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Morning Brief – Archegos

Archegos

 

Much will be written interspersed with plenty of handwringing as to how Archegos Capital could have built up leverage to an extent which at present is unknown but is estimated at USD 50 Billion. An estimate of investment bank losses is (currently) tentatively set at USD 6 Billion. How and why? All investment banks offer “prime brokerage” services which work as follows: an asset manager or hedge fund with a credible amount of capital raised from investors, or in the case of Archegos primarily from one investor, approaches a PB and pitches them their business model and strong risk management capability; the undoubted risk management capabilities of the investment bank are assumed to be flawless. Once approved, the asset manager or hedge fund is granted credit and liquidity lines which translates into a leverage ratio on their capital with the proviso that all positions or exposures are reported in real time to the PB. What is not appreciated by those not in the PB market is that the PB has the right to firstly change the leverage ratio by increasing the margins on those exposures with immediate effect and secondly and crucially the PB has the right to take action by intervening and reducing those exposures unilaterally and without the intervention of the asset manager.

This was a lesson that I learnt in the hitherto sunny climes of Bermuda almost 30 years ago when the PB of the hedge fund where I worked decided that they should (because they could) double the margin on the positions that we held in the Indian stock market- overnight. Happily because we held a large supply of US Treasury Bills, we were able to meet that increased margin requirement and therefore there was no call for the PB to intervene and sell our Indian stock market positions.

The unfolding Archegos drama which has much more risk to be unwound, started with Viacom shares initially falling 10% last week which in turn led to an increase in margin calls for Archegos, was then compounded by an increase in those margin levels and was then rounded off by the PB selling assets into a falling market. As with all large funds, and although Archegos is not well known, it is large, they had multiple PBs. The two largest are Nomura and Credit Suisse, but the knock on effect of the sales of stocks and much larger amounts of derivatives has caused a ripple effect on the valuations of all investment banks including UBS, Goldman Sachs and Morgan Stanley. Crucially those PB’s have procedures to follow regarding selling down positions when values fall, but they do not include doing so in co-operation with other PB’s. This is a big story with plenty of questions and now commercial bank Wells Fargo has become part of the story.

 

Iranian Oil

 

It’s cheap and on the back of US and EU sanctions, it’s hard for the Iranians to sell. Or rather that is the official line. The reality is that 1 million barrels a day is being sent to China and China is estimated to be benefitting from 30 million barrels in March. To put this in perspective, Saudi Arabia exported 60 million barrels to China in January and February. This is much of the reason behind the fall back of global oil prices in the last few weeks. WTI trading at $60.61.

 

Jimi Hendrix on Fire

 

It was this day in 1967 that Jimi Hendrix had the bright idea of setting his Fender Stratocaster guitar on fire at the Rainbow Theatre, Finsbury Park in London. It was successful but not that successful as Jimi sustained burnt fingers that he had to have treated in hospital. It did not prevent him repeatedly setting his guitar on fire subsequently until his untimely departure on September 18 1970. Here is one of Jimi Hendrix’s finest songs, Little Wing from the 1967 album, Axis Bold as Love:

 

Well she’s walking through the clouds
With a circus mind
That’s running wild
Butterflies and zebras and moonbeams
And fairly tales

 

That’s all she ever thinks about

 

Riding the wind

 

When I’m sad she comes to me
With a thousand smiles
She gives to me free

It’s alright, she says
It’s alright
Take anything you want from me
Anything

 

Fly on, little wing

 

 

 

Discussion and Analysis by Humphrey Percy, Chairman and Founder

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team discussion

Morning Brief – Hey Ho up she rises

Hey Ho up she rises

 

Carrying 18,300 containers, the cost of the stranded Ever Given vessel in the Suez Canal was costly for its operators, Taiwanese Evergreen, the privately operated canal, global trade, and me. Perhaps my IKEA package that spent nearly a week of it’s pre-delivery life on that boat stranded just outside the Egyptian city of Suez is small change in comparison. In fact, the private canal operators are expected to have lost tens of millions of Dollars in foregone passage fees. The estimated hold up to global trade could have knock on effects that leave a lasting impact on annual figures with just-in-time supply chains already at breaking point due to the pandemic. After the spring tide allowed the gigantic container ship to be refloated into wider passages of the canal for inspection, the price of oil immediately fell 1%. The Suez blockage has created interesting dynamics in commodity markets that in turn have fed into commodity currencies and risk assets in interesting ways.

 

Consider Brent crude oil: the European benchmark of North Sea oil adopted globally. A lot of the supply of Brent crude passes through the canal each day satisfying demand from the Far East. Similar delivery methods to keep this market ticking involved taking over one week of additional travel and shipping time and cost to go around the Horn of Africa. This constrained the supply of Brent crude within the market but also had a knock on impact upon demand as it was reallocated elsewhere geographically where possible. This conflict between supply and demand made the price action messy with the price of many commodities showing a high degree of volatility as they reflected idiosyncrasies of the individual deal and delivery more than generic futures contracts.

 

Provided that the total volume traded of each commodity whose price rose due to the Suez crisis did not fall, so as to deliver a lesser total revenue, the blockage could be positive for the national currency that has a chiefdom within the export market for that particular commodity. I.e if one nation exports one commodity whose price was inflated, provided they face an ineleastic demand curve it would entail more demand of local currency whose price in turn should rise. The equities rout on Friday has further obscured the impact of the supply chain woes upon commodity currencies. So too the surprise turn in the course of the pandemic in Europe is still unsettling global commodity markets.

 

There is one further risk that will create opportunities associated with the volatility and uncertainty that it will inevitably cause: data. Did you know airline passenger numbers are up 491% in the US compared with one year ago? ‘Tis the season for year on year annualised data crimes due to the medieval levels of economic activity associated with this observation period across the globe one year ago. Rather therefore, a more accurate picture would be one year ago one bloke and his carry-on went on a flight, versus 491 people today – still peanuts versus our pre-pandemic path. This reality will make isolating the trend and recovery from the noise harder and possibly lead to more volatility in markets struggling with erroneous data.

 

 

 

Discussion and Analysis by Charles Porter

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St Mary Axe view

Morning Brief – Consensus 2021

Consensus 2021

 

As we entered 2021 the consensus trade was: weaker USD on the back of President Biden’s trillion dollars of stimulus leading to easy money and a rise in the stock market. Well the last part has been right but at the end of the first quarter, it is clear that the relationship between a weaker USD and stronger Equity markets has broken down. The reason for this is the success of the USA’s vaccine rollout and the opposite of that in the EU. That means that as long as the economies of the EU and the USA diverge, it would be wrong to assume a weaker USD. There is now a second plank in the argument towards leading to a stronger USD scenario: the US economy will prompt the Federal Reserve to react which they will do promptly by tightening, and the consequent higher interest rates in the USA will lead to a stronger USD. For consensus traders, EUR/USD at below 1.18 is testing their pain levels so that may prompt if not a rush certainly a brisk move towards the exit of that particular trade.

 

South China Sea

 

This time it’s tensions between Chinese fishermen and the Philippines instead of Taiwan and their airspace: more than 220 Chinese fishing boats are fishing off the Whitsun Reef west of the Philippines’ Palawan Island. While nearly 7000 miles from the UK it is also by no means close to the nearest city in China, Guangzhou -in fact 1000 miles distant. The situation is being monitored but meantime the Philippines have scrambled their air force and are patrolling the area. Tensions in the area have prompted the Philippines to strengthen their Air Force and while it has 15,000 personnel and 211 aircraft, there has been a long period of cuts that has led to a need for modernization. Biggles aficionado, SGM-FX staffer, Euan Maskell explains that while they have 25 combat aircraft including 12 Korean KAI-T250’s, most of their deployment is in the shape of helicopters which given the huge size of the Philippines’ archipelago is a major challenge when it comes to providing an effective airborne deterrent. They do however have 3 batteries of Israeli Spyder surface to air missiles on order and due to be delivered in Q2 2021 which everyone hopes will be held in reserve-that is if they are not queued on a ship on the north side of the Suez Canal.

 

Stairway to Heaven

 

It was this day in 1975 that Led Zeppelin had all 6 of their albums in the Billboard Top 100. One of their best songs which is often described as the best rock group song ever was released in late 1971 and featured on the hugely influential Led Zeppelin IV album. Here is Stairway to Heaven:

There’s a lady who’s sure
All that glitters is gold
And she’s buying a stairway
To heaven

When she gets there she knows
If the stores are all closed
With a word she can get
What she came for

And she’s buying a stairway to heaven

There’s a sign on the wall
But she wants to be sure
‘Cause you know sometimes
Words have two meanings

In a tree by the brook
There’s a songbird who sings
Sometimes all of our thoughts
Are misgiven

Ooh, it makes me wonder
Ooh, it makes me wonder

There’s a feeling I get
When I look to the west
And my spirit is crying
For leaving

In my thoughts I have seen
Rings of smoke through the trees
And the voices of those
Who stand looking

Ooh, it makes me wonder
Ooh, it really makes me wonder

 

 

 

Discussion and Analysis by Humphrey Percy, Chairman and Founder

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SGM-FX View of london

Morning Brief – US Federal Reserve

US Federal Reserve

 

Strong comfort for the markets from the Fed promising to ensure that the US economic recovery is broad and well established before removing its market assistance. USD still firm on the back of this trading at 1.1760 v EUR. Unemployment falling but still 18.9 million drawing benefits hence the Fed focusing on a full recovery-quickly.

 

Canada

 

Canadian Dollar weaker on the back of lower oil prices and lower bond yields-the 10 Year Canadian Dollar Government Bond now at 1.45% having been 1.67% just over a week ago. The differential in Canada’s bond yields versus the USA’s is doing the Loonie no favours.

 

Bitcoin and Tesla: Elon Musk offers to accept Bitcoin in payment for Teslas

 

Suspend disbelief(again) but Bitcoin investors (who apparently are the same people as Tesla buyers) have in all seriousness raised a question which is actually being considered: will they be recompensed if they use their Bitcoins to buy a Tesla car and then Bitcoin goes up in value? No question of course about what happens if Bitcoin declines in value! On one hand Bitcoin investors buy the argument that it is a substitute for Fiat currencies but at the same time by asking this question, they clearly do not. Bitcoin has had a losing week having fallen from over $60K to $52K or…..pretty much the price of entry level Tesla models.

 

Tarzan

 

In the 1999 animated film re-make of the original Johnny Weissmuller character, Phil Collins played his song, You’ll be in My Heart which was one of the five songs he wrote for the Walt Disney film and many would say his best. Here it is:

 

Come stop your crying
It will be alright
Just take my hand
Hold it tight
I will protect you
From all around you
I will be here
Don’t you cry

For one so small
You seem so strong
My arms will hold you
Keep you safe and warm
This bond between us
Can’t be broken
I will be here
Don’t you cry

‘Cause you’ll be in my heart
Yes, you’ll be in my heart
From this day on
Now and forever more

You’ll be in my heart
No matter what they say
You’ll be here in my heart
Always

 

Have a Great Weekend!

 

 

 

Discussion and Analysis by Humphrey Percy, Chairman and Founder

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Morning Brief – More stimulus?!

More stimulus?!
 

When you look at the inflation concerns that have been developing in the US economy as a result of Biden’s €1.9tn stimulus package you may have thought it would be madness to start planning yet another round of $3tn worth of stimulus. After all, if people thought that the existing package risked creating excessive inflation and the economy would be over stimulated during the recovery phase from the pandemic, how can borrowing and spending even more be any different. But I’m not so sure. Whilst the initial headlines may have been a surprise, this new stimulus plan could provide support to the US economy without risking undue inflation and crowding out the private sector.

 

Let’s make it clear initially that the $3tn stimulus plan was a headline grabber. This fiscal stimulus policy was something that the White House is reportedly considering and not something that is a reality or even close to fruition yet. Rather the prospect of it in the US and indeed globally is critical to understanding how the global foreign exchange market will react to national recovery programmes and how nations can determine their own recovery. It is the job of the White House as it is any government to consider every policy possible and to analyse the best path forward. But let’s say the US economy (or any other for that matter) really did pursue a fiscal response of this size during the recovery phase of the economy. After the tsunami of stimulus that has preceded it – could the economy soak up that extra spending and what would be the result?

 

The core of my argument is that the proposed $3tn stimulus plan is completely unlike the stimulus plan of $1.9tn that got markets up in arms and marching for the exit in the bond market recently. The stimulus that President Biden has already passed afforded direct payments to US citizens and was a crisis era response policy. With a world class vaccination programme and a well positioned economy it was thought that the short term fiscal stimulus including putting purchasing power into the pockets of US consumers directly would cause upward price pressure. However, the plans now supposedly under consideration concern infrastructure spending programmes designed to level up the economy, invest in its supply side capacity (typically a deflationary exercise) and expand the productivity of the US economy.

 

There is and will still be a considerable output gap in nations emerging from the pandemic and productive capacity is likely to remain both below pre-pandemic absolute and projected levels for some time. Therefore, when the nature of spending and borrowing is targeted towards infrastructure and productivity spending, the effect is not inflationary, unlike putting another $1,000 in someone’s pocket. Similarly, whilst the amount spent is larger in the proposed infrastructure plan, it is investment and productivity spending that are likely to see the slowest recovery in the private sector having been caught on the back foot for the past year. The time horizon of infrastructure spending is also considerably longer – how long does it take to build a bridge, or upgrade telecommunications or deliver a new cross-country railway versus spending $1,000 in your pocket?

 

Infrastructure borrowing and spending should be a key component of any successful nation’s response to the pandemic and help foster a more even and balanced global recovery than the economic crisis of 2007/8. Encouraging borrowing at the longer end of the yield curve due to the duration of the spending projects, this should steepen rather than crowd out the yield curve and encourage growth expectations. Normally, this would play out to the benefit of the national currency, however, with a unique safehaven status and often idiosyncratic reactions to economic adjustments, the path of USD will be less clear.

 

 

 

Discussion and Analysis by Charles Porter

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UK buildings

Morning Brief – Oil

Oil

 

A sharp 4% fall in oil prices on the back of further restrictions and slow vaccine programs in Europe saw WTI falling below $60 to as low as $58.50. This meant that USD strengthened as further LockDowns were announced in France and Germany exacerbating fears of a further hit to the global economy.

 

South Africa and Turkey

 

Lesetja Kganyago of the Republic of South Africa’s Central Bank will appreciate the lesson that the markets are teaching Turkey in the wake of the defenestration of the Governor of the Central Bank of Turkey: scrapping a tough monetary policy and higher interest rates in Turkey led to an immediate 10% caning of the Turkish lira as we described yesterday. That political interference lesson will not be lost in South Africa and will bolster support for the Central Bank’s fight against inflation.

 

Convenience Foods

 

When did these start and why? It turns out that both baked beans and condensed milk were popular with the soldiers during the American civil war in the 1860’s. Improvements in canning meant that soups and fruit were able to be preserved and sold in cans in the 1870’s. Libby’s launched their corned beef in 1875 and H.J.Heinz produced ketchup for the first time, one of their 57 varieties in 1876. At the same time Herschey produced his eponymous chocolate bar, Quaker registered Quaker Oats and for the first time peanut butter was marketed. Kellogg produced granola, Hires launched root beer and the list goes on. The interesting thing is that all this happened within 5 years in the late 1870’s.

 

Hello…

 

SGM-FX pop followers of a certain vintage will recall moments from their earlier lives which doubtless featured dimly lit night clubs and Lionel Ritchie’s number one hit, Hello. Here it is as good as it was in 1984 when it was released:

I’ve been alone with you inside my mind
And in my dreams
I’ve kissed your lips a thousand times
I sometimes see you pass outside my door

Hello
Is it me you’re looking for?
I can see it in your eyes
I can see it in your smile
You’re all I’ve ever wanted
And my arms are open wide
‘Cause you know just what to say
And you know just what to do
And I want to tell you so much
I love you

I long to see the sunlight in your hair
And tell you time and time again how much I care
Sometimes I feel my heart will overflow

Hello
I’ve just got to let you know
‘Cause I wonder where you are
And I wonder what you do
Are you somewhere feeling lonely?
Or is someone loving you?
Tell me how to win your heart
For I haven’t got a clue
But let me start by saying
I love you

 

 

 

Discussion and Analysis by Humphrey Percy, Chairman and Founder

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Morning Brief – Fowl Play – Stuffed Turkey

Fowl Play – Stuffed Turkey

 

A dramatic move over the course of the weekend has the Turkish Lira on its knees with the monetary credibility of Turkey back at all time lows. Yesterday’s European trading session saw the Lira priced around 10% weaker versus its closing price on Friday afternoon. Given market positioning around the Lira and the significant degree of focus that markets have afforded it so far this year, the devaluation has had ramifications for the wider market, not least the basket of emerging markets for which this move in Turkey served as a timely reminder of the institutional instability and capture in emerging market economies.

 

On Thursday, the central bank Governor hiked interest rates by 2% to tame the nation’s rampant inflation rate and continue to support the nation’s currency. This rate hike was welcomed by the market as it brought rates to 19% which, even with Turkey’s untamed inflation rate in the teens, afforded one of the only positive real rates on the planet. With interest rates almost 10% higher since this time last year, the Lira had become the best performing currency across the market year to date. This stronger currency was providing the self fulfilling prophesy of controlling import-driven inflation and moderating the economy to sustain currency and economic stabilisation. However, someone didn’t like it: President Erdogan.

 

The President has exercised control over Turkey’s central bank for a long time helping to fuel currency crises over the past few years. He has publicly claimed that higher interest rates over a sustained period actually cause higher inflation than lower rates – not something that any economist has been able to support theoretically or empirically. The presidents own study of Erdoganomics has therefore led to a constant clash of heads between central bank governors and government. The authoritarian nature of national governance has therefore delivered Turkey with its 4th central bank Governor in three years… and counting.

 

To deliver President Erdogan’s prescription of low rates, an academic who has long shown a persuasion towards and even lobbied for lower rates in Turkey has been appointed as the new governor. The move forced the market to unwind the carry trades that have sought to capitalise on the Lira’s appreciation and positive real yield at break-neck speeds, sending the currency plummeting. Those carry trades were funded by short low yielding Euro and Japanese Yen positions. There was significant evidence of Yen and Euro buying to cover these short positions at the expense of the free falling Lira. A persuasion towards low interest rates will deter Lira buying, encourage still higher inflation rates with the monetary credibility of Turkey already in tatters. The Lira will struggle to post any further gains within this regime.

 

 

 

Discussion and Analysis by Charles Porter

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Morning Brief – Blue Hydrogen

Blue Hydrogen

 

This is the splitting of gas between hydrogen and CO2 which captures harmful greenhouse gases and therefore mitigates harmful effects on the planet. News that Saudi Armco is working with China as the green agenda assumes increasingly greater priority is interesting. What do the Chinese want in return? The answer is for Saudi Arabia to prioritise supplies of oil towards China now…and the blue hydrogen project is the quid pro quo.

 

Duckhorn

 

SGM-FX readers who are fans of Californian wines will know this luxury brand winery and may have missed their IPO at the end of last week which raised $300M valuing the winery at $2 billion. Most wineries are too small to IPO which is why this first winery IPO for more than 20 years has caused a stir-the last ones were Robert Mondavi in 1993 and Ravenswood in 1999. Duckhorn does of course command high prices for their The Discussion or Three Palms red wines, but also offers a Sauvignon Blanc for $40 or GBP23 as well as a Cabernet Sauvignon called Greenwing for $27 or GBP19. The shares immediately went to a premium of 20% but if you subscribe to the argument that in future we will all drink better wine, it is worth taking a closer look at Duckhorn listed on the New York stock Exchange under the ticker NAPA Stock/US/IPC

 

Top Clothes seller in the USA?

 

Most people would hazard a guess at one of Walmart, The Gap, TJ Maxx or Target-they would be wrong. With sales of $41 billion including third party sellers, Amazon has just assumed the crown of top clothes seller. Walmart recognize the threat posed by Amazon and have hired well known fashion designer Brandon Maxwell for their two fashion labels. Further evidence of a further change in consumer behavior accelerated by Covid and Lockdown.
 

The Jam

 

Straight in to the charts and the first hit in 1980 to go straight in to the Number One slot, The Jam’s anthem Going Underground enjoyed huge popularity across clubs and parties in the UK from Cleethorpes to Chelsea and subsequently across the world capturing the zeitgeist of the era. Led by Paul Weller and founded in a school near Woking, the band released 18 top 40 singles and were a tour de force in the mod/punk scene until they split up finally in 1982. Here it is:

 

Some people might say my life is in a rut
But I’m quite happy with what I got
People might say that I should strive for more
But I’m so happy I can’t see the point

 

Something’s happening here today
A show of strength with your boy’s brigade and
I’m so happy and you’re so kind
You want more money, of course I don’t mind
To buy nuclear textbooks for atomic crimes

 

And the public gets what the public wants
But I want nothing this society’s got
So I’m going underground
(Going underground)
Well the brass bands play and feet start to pound
Going underground
(Going underground)
Well let the boys all sing and the boys all shout for tomorrow

 

Some people might get some pleasure out of hate
Me, I’ve enough already on my plate
People might need some tension to relax
Me, I’m too busy dodging between the flak

 

What you see is what you get
You’ve made your bed, you better lie in it
You choose your leaders and place your trust
As their lies wash you down and their promises rust
You’ll see kidney machines replaced by rockets and guns

 

And the public wants what the public gets
But I don’t get what this society wants
I’m going underground
(Going underground)
Well the brass bands play and feet start to pound
Going underground
(Going underground)
So let the boys all sing and the boys all shout for tomorrow

 

 

 

Discussion and Analysis by Humphrey Percy, Chairman and Founder

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SGM-FX London skyline

Morning Brief – Decoupling?

Decoupling?

 

Market watchers not only alerted by US 10 year Treasury yield breaking up to 1.74% but also the US-German 10 Year Yield Curve spread breaking through the key 200 Basis Point mark. This points to markets expecting the US economy to not only outpace but accelerate away from the EU economic performance in 2021/2. USD having flirted versus EUR with 1.20 immediately after the Fed Meeting, has strengthened back to just over 1.19. Ursula Van der Leyden and her team not helping the cause of the EUR in the eyes of international investors looking for signs of a stronger EU grasp of the Covid vaccination roll out rather than a blame game.

 

Greece

 

In the dog days following the 2008 financial crisis, Greece struggled to borrow at all, so this week’s 30 Year Greece Bond raising EUR 2.5 Billion for the Republic was evidence of a complete turnaround in sentiment. As a reminder it was in 2015 that the 10 year Greece yield reached 19.4%. This week’s auction was 10 times oversubscribed and delivered funding to Greece for 30 Years at 1.93%!

 

Egypt

 

Analysis shows that Queen Cleopatra in today’s terms was worth $96 Billion or 3 times that of Queen Elizabeth ll. The Ptolemaic system was tilted in favor of the ruler and so Cleopatra just got richer as the bulk of the country’s revenues went into her treasury. Egypt was of great acquisitional interest to the Roman Empire but had no standing army which meant that Egypt was vulnerable. Two thousand years later Egypt is the second wealthiest country in Africa and is worth….$96 Billion. USD/EGP unchanged at 15.7 on all this old history.

 

Billy Joel

 

Worth an impressive $225 million, Billy Joel aka the Piano Man and at a sprightly 71 years of age, has had a string of hits over the past 45 years and none better than this 1977 number, Just The Way You Are:

 

Don’t go changing to try and please me
You never let me down before, mmm
Don’t imagine you’re too familiar
And I don’t see you anymore

 

I would not leave you in times of trouble
We never could have come this far, mmm
I took the good times, I’ll take the bad times
I’ll take you just the way you are

 

Don’t go trying some new fashion
Don’t change the color of your hair, mmm
You always have my unspoken passion
Although I might not seem to care

 

I don’t want clever conversation
I never want to work that hard, mmm
I just want someone that I can talk to
I want you just the way you are

 

I need to know that you will always be
The same old someone that I knew
Oh, but what will it take till you believe in me
The way…

 

Have a Great weekend!

 

 

 

Discussion and Analysis by Humphrey Percy, Chairman and Founder

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Morning Brief – Powell: and the yield is gone

Powell: and the yield is gone

 

Improving economic forecasts for global and US growth in particular have been captivating markets in recent weeks as we have spoken extensively about. The main impact has been to drive up the yield on US debt to reflect the increased inflation and growth that lies in store for the US economy. Before the US Fed announcement and press conference by Chair Jay Powell, the generic US ten-year note reached post Jan-2020 highs in excess of 1.65%. His testimony, however, did not address the rising risks of inflation that the market has been increasingly sensitive too and accordingly US central bankers took no monetary action akin to the ECB last week, to address the rising bond yields in the US. Holding rates close to zero, the Federal Reserve’s expectations for interest rates out to 2023 and the future beyond barely changed with a meagre two (out of 17 total) additional members expecting a rate rise above previous forecasts by the end of 2023.

 

There are two possible interpretations of this monetary policy decision and in the 12 or so hours that have unfolded since the decision was made by the US monetary authority, we have seen both. The first interpretation is for the market to take the Fed’s predictions of underwhelming inflation below target over the medium run at face value. It is therefore to concur with Chairman Powell that inflation later this year will be transitory and more accommodative policy is required to stimulate the economy during the bounce back from the pandemic despite the additional fiscal stimulus that Biden’s Presidency has so far provided. If the market steps back and believes the Fed that inflation is not an issue and tapering is not something that is required at this point and policy is where it should be for now then yields would fall, value be released from the Dollar and stocks rally on the back of easier market-derived credit conditions.

 

The other interpretation is for the market to stick to its guns and continue to forecast higher inflation alongside the upward revisions to GDP growth that we have seen so far this year. From this perspective the Federal Reserve has allowed the fuel of easy monetary policy to continue to spill into the fire of an economy positioned to overhead with above target price inflation. Under this interpretation the Fed has opted deliberately to fall behind the curve and leave itself vulnerable to be led by, rather than leading, the market. If the market sticks to its forecasts of higher inflation in the coming years and the need for tapering and the removal of stimulus in a boom cycle, yields would continue to rise, encourage further demand into now non-negligible USD interest and risk the kind of equity market correction that has been forecast at higher levels.

 

Last night, outside of European trading hours, the Federal Reserve delivered its monetary policy decision. The immediate knee-jerk reaction last night was more stimulus, equals lower yields for longer, weaker Dollar and outperforming equities. Scenario one therefore played out, pushing EURUSD back towards 1.20 and GBPUSD towards 1.40 overnight. As the European open began to wind up this morning, however, the second scenario began to take hold. The market realised that lower for longer actually exacerbates their projected inflation overshoot and undermined the demand for US treasuries at current valuations and pushed yields higher. The 30-year generic US note pushed on further to exceed August ’19 highs. This higher yield and a reversal in the market’s interpretation saw the Dollar claw back some strength once again as the 10-year note hit new post-pandemic highs in excess of 1.75%. The market is therefore betting that the Fed will have to blink at some point. Until it does, the Dollar should continue to strengthen in line with rising yields and the bet that the US will have to normalise policy first.

 

 

 

Discussion and Analysis by Charles Porter

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