As we head into an atypical summer, some issues like Italian debt have been postponed (again), while others, such as regulation of hedge funds and asset managers are starting to re-emerge – as are some longer terms trends like a weaker dollar. Aside from the normal inverse correlations from a lower dollar, such as commodities and emerging markets, markets are starting to position a little more cautiously as economic and political uncertainty mounts ahead of the US elections in November.
The big macro news behind the noise this week is probably the ‘deal’ put together by the EU for a pandemic fund, meaning that Italy’s problems have been rolled over into next year as it has effectively secured the billions of dollars of cheap funding it needs to keep the show on the road. Just as the support for the US credit markets from the Fed has led to yield spread compression in the US between high yield and investment grade bonds, so the spreads on higher yielding EU sovereigns like Italy and Greece are coming in, as bond investors head in the same direction as the holiday makers. Perhaps not surprisingly, this has helped the Euro spike higher as the periodic bond risk premium of the Eurozone eases once again as the proverbial can is kicked down the proverbial road.
EU ‘deal’ pushes Euro higher
Although not as dramatic, Sterling has also headed higher against the dollar, breaking above its long term moving average, while the other major cross exchange rate – the Yen – is also stronger. Technically this has all combined to push the Dollar Trade weighted index below its March low and ,with little support in sight, is suggesting a resumption of some of the 2018 weakness.
Consistent with a weaker dollar, oil is edging steadily higher, while copper and gold have broken to new highs. Emerging markets – another asset largely inversely correlated with the US$ – are also climbing steadily higher. US long bonds have also traded higher this week – the risk levels on our Global bond Model have been re-allocating towards long bonds – which some are suggesting is a warning sign, although in the light of the Euro move it is perhaps worth highlighting that to a Euro based investor the picture looks more stable.
Having said that, Vix is edging higher and the ratio of the Utilities index to the S&P 500 also looks to be bottoming again, suggesting some defensive rotation appearing. This is something we have seen a few times in recent years and is certainly raising risk level concerns for us. However, we run our model portfolios and associated recommendations on the basis of risk/return and probability and adjust in real time rather than seeking to make big statement forecasts about crashes in the hope of claiming subsequent credit for predicting the markets. So for now, we are watching, not rushing for the exits.
Trade Weighted Dollar breaking lower, pushing inverse correlated assets higher
The one major currency (from an investor perspective) that hasn’t rallied this week is the Chinese Yuan, which backed off sharply following three weeks of gains and a break of the psychological 7.0 barrier against the $, after a further intensification of the war of words with the US. This also triggered a selloff of almost 4% in the Shanghai Composite index, which has had a similar strong run in recent weeks. This week there were tit-for-tat closures of consulates with the, ever moderate, Mike Pompeo describing the Chinese as “Tyrants intent on world domination”. One, largely under-reported, fact was that part of the spat was caused by China refusing to allow the 1500 or so US consulate staff who had fled Wuhan to return without appropriate levels of testing and quarantine, pointing out, not unreasonably, that Diplomatic immunity did not imply viral immunity. More likely, the US did not want their ‘military attaches’ having to provide DNA samples. Moreover, the declaration that China was closing the Chengdu consulate in retaliation to the closure of their consulate in Houston, was not a random choice – it’s the key ‘listening post’ for the US in terms of Tibet and by extension the activities linked to the current disputes with India up in Kashmir.
Meanwhile as some speculate that the US may suspend China’s access to holdings of Treasuries – highly unlikely but illustrating who has the capital at the moment, it is interesting to note that Shanghai has overtaken London and New York in terms of IPO listings – with 118 listings this year raising over $20bn – according to Bloomberg who highlight that most of this year’s crop of newly minted billionaires are in the Healthcare and tech industries that have done particularly well with Covid. Their total ‘new wealth’ exceeds $70bn and is largely funded by domestic retail. This is seen by some as a bubble, but we would regard it as different to 2015 and as part of the ongoing development of a domestic capital market – as China evolves from being overly dependent on its banking sector to recycle savings into investment. In this, as in so many other ways, China is actually simply following the path that the US itself did one hundred years ago, when it moved away from being dependent on foreign (largely British) capital markets to fund its economic development.
Finally, what we would see as a very important little article from John Dizard at the FT about how the Fed are going to crack down on large Hedge Funds and investment banks. This was a fear under a potential President Elizabeth Warren, one that had largely subsided, but now needs to be re-examined. For readers without access beyond the FT paywall, the essential point is that during the second half of 2019, the traders put on huge ‘gamma scalping’ strategies that relied on the Fed keeping volatility in Treasuries low and the prices within a range, a proverbial picking up pennies in front of a steamroller strategy. As happens all too regularly, this blew up with Covid in March, leaving them nearly all broke and needing to be rescued by the Fed. At which point they used all the new free money to put on a giant carry trade bet on US bonds, as highlighted in their huge second quarter profits. The Fed are not happy and as John Dizard points out, regardless of who wins in November, limitations of leverage, greater regulation for large funds and even transaction taxes to limit abuse of liquidity are all coming. Perhaps they will try and switch to trading China?
