in more rational, orderly markets – and there is perhaps a greater likelihood that near term rhetoric emphasises some of the positive aspects of US growth against a nervous equity market backdrop.

Volatility is likely to remain at elevated levels for the rest of the week, however, after urging caution earlier in the week, we feel that re-entry into long USD and GBP vs. EUR and perhaps AUD now offers greater risk reward. 

By Neil Staines on 14/10/14 | Category - Comment

"Patience is bitter, but its fruit is sweet”                              - Jean-Jaques Rousseau

This morning’s inflation data in the UK was keenly awaited as the market attempts to clarify its expectations amid an increasingly complicated global macroeconomic backdrop. The inflation data for September showed a greater than expected decline in both the core and headline readings and although there was an (anticipated) impact from recent energy price declines, there is also clear evidence that the deflationary haze that has gripped the eurozone is beginning to impact broader global price pressures.

In the short term, this has likely heavily impact GBP in FX markets, as interest rate expectations get pushed back (even) further and the years low at 1.5944 will be a key barometer of that. Indeed, we feel that there are a number of interesting dynamics making the evolution of financial market price developments more complex in the short-term, notably in FX.

If we take the USD as an example, our view remains that the backdrop for the USD in the medium term remains positive, particularly against the EUR, AUD where monetary policy and growth divergence as well as valuation arguments remain. However, in the short term, deleveraging in equity markets has also led to some deleveraging in FX. This risk-off backdrop has also driven up those currencies that are negatively correlated to risk appetite, such as the JPY (quite markedly against the USD from above 110, to below 107 this morning).

One of the most concerning developments over recent sessions has been the decline in US yields. At the long end of the curve, US 30 year yields fell below 3% last night for the first time since May 13 and 10 year yields are now at their lowest level since June 2013. Perhaps most importantly, the 2 year yield is at its lowest since June, and almost a full 25bps lower than it was at the time of the last FOMC meeting.

This decline in US yields, perhaps a function of risk aversion as equity declines drive money into the relative safety of the Treasury markets, have also driven spreads relative to other currencies, most notably the EUR, tighter. We were very audible in our suggestions that the widening of the EURUSD 2 year forward points (which went from 19bps in December 2013, to 233bps in September) should be indicative of a move lower in EURUSD. Since the middle of last week this spread has narrowed back to a low of just 165bps this morning. In and of itself, this would argue for a correction in EURUSD, or at least more of a two way market.

"Euro area must get its act together”     - Dijsselbloem

The overall macro picture in the Eurozone, however, continues to deteriorate. Inflation and growth remain too low and the downward revision to forecasts (most notable in Italy and Germany) highlight that there is no remedy to the ailments of the Eurozone in the short to medium term. This morning, saw a further sharp deterioration in the German ZEW assessment of current situation, and expectations, both back to 2012 lows. On a positive note, perhaps the increasing convergence of (negative) growth across the region will accelerate the structural reforms and accommodative monetary policy that the region so badly needs to avoid the prospect described by French Finance Minister yesterday that "Europe faces a Japanese scenario”.

"Endurance is patience concentrated”   - Thomas Carlyle  

However, outside of the near term we retain our view that the USD, and indeed GBP, will re-engage their outperformance. Economic momentum in the US remains significant and, while there may be a short pause for thought, as the threat of deflation pushes back timing expectations of monetary normalisation, economic and monetary divergence ultimately remains in tact.

In the UK, rate hike expectations, which centred around November when GBPUSD was up above 1.70, are now priced beyond the elections in May prompting GBPUSD to fall markedly. Further, the uncertainty surrounding the Scottish Referendum debate and the subsequent impact and implications on investment decisions and activity in the UK, have also weighed on GBP, helping to bring GBPUSD below 1.60. However, going forward, we expect the economic momentum in the UK to continue, and interest rate expectations to once again edge nearer. On that basis, we view any further near term declines in GBP (particularly against the EUR at the current juncture) as representing good value and providing a buying opportunity over the medium term.    

Sentiment will likely continue to be driven predominantly by equity markets over coming sessions and, with the start of the US reporting season today {Citigroup, JP Morgan and Intel}, this will likely become more acute. FX volatility will continue, and, while more complex in the near term, it is likely that clearer trends re-emerge before long.

By Neil Staines on 09/10/14 | Category - Comment

"If you want to make enemies, try to change something”            - Woodrow Wilson

On Tuesday we touched on the global economic backdrop as global growth forecasts moderate. Subsequently the IMF published their World Economic Outlook (WEO) entitled ‘Legacies, Clouds, Uncertainties’ highlighting the fact that sentiment at the IMF has clearly deteriorated since earlier in the year. Against this backdrop we also noted that "central bankers and policy makers remain under pressure to reinvigorate stale economic momentum and, where growth momentum exists, to be patient with monetary normalisation.” We also noted a likely "marked uptick in FX volatility and a greater focus on FX as an increasingly important asset class.”

Last night it was the turn of the Fed (albeit delayed from its point of reference) and the release of the minutes from the September FOMC meeting. The Fed duly referenced a ‘global slowdown’ as being among the risks to the US outlook, yet it was their heavy reference to the downside risks to growth from a stronger USD that made the headlines.

"…What this world is about”     - Under Pressure, Queen

We are acutely aware that central bankers are under intense scrutiny and heightened pressure, none more so than the Fed (as their actions likely have the greatest influence on the global economy). However, after seemingly going to great lengths to emphasise the importance of the economic data on the trajectory of monetary policy, the Fed, in our opinion, are increasingly at risk of undermining confidence in the US economic momentum - If beauty is in the eye of the beholder, the Fed are not being as complimentary as we feel they should be. US Q2 GDP rose 4.6% q/q annualised, the current pace of job creation is at its fastest since 2006, the unemployment rate stands at 5.9% (albeit after an initial weaker employment report for August – the last information at the disposal of the Fed for the September meeting) and the revised ‘dot plot’ from the Fed members themselves suggests an interest rate term structure significantly above that of the market.  Yet the tone of the minutes remains extremely cautious and uncertain.

Further, it is likely that the appreciation of the USD would have to go much, much further in order for it to have a meaningful impact on inflation or growth.

Over the past months we have seen a raft of central bank heads implicitly (or in some cases explicitly) provoking a weakening of their respective currencies on the basis of a divergence of domestic monetary policy path in relation to that of the US (ECB, RBA, BoC, BoJ, RBNZ,…). Taking this into consideration in conjunction with broad macroeconomic consensus and, in many cases, positioning, it is perhaps not surprising that the Fed should issue a cautionary tone so as to minimise the impact and implications of such divergent monetary policy on the USD.

"It’s not a normal condition to have interest rates at zero”         - Lloyd Blankfein

While the USD declined somewhat in response to the Fed, arguably the most notable move was in US interest rates with the 2 year yield plummeting (not a word we use lightly) from a high of 59bps the day after the FOMC policy meeting (and press conference) to a low of just 42bps this morning. This in itself is a significant justification for a weaker USD, and while it is possible that we see a further decline in the USD in the near term (as interest rate differentials and positioning adjusts), our views on the continued economic and monetary outperformance of the US, and thus the USD in all but the very short term remain unchanged.

A Viable Alternative?

In the UK, after a reasonable period of negative sentiment towards GBP, we expect the emphasis on UK economic (and monetary) outperformance to gradually return over coming days, weeks. The Bank of England meeting today is unlikely to offer any new information, however, survey data (especially in the dominant services sector) remained relatively unscathed throughout the uncertainties of the Scottish Referendum in September and as USD positioning is reduced after the Fed’s (over?) dovishness, we would expect GBP to emerge as a strong alternative to the USD in the ‘currencies I would like to BUY bracket’. After all, there is certainly not a shortage of options in the ‘currencies I would like to SELL’ category.

With limited data today, it is likely that sentiment, equities and US rates are the core drivers within FX as the markets digests the Fed. With industrial production from a number of Eurozone countries and the UK trade data the highlights for tomorrow, this theme will likely carry through to the weekend. Volatility may calm during this period, but opportunity remains

By Neil Staines on 07/10/14 | Category - Comment

"World economy needs bold moves to avoid ‘new mediocre’”   - Christine Lagarde

As global growth forecasts moderate, central bankers and policy makers remain under pressure to reinvigorate stale economic momentum and, where growth momentum exists, to be patient with monetary normalisation, at least while inflation pressures (at the consumer price and wage level) remain muted. At the current stage of the economic recovery (or not in some cases), with interest rates less viable as a near term policy tool, the battle ground for avoiding mediocrity, or worse, is likely the foreign exchange market. We are not suggesting that we are in an environment akin to a ‘currency war’, but we certainly see a marked uptick in FX volatility and a greater focus on FX as an increasingly important asset class in global macroeconomic developments.  

"Currency war is a zero sum game… everybody loses”   Guido Mantega, Brazil Finance Minister

In the Eurozone a lower currency remains the only viable policy tool (though German opposition from former and current Bundesbank heads is becoming increasingly audible – both in terms of currency devaluation and the use of non-standard measures such as the ABS purchase programme). In part, this is a function of the joint structure of the Eurozone and its regulations which restrict the fiscal channels. The alternative monetary channel has also likely reached its limit (at least in terms of interest rates) or is facing increasing opposition (ABS), thus a lower EUR exchange rate becomes a key (if informal) tool for the ECB

"Sputtering Europe holding back global economy”         James Bullard, St Louis Fed

An increasing number of commentators have highlighted recent currency movements (EURUSD specifically) as a counter argument to both Eurozone deflation risks and US economic growth outperformance – in essence arguing for reduced impetus for further EURUSD declines. While at some point we would concede that a lower EUR will reduce disinflationary pressures just as a higher USD may damp US economic outperformance, we do not yet view this as a strong argument for a turn in EURUSD at the current juncture. Recent underperformance of Eurozone inflation relative to expectations (as well as increasing concern expressed by the ECB and falling inflation swaps) and the resurgence of US labour market strength in September following a lull in August (in addition to maintained survey strength, particularly in the dominant service sector) continue to support this view.

"Fed behind schedule on raising rates as QE3 nears end”             James Bullard, St Louis Fed

This week’s release of the minutes from the September FOMC meeting will be closely watched. While the impact of the minutes would usually be damped by the fact that the September was accompanied by a press conference, the minutiae surrounding the inclusion of the "considerable time language” (particularly, as we pointed out following the Fed statement, as Yellen appeared to remove the meaning of "considerable”, by suggesting that it was entirely data dependent) will be keenly watched.

"Rate rises will come sooner and will be more rapid if economic improvements imply faster convergence on target unemployment and inflation.”  Janet Yellen


Yesterday, we saw a pick-up in USD volatility which began with a sharp correction in USDBRL after the first round of the general elections drove a wave of USD selling. With little on the economic calendar and likely an increased long USD positional bias, following the stronger than expected US September employment report, further USD longs were unwound overnight.

Adding to this dynamic, increasing uncertainty over official support for - and, perhaps more significantly, growing uncertainty over the detrimental economic implications of- further JPY weakness, has prompted another retreat from the 110 level in USDJPY.

To this point the USD rally has been significant as well as relatively orderly. Going forward, while we anticipate USD strength to continue, it will likely become a more selective process both in terms of timing and with reference to specific alternate currencies. Overall we view the current backdrop as a significant development in the increasing importance of foreign exchange as an asset class following an extended period of relative stability. It will not likely be all one direction from here, but significant opportunities remain. 

By Neil Staines on 02/10/14 | Category - Comment

On Tuesday we discussed some of our views and expectations for Q4, as some increasingly dominant themes take hold of the foreign exchange markets. As is very often the case, the focus of the financial markets is most acute during the first week of this month as the US employment report and ECB policy meeting (and press conference) take centre stage. Although we are at the very start of Q4, these events this week are likely to shape expectations and sentiment for a good part, if not the entirety, of Q4.

"For every problem there is a solution that is neat and simple… and wrong” - H L Mencken

First up is the ECB and, after the TLTRO take-up disappointment in September, it is likely that Draghi re-emphasises his expectations of a significant expansion of the ECB balance sheet. While we concede that the probability of QE in the Eurozone has grown, with the recent deterioration in the Eurozone backdrop, it is likely a step too far given the recent proximity to new measures (TLTRO’s and ABS – not to mention the political difficulties posed by Bundesbank Head and ECB board member Jens Weidmann - and at least one other- dissenting against ABS purchases). However, we would expect Draghi to signal his intent to deliver on his inference from last month’s press conference that the ECB balance sheet will be expanded by around EUR 1 trillion (to 2012 levels). Broad expectations for the ABS and covered bond programmes are in the region of EUR 400bn over the course of this year.

News that euro-area factories have cut prices in September by the most in a year, in addition to the fact that yesterday’s PMI data suggested that German manufacturing activity contracted, highlight that the downward pressure on prices is not easing and that faltering demand (and moderating growth trajectories) is becoming just as much an issue for the core as it is for the periphery. This in itself is enough to maintain the easing bias and likely dovish sentiment in the statement.

The only way is … Down!

Another of the issues Draghi faces is the divergence of fortunes within the Eurozone economies, which is arguably now as great as ever. Against this backdrop, it could be argued that policy from the ECB targeted at the region as a whole (or by default the median), may be ineffective to all. The only real answer to the woes of the average, considering where peripheral (and perhaps even more notably core) yields are is likely a lower EUR. On that basis we would expect Draghi to continue to stress the longevity of monetary policy divergence between the US and the Eurozone, which we view as implicit verbal intervention. A lower EUR is increasing the only option for a Eurozone recovery.

Many commentators have highlighted the risk of a ‘short squeeze’ in the EUR if Draghi under-delivers. While this cannot be ruled out, we continue to argue that the market is not sufficiently short of EUR (or not as short as they should, or would, like to be), and thus, as ECU Global Macro Team member, Kit Juckes sums up this morning "a EUR bounce born of failure to tackle Europe’s Japanification would be short lived

"All is numbers” - Pythagoras

The US economic data has been more mixed of late. However, relative to the broader global economic backdrop the US (and indeed the UK) data remain positive outliers. The disappointing ‘dip’ in payroll growth for the month of August (typically a very difficult month in terms of seasonal adjustment) was not mirrored in the private sector ADP data (confirmed yesterday) and its September print retaining a the greater than 200k payroll growth, something which should be viewed as being consistent with further unemployment rate declines.

Expectations for the US September employment report remain firm, however, and the ‘true’ expectation (adjusted for market sentiment) is likely to be even stronger than the median estimate by economists of around 213k. The revision to the August headline number should be given equal weighting in the market reaction to Friday’s report.

Another point worth noting about the unemployment report, after ISM pointed out some increasing labour shortages, is the rising significance of the average hourly earnings data in the report. If payroll growth and the unemployment rate are broadly in line with ‘true’ expectations then earnings growth will be the key driver for interest rate (and thus USD sentiment) in the following sessions.

"Information is the resolution of uncertainty” - Claude Shannon

In the UK, all eyes will be focussed on the service sector PMI data on Friday morning, particularly after the decline in the manufacturing index earlier this week. We have highlighted our concerns that there may be some negative spill over effects from the uncertainties of the Scottish Referendum on the September data in the UK (particularly in the week approaching the vote). However, we maintain the view that the UK economic momentum remains broadly intact and that any weakness in the September data likely provides buying opportunities for GBP against some of those currencies more vulnerable to rising US (and ultimately UK) rate expectations, such as EUR, AUD and CAD.

In Japan, despite the slightly stronger economic data, the JPY briefly broke above 110 yesterday, before reversing clearly and ending the day on a technical engulfing key day reversal. Indeed, the case for JPY weakness is no longer as strong at these levels. Rising discontent within official rhetoric over the demerits of JPY weakness is drawing more attention and this, combined with higher equity volatility, imply that the direction of the JPY in Q4 may well frustrate market expectations of a weaker JPY.

By Neil Staines on 30/09/14 | Category - Comment

"Crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought - Rudiger Dornbusch

As we work through the remaining hours and data releases of the month and quarter, today we take a step back to reflect on Q3, and look ahead to what Q4 2014 may bring. At the start of the year, we had a number of core views that we discussed at length in our published communications. The most prevalent being:

(i)The increasing dominance of the FISH {France, Italy, Spain and Holland} on the (negative) fortunes of the Eurozone and the EUR, as the central focus of the fragility of the region moved away from the periphery in 2013, towards the core in 2014.

(ii)Our views that the UK economic outperformance was stronger (and would show more resilience as its contributing drivers broadened) than both market expectations and the valuation levels of GBP suggested at the time. Further, in this regard, we suggested that the UK would be the first to raise interest rates, in Q4, closely followed (and subsequently outpaced) by the US in Q1 2015

(iii)That economic and monetary differentiation would emerge as the core driver of foreign exchange markets, as some economies (most notably the UK and US) move towards monetary normalisation and others (most notably the Eurozone and Japan) strive for further stimulus and monetary accommodation.

As the infamous quote sums up very eloquently, the developments that we outlined above took longer than expected to take hold in 2014. However, they largely came to fruition in Q3. The purpose of today’s piece, however, is to look forward and assess the possible events and developments that may shape the backdrop for the currency markets in Q4.

"I need a dollar Aloe Blacc

The re-emergence of USD strength in Q3 was significant and of sufficient magnitude that many have begun to question the longevity of the move. From our perspective, however, there are a number of factors that remain dominant. For example, the US monetary normalisation cycle is just beginning and although, like the UK, wage and consumer price inflation remains moderate, growth continues to support monetary tightening. The current 2 year yield of 58bps is low, even with the first rate hike in June 2015 (we would still favour Q1’15). Further strength in the front end will likely support the USD through Q4, particularly against those currencies whose monetary bias is becoming increasingly dovish (such as EUR and JPY), as economic and monetary divergence remains considerable.

QE-asy does it?

Q4 also brings a more definitive divergence of monetary policy as US asset purchases (QE) come to an end. It is ironic, perhaps, that after such a long period of asset purchases from the Fed and after a sharp downturn in the economic fortunes of the Eurozone, that Q4 may also witness the start of QE from the ECB. Until a few weeks ago we would have seen such a move as unlikely. However, prolonged 'lowflation' in the Eurozone (compounded by a further decline in the headline and core rate this morning) combined with widespread downward revisions to eurozone growth forecasts and rising political concerns (of which we have discussed at greater length recently), more accommodation from the ECB seems increasingly likely.

Sound as a pound

As stated above, at the start of the year we suggested that the Bank of England could begin raising rates as early as Q4 2014. More recently, the Scottish Referendum and the significant political and economic uncertainties that it brought, pushed interest rate hike expectations back somewhat. However, since the larger than expected ‘No’ vote prevailed, those expectations have, once again, been brought forward. We continue to anticipate that rate rise expectations will continue to be brought forward and, notwithstanding a possible pause in the activity and investment data preceding the result, we anticipate the momentum in the UK will be maintained through Q4.

The Bank of England suggested in the last set of minutes that it expects growth momentum to slow in Q4. However, the BoE have pushed back their expectations for growth moderation several times this year and we expect that to continue. Indeed, renewed momentum into Q4 may well be enough to see the interest rate normalisation cycle in the UK begin in Q4 afterall.

On Thursday, we will continue to discuss our views and expectations for Q4. Until then, we would anticipate that the current underlying dynamics continue. The big economic focus of the week following today’s Eurozone inflation data is Friday’s US employment report for September. The report is particularly significant following the unexpected dip in August and expectations for a rebound and / or upward revision to August are widespread. Tomorrow’s private sector ADP report will be closely watched for any hints as to the direction of Friday’s data.



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