St Mary Axe view

Morning Brief – China Politburo

 

China Politburo

 

China’s monetary policy will be more flexible and its fiscal policy more proactive in H2 2020. While a long way from embracing Western human rights values as we know, China is demonstrating that its economic approach is completely different today to how it was when the First 5 year Plan focussing on rapid industrial development was decided on in 1953; this gave way to the Second 5 year Plan in 1958 when the focus under the Great Leap Forward was on agricultural communes and smaller industrial enterprises. In other words when China used to set a course and a 5 year Plan, that was it-no deviation at all. Looking at the direction of 5 year USD versus CNY graph, the 12% CNY devaluation to where it stands today at 7.00 has certainly not been a straight line and reflects China’s efforts to establish the credentials of the CNY as a major global currency.

 

 

UK Residential Property

 

It is anecdotal, but the UK Chancellor lifting Stamp Duty Land Tax to kick in at GBP 500,000 is injecting life into the moribund UK residential property market- in London at least. SGM-FX Operations Officer Jisun has been up with the lark over the past few weekends to join long viewing queues for houses in North East London. Jisun and her husband have encountered that old chestnut of agents informing them that only offers at or above the asking price will be countenanced. However their persistence has finally paid off and they have managed to beat off other hopefuls and snag the house that they wanted at below the asking price.

 

 

1,540,556 Miles

 

British Airways mailed yesterday to advise me that in the past 28 years I have flown more than 6 times the distance from the Earth to the Moon with them. Right now long distance and regular air travel is looking to be a long way away from making a comeback, but just to motivate their customers, BA is offering double Avios.  In recent years I have also regularly patronised both Singapore Airlines and Virgin Atlantic to Asia and North America respectively so my total is well over 2 million miles but still close to home against the 34 million miles between Earth and Mars. The question was certainly on David Bowie’s mind in 1971 with this classic from Ziggy Stardust:

 

Life on Mars

 

It’s a God-awful small affair
To the girl with the mousy hair
But her mummy is yelling “No”
And her daddy has told her to go

But her friend is nowhere to be seen
Now she walks through her sunken dream
To the seat with the clearest view
And she’s hooked to the silver screen

But the film is a saddening bore
For she’s lived it ten times or more
She could spit in the eyes of fools
As they ask her to focus on

Sailors fighting in the dance hall
Oh man! Look at those cavemen go
It’s the freakiest show
Take a look at the lawman
Beating up the wrong guy
Oh man, wonder if he’ll ever know
He’s in the best selling show
Is there life on Mars?

 

 

 

Discussion and Analysis by Humphrey Percy, Chairman and Founder

Click Here to Subscribe to the SGM-FX Newsletter

SGM-FX buildings

Morning Brief – TRY again!

TRY again!

 

The Rand, Brazilian Real, the Ruble and the Indonesian Rupiah join the Turkish Lira to form a basket of emerging market currencies that are particularly vulnerable to capital flight – the so-called “fragile five”. During the height of the pandemic this basket of currencies recorded heavy losses versus their G10 counterparts. Losses had largely peaked by the end of March with the immediate speculative sell of in emerging market currencies moderated by global central bank action to support economic and monetary conditions. Since then rising infection rates across Latin America have put pressure upon the Real, historically low and volatile oil prices continued to undermine the Ruble and strict lockdown measures in Indonesia and South Africa have kept the Rupiah and Rand well discounted.

 

During the height of the episode of global market volatility spurred by the spread of the pandemic, losses within the Turkish Lira were noticeably contained. Thanks to measures introduced to limit the capacity for speculative selling and capital flight from the economy, the Lira was reluctant to sell-off at the pace of its vulnerable counterparts. However, four months on and the basket of emerging market currencies continues to firm up with one notable exception: Turkey. Despite a momentous sell-off in the USD to two-year lows over the last couple of weeks, the Lira fell to a 2.5 month low versus the Dollar. Against the European Single Currency things look even worse. EURTRY has now surpassed the levels reached during the Lira’s flash crash in 2018 and now sits at all time lows. The main cause behind the vulnerability that looks set to continue is monetary policy and economic mismanagement.

 

Turkish President and wannabe Economics Professor Recep Erdogan detests high interest rates. He sees them as a demand from an external group who demand high interest in order to reward/insure their speculative bets in the Lira. He also sees high rates of interest as the enemy of growth. As a result of this Turkey faces a structural balance of payments crisis leaving its currency vulnerable to speculative selling and an environment hostile to much needed overseas investment. Interest rates in Turkey stand at 8.25 percent. That sounds healthy, right? Well with inflation reaching 12.6 percent (annualised) last month, Turkey has a deeply negative real yield that renders it among the most unattractive currencies from a yield perspective on the planet.

 

Whilst sinking to record lows the market has shrugged off an estimated $1bn spent by Turkish authorities each day to sustain the Lira. Spending operations are not published in Turkey so the impact upon foreign exchange reserves remains an estimate. With lockdowns re-emerging across the globe and notably in Europe, FX intervention is a game that Turkey will find it rapidly cannot afford to play. In the past rapid sell offs in one of the fragile five currencies can have a contagion effect upon the other currencies. For now, and whilst the Lira’s decline seems quintessentially Turkish, the rest of the group are stable and still gobbling up (pardon the pun) accommodating monetary backdrops across the globe.

 

 

Discussion and Analysis by Charles Porter

Click Here to Subscribe to the SGM-FX Newsletter

 

SGM-FX View of london

Morning Brief – Grace Hopper 1907-1992

Grace Hopper 1907-1992

 

GH had a sparkling career stemming from an insatiable curiosity for knowledge as a child; she went on to enjoy a first class education at Vassar College followed by a PhD in mathematics at Yale University. Having extended her mathematics knowledge into a career in what became computer science, Grace Hopper was responsible for developing what was initially called Flowmatic and which subsequently became the much better known COBOL or Common Business Orientated Language. Not content with teaching mathematics at Vassar and being a computer pioneer, GH joined the US navy reaching the rank of Rear Admiral before retiring and advising DEC. This week Grace Hopper is being honoured in a different way and this time by Google which has named their new transatlantic subsea superfast data line after her and which will stretch between NYC and both Bude, Cornwall and Bilbao, Spain and is due for completion in 2022.

NB Spookily today July 29 saw British PM Margaret Thatcher sign an agreement with France’s President Francois Mitterrand to build a tunnel underneath the Channel. Never mind that they could not agree whether it was the English Channel or La Manche: Eurotunnel was green lit.

 

 

Greggs

 

At last some better news from the beleaguered High Street fast food/ takeaway sector: when all we hear about are closures and layoffs, it is refreshing to see that while Greggs, purveyors of sandwiches to sausage rolls has made a loss of GBP 65.2M for the first 6 months of 2020 versus a corresponding profit of GBP 36.7M in 2019, sales of their products are now back running at 72% of the 2019 rate. Why? Simply this: Greggs caters for customers who cannot and do not work from home and now that building sites and construction projects are fully back, Greggs are back too with almost all of their 2025 outlets open. SGM-FX’s very own galloping gourmet, Richard Picton-Turberville having flirted briefly with a vegan sausage roll last week has now joined the other artisans in Eastcheap queuing up for bacon baguettes each packing a punch with reassuringly powerful boosts of 507 kcal and 2141 kJ. With all that energy, Rich should be unstoppable!

 

 

Aubrey Drake Graham aka Drake

 

The Canadian rapper has overtaken Madonna, the Beatles, Rihanna and actually everyone with the most Top 10 singles in the US Billboard chart. Aged 33 and followed closely by avid fan SGM-FX’s Conor who admiringly gasps that he is the “most famous rapper on the planet”. Drake is well known for romancing- at separate times- both Rihanna and Jennifer Lopez and he has not exactly been a slouch in the money making stakes either with a fortune estimated at USD 180 Million+.

Here’s a sample of how he made it with his franglais (Canadian obv) geographically challenged chart topping number, Greece which he recorded with DJ Khaled :

 

Come with me, leave all of your things, yeah
We can stop at Gucci, stop at Louis V, yeah
Come with me, fly you out to Greece
Full speed, survoler Paris, yeah
Come with me, leave all of your things, yeah
We can stop at Gucci, stop at Louis V, yeah
Come with me, fly you out to Greece
Full speed, survoler Paris

 

Speedboats, baby, in Nikki Beach
Waves in my ears, smokin’ weed (Oui, oui)
Whippin’ through the sand in a Jeep (Oui, oui)
All because of what I did on beats, baby
Life’s sweet, baby, iced out, baby
You just go get ready, we go out, baby
Long time lookin’ for the bounce, yeah
OZ had the bounce, yeah

 

 

 

Discussion and Analysis by Humphrey Percy, Chairman and Founder

Click Here to Subscribe to the SGM-FX Newsletter

SGM-FX London skyline

Morning Brief – How low can you go?

How low can you go?

 

With Euro-Dollar at two year highs, the rapid sell-off in the Dollar is in question. The trade weighted Dollar index is flashing oversold suggesting the broad-based USD sell off that has been underway since June could be running out of steam. A direct counter party to many fx trades and involved in some way in yet more, the path of the Dollar has a huge impact upon global markets. With an FOMC meeting staring down the Dollar tomorrow, let’s have a look at the main factors moving USD.

 

One factor driving the Dollar lower is a byproduct of the States’ response to the pandemic. The US balance sheet has swollen by around 70% thanks to the immense stimulus measures the Federal Reserve undertook at the start of the pandemic. The rapid injection of cash into markets has the effect of diluting the existing pool of currency with the effect of trimming the value of the wider currency. Opening swap lines overseas for Dollar liquidity too is known to devalue a currency on foreign exchange markets – why fund the purchase of Dollars with a currency trade when you can fund directly in USD? This would not have been an unwelcome side effect of the pandemic response. Whilst some of these policies are winding down there is no sign that the excess cash dumped on markets will be unwound any time soon. The persistently accommodating stance of the Fed should continue to weigh on the Dollar.

 

This huge injection of liquidity across the globe has pushed yields lower in many assets. The value of negative yielding debt is now greater than 15 trillion Dollars. What that means is that there are debt instruments out there approximately the size of the US economy itself that to buy (and therefore lend) will cost you. Within these instruments, if you lend money you will get back less than you initially lent. In an environment where real yields behind the Dollar are deeply negative, the currency loses some of its appeal to greener, less costly grass.

 

Over the last few decades the relative rate of inflation in the Eurozone and the United States has been a good indicator of EURUSD performance. When US inflation was considerably higher than in the Eurozone, the Dollar tended to outperform the Euro. With the obliteration of inflation in the United States and a surprisingly robust Eurozone economy, the inflation gap is now knocking on the door of 0 for the first time in a decade with inflation in Europe almost as high as it is in the United States. If the last two decades are anything to go by then EURUSD could have some catching up to do.

 

After seven consecutive days of losses versus the Euro, the Dollar is taking some breathing time around the 1.17 mark with the pair down from its overnight highs. The Dollar is fighting with its support levels from a trade weighted perspective and across G10 currency crosses. Expect choppy conditions as the Dollar decides which side of the line it wants to sit on. If the Dollar does break its support levels expect the sell off to gain new momentum and breakout into a new range. Any move by the Federal Reserve to loosen monetary policy further tomorrow will undoubtedly push the Dollar lower once again.

 

 

Discussion and Analysis by Charles Porter

Click Here to Subscribe to the SGM-FX Newsletter

 

Blog banner

Morning Brief – GBP: the Pound Between the Scylla of a weak USD and the Charybdis of a strong EUR

GBP: the Pound Between the Scylla of a weak USD and the Charybdis of a strong EUR

 

Last week GBP finished a whisker short of USD 1.28 and notched up its best week for some time versus USD. Against the EUR however it was a different story. EUR strong at EUR/USD 1.1650 which meant that GBP was stuck at EUR 1.09 and found it hard to make any progress from there. With the market looking for good news from the Brexit talks to justify current levels, GBP is definitely susceptible to any disappointment on that front. Meanwhile it is steering an increasingly narrowing course between the twin rocks of Scylla and Charybdis.

 

 

Vincent Van Gogh

 

It was exactly 130 years ago today in 1890 that VVG shot himself in the chest with a 7mm Lefaucheux revolver in a field having already severed most of his left ear some time earlier following an argument with his friend Paul Gauguin. He took a further two days to succumb of an infection from the wound-miraculously he managed to miss any vital organs-and then the tortured genius was no more but he left the world with a rich legacy of his wonderful paintings and drawings. The Van Gogh museum in Amsterdam in normal times welcomes more than 2 million visitors a year and is not only a fabulous place to visit but it holds the world’s largest single collection of his works. 3 years ago his painting of Laboureur dans un Champ fetched a staggering USD 111 Million in a NYC auction.

 

 

US Presidential Election 2020

 

Interesting value from bookmakers on the outcome of the November election: for example Paddy Power are offering 4/1 for Trump to win a share of the popular vote between 46 and 48.99%. Last time round in 2016 Trump achieved 46.1%.The odds for the Democrats to win are 8/15 and the Republicans 13/10. The Independents are offered at 40/1 which sounds positively parsimonious unless you believe that Kanye West really is a runner-if you do, you had better look at the stats on Independents and you will probably then conclude that you would do better to go down to the pub and spend your money there!

Here’s what Kanye is probably best known for but be warned: you will need a strong constitution for these lyrics and suffice to say, this song is probably not going to get him to the White House:

 

Famous:

Man I can understand how it might be

 

Kinda hard to love a girl like me
I don’t blame you much for wanting to be free
I just wanted you to know
Swizz told me let the beat rock

 

For all my Southside niggas that know me best
I feel like me and Taylor might still have sex
Why? I made that bitch famous (God damn)
I made that bitch famous
For all the girls that got dick from Kanye West
If you see ’em in the streets give ’em Kanye’s best
Why? They mad they ain’t famous (God damn)
They mad they’re still nameless (talk that talk, man)
Her man in the store tryna try his best
But he just can’t seem to get Kanye fresh
But we still hood famous (God damn)
Yeah we still hood famous

 

 

 

Discussion and Analysis by Humphrey Percy, Chairman and Founder

Click Here to Subscribe to the SGM-FX Newsletter

Figures

Morning Brief – Australia

Australia

 

With their budget deficit already at a record at A$86 Billion versus a budgeted A$ 5 Billion surplus, Australia is forecasting it to get much worse at A$184 Billion this coming year. AUD at 1.41 versus USD.

 

 

South Korea

 

For the first time in 17 years, South Korea has entered a recession however, unlike many or most other countries, this Asian economic powerhouse expects to bounce back at the end of 2020. USD stands at KWD 1200 exactly where it was a year ago.

 

 

Today 24 July is: Simon Bolivar day

 

Simon Bolivar was born to a rich family in Caracas, Venezuela then part of the Spanish Empire on this day in 1783. At the age of 16 he was sent to Spain to be educated. Not only was he educated but he embraced the Enlightenment movement and, upon returning home he embarked on a marathon independence campaign against the Spanish Empire fighting 100 battles and riding over 70,000 kms with a final tally of: Ecuador, Venezuela, Colombia, Bolivia, Peru and Panama. In other words, Simon Bolivar at one time captured and presided over an area from the borders of Argentina right up to the Caribbean.  Unfortunately at the age of just 47 in 1830 he succumbed to tuberculosis and died. Apart from numerous statues of Simon Bolivar in city centres throughout South America, his legacy is of course to have a country named after him: Bolivia. The currency is naturally enough named the Boliviano and currently trades at 6.83 versus USD.

 

 

Warre’s 1975 Vintage Port

 

In this the 18th week of LockDown but at least Lockdown lite, my drinks cabinet is now displaying noticeable gaps and the Vintage Port section is now taking punishment. Having removed the cork with great care, I strained and decanted the Warre’s 1975. Warre’s is the oldest of the port houses having been founded in 1670 and has been managed for most of that time by the Symington family. Originally established 350 years ago as a trading house to export fruit and olives and to import dried cod and English woollen goods, the world is fortunate that Warre’s changed their operating model to concentrate on port. For those canny investors among our readers, port has been deeply unfashionable in the past 30 years but is now enjoying a renaissance in popularity with prices of this particular vintage of Warre’s having increased by 25% in the past 8 months. So if you want to lay down some vintage port to enjoy in 20 years’ time, this is a good moment as there are some bargains out there. Also, purists among you look away now, it is now acceptable in polite company to mix port with pretty much anything.

 

Have a good and dry weekend (weatherwise)!

 

 

 

Discussion and Analysis by Humphrey Percy, Chairman and Founder

Click Here to Subscribe to the SGM-FX Newsletter

Contact

Morning Brief – A new Gold Standard?

A new Gold Standard?

 

Global stocks flinched this week as the US Administration ordered the close of the Chinese consulate in Houston. The abrupt closure was justified on grounds of national defence and in particular spying concerns. China has promised to retaliate if Washington does not reconsider its decision, marking the closure a serious violation of the international order. Sino-US tensions have been rising following China’s imposition of a Security Law on the territory of Hong Kong with commentators marking the materialisation of these new tensions on US soil as a tipping point in this saga.

 

Given the Chinese Renminbi’s (CNY) peg to the US Dollar, transpacific risk is difficult to detect within the USDCNY currency pair. A good barometer for this tension is AUDJPY, the rate of which is free to fluctuate based upon fundamentals and trading activity. The Aussie Dollar is a proxy for the Chinese economy due to its high industrial exposure to China and integrated supply chains. The Japanese Yen on the other hand, AUDJPY is a proxy for risk as a highly defensive asset with strong safe haven appeal. AUDJPY higher amidst Chinese tensions signals robust or improving risk conditions where the fx market is shrugging off the tensions. A falling AUDJPY signals to the world a more defensive tone and will likely spill over into equities.

 

AUDJPY is elevated from its pandemic lows at present showing that the improvement in the status of the pandemic globally is overwhelming idiosyncratic Chinese tensions. However, the pair is approaching a level that it has tried and failed to break through twice already this year. Failure to break through this level (76.8) will confirm a triple top and give rise to stronger Yen prices. When Chinese tensions were on the rise last year we commented on the scope of a potential inflammation in transpacific relations and the cessation of trade between the world’s two largest economies. The big weapon at stake: US treasuries.

 

Pegging the Yuan to the Dollar gives China a (un)competitive advantage over the rest of the world. Holding the USDCNY exchange rate above its fair value by an estimated 10-15% has the effect of making Chinese exports look cheaper overseas. To pay for it, however, there have to be hefty Capital account deficits and a transfer of money from China to the United States. The best way to achieve this China has found is the acquisition of Treasury bills meaning that China is traditionally the largest holder of US government debt outside of the States. This weapon can be used to China’s advantage if it’s disposal of the asset could lead to destructive forces within the United States’ government funding markets. It can also backfire if the US takes measures to undermine the value of China’s reserves. The potential ticking time bomb has prompted some commentators to begin discussing the end of the USDCNY peg.

 

Against a backdrop of a weakening US Dollar and a rising value of Gold, commentators have been weighing the possibility of a Yuan pegged to the value of the precious commodity. China also holds reserves of Gold worth over $117bn. Compared to over $1tn of US Treasuries in the coffers, China’s gold reserves are miniscule. If China was to decouple its currency from the US Dollar its holdings of Gold would have to increase dramatically. XAU/USD, the exchange rate of a Troy Ounce of Gold in Dollar terms would also have a considerable bounce. With the implied volatility of Gold considerably higher than that of a US Dollar (nearly 10x in fact), the move seems inconceivable as the pairing could destabilise the very trade it is in place to encourage. But are these not strange times in which we live?

 

 

 

Discussion and Analysis by Charles Porter

Click Here to Subscribe to the SGM-FX Newsletter

 

SGM-FX handshake montage

Morning Brief – Nifty

Nifty

 

The Nifty Index has lived up to its name: the Nifty (Fifty) comprises 50 of the largest Indian stocks on the National Stock Exchange and fleet of foot investors who bought on March 24 this year will be congratulating themselves today on a 43% rise in their fortunes with the Nifty Fifty now at 11,162. The Indian Rupee at 74 versus USD has strengthened 2% in the same period so unhedged international investors have not only preserved but enhanced their investment gains: Wanting, getting and winning!

 

 

Silver

 

Silver now through the psychological important $20 level is up no less than 15% this year and has outpaced gold in percentage terms and which is now at $1830. This means that the gold silver ratio which started the year at 88 and rose briefly to 102 earlier this month has crashed back to 89. Markets are expecting that ratio to fall further as silver continues to be in strong demand and gold appears to have run its course for the moment.

 

 

Tea and Biscuits

 

Yes it is official: the UK cemented its reputation during LockDown as GBP 24Million more was spent on tea and coffee and GBP 19M more on biscuits than in the same period last year. Less healthily alcohol sales for home consumption rose 41%, but hardly surprising given the falling off a cliff shape to the pub takings graph. SGM-FX’s Graham has definitely been a coffee monster sporting a new ritzy coffee maker, but due to the arrival in June of new son and heir, Oscar during LockDown, Graham has been travelling on an entirely new vehicle for him: the wagon!

 

 

208 years ago today…

 

Our French readers may want to look away now: the English and Portuguese commanded by the Duke of Wellington and evenly matched against the French under Marshal Marmont (50,000 on each side if you are interested) met at the Battle of Salamanca in Spain this day in 1812. The result was decisive and swift(40 minutes) with France incurring heavy losses and as a result being forced to give up Andalusia permanently- leaving the Brits and the Germans to fight over the sunbeds on the Costa del Sol.

EUR strong versus USD this morning (despite this anniversary.)

 

 

 

Discussion and Analysis by Humphrey Percy, Chairman and Founder

Click Here to Subscribe to the SGM-FX Newsletter

SGM-FX office view

Morning Brief – Russia

Russia

 

This is how it works in a pandemic affected Russia under President Putin: he simply instructed his officials yesterday to “fully restore the labour market” and stated his displeasure that 3 million or 6.3% of Russians were unemployed. USD/Ruble at 71.22.

 

 

Saudi Arabia

 

Spare a thought for the citizens of the Kingdom who were reeling last night from the VAT rate having tripled from 5% to 15% and a cost of living allowance being scrapped. Most countries are looking for ways to stimulate their economies but Saudi Arabia in a move to restore their depleted finances due to the much lower oil prices have gone in diametrically the opposite direction.USD unchanged at SAR 3.75

 

 

July 17 1717

 

When you are George 1 of England and announce that you want a concert on the River Thames, this is what you get: George Frederic Handel composing it, 50 musicians on a barge and the premier of the world famous Water Music this day 303 years ago today. So taken was George 1 with Handel’s 3 movement piece that he asked for all of it to be repeated that inaugural evening…twice. Consequently the Royal party was out on the river from a start of 8pm until after midnight. Handel had a hit on his hands having found Royal favour and the word prolific does not do justice to his total life output which included 42 operas, 25 oratorios, more than 120 cantatas, trios and duets, numerous arias, chamber music, a large number of ecumenical pieces, odes and serenatas, 18 concerti grossi and 12 organ concertos. Phew!

 

 

Majorca/Mallorca

 

News in last night that left SGM-FX Compliance’s Alberto incandescent behind his mask as he looks forward to his long awaited annual hols back home: the infamous Punta Ballena strip in Magaluf is to be shut immediately due to post LockDown Brits failing to socially distance. It turns out that Alberto is not going to Mallorca but is rightly concerned that such behaviour will spoil his summer hols in the nearby holiday isle, Ibiza, Spain not only for Brits but also returning Spaniards like Alberto. EUR untouched by all this after Christine Lagarde’s ECB meeting yesterday which reported that the European economies are in recovery mode and that the ECB council will do “whatever it takes within our mandate” which has left EUR/USD strong and over 1.14 and Alberto packing his Villebrequins.

 

Enjoy the weekend and some sunny weather wherever you are!

 

 

 

Discussion and Analysis by Humphrey Percy, Chairman and Founder

Click Here to Subscribe to the SGM-FX Newsletter

team discussion

Morning Brief – Global Japanification

Global Japanification

 

 

I’m told that when you make a risotto, you’re supposed to add the stock a ladle at a time and let it evaporate/absorb. Have you ever just dumped the lot in and feared you’ve ruined the whole dish? How about building a fire. Have you ever smothered it in so much wood that the embers begin to fade and die out? If you haven’t, congratulations, you’re a better chef and pyromaniac than me. But if you have, you’re likely more in tune with something called ‘japanification’ than our masterchefs. We use this term to refer to the economic malaise that has plagued the Japanese economy for several decades. Despite the immense injection of monetary stimulus (stock/wood) they can’t get the rice to cook, the fire to catch or the economy to grow. The economy has been stuck in a low growth and disinflationary trap that has moved bond yields lower even as the level of debt continues to rise.

 

The developed world has largely entered at least a temporary phase of Japanification thanks to the de facto yield curve control taking place within most central banks. The UK’s £300bn asset purchase program has provided a lot of fuel to the UK economy and governments have produced debt pushing the UK’s debt to GDP ratio above 100% – the highest since records began in 1993. Despite that, yields continue to sit at record lows with little sign of abating. Implied volatility in these assets is also at all time lows. The figures are comparable in the Eurozone and the US with a Covid central bank spending tab of €1.35t and $6t respectively as government debt continues to drive higher. Most nations haven’t embarked upon a path of explicit yield curve control despite a lot of discussions about it. However, almost every developed central bank has committed to maintaining the stability of credit markets to ensure the smooth functioning of the economy. If that isn’t a guarantee of low borrowing costs, I don’t know what is.

 

Here’s why you should care. Interest rates are the main driver of fx forward/swap rates. The expectation of how respective interest and inflation rates will converge/diverge also plays a significant role in forward pricing. If a state of Japanification overcomes developed markets it has the impact of driving yield investors into riskier contracts. This could come in the form of underperforming corporate debt or lower quality bonds but it frequently drives investors to hold emerging market higher yield debt overseas. We have seen this come into play already in markets including South Africa, Mexico and Brazil. Each of these nations’ forward contracts over 6 months have become 38%, 28% and 36% relatively more expensive to buy into since the begging of the year.

 

If you never buy forward and keep your currency transactions limited to spot this will also spill over to impact you. Spot values will try to converge with forward rates. If a currency attracts a significant level of interest leaving it with a strong forward price more market participants (ceteris paribus) will want exposure to the pair encouraging the spot price to move in favour of the higher yielding currency. Typically referred to picking up pennies in front of a train, these conditions can lead to vulnerabilities in the form of rapid short coverings in emerging market currencies if fundamentals deteriorate.

 

 

 

Discussion and Analysis by Charles Porter

Click Here to Subscribe to the SGM-FX Newsletter