Tag Archives: Charles Porter foreign exchange

Skyscraper view

Morning Brief – One Step Forward…

One Step Forward…
 

As avid observers of financial markets we spend a lot of our waking hours keeping up to date with market sensitive news. It is an important pursuit to stay on top of markets and the source of that news can come from (virtually) anywhere. Over the last couple of years I’ve seen markets light up from headlines emanating everywhere from the London Evening Standard, through to the financial news source, Bloomberg. Whilst everyone is at home self-isolating and concerned by how coronavirus is progressing across the globe, news becomes of even greater importance to our society. With great power comes great responsibility. I recall when Robert Peston was brought before the House of Commons Treasury select committee for his role in precipitating the financial crisis by employing hyperbole and scaremongering.

 

In this important time I am extremely disappointed to see (sometimes) reputable news outlets publishing similarly unfounded or misleading analyses. I shan’t name names but on Sky News last night I witnessed a chart with possibly the most ridiculous choice of y-axis I have ever seen. My Physics teacher would not have been impressed had I produced such a graph! The graph had been deployed to demonstrate the potential number of infections if the exponential phase of virus spread continued seemingly indefinitely. Yes, a projection about as useful as a spork in a knife fight. If you were interested, Peston, journalist and presumed significant stakeholder in Combe Incorporated, is still at it. Mr Peston has now been brandishing admonitions that the coronavirus pandemic may be “on par with [the] economic crash”.

 

This morning’s daily brief is intended to serve as an explainer to counteract the global fake-news pandemic! The principle of infection and exponential growth is a simple one. If each person infected goes on to infect more than one other person then the virus growth will be positive and can appear exponential. It follows that if each person infected on average infects less than one other person the virus will be in decline and eventually be overcome. In health studies this measure called the reproduction number (otherwise known as R or R0) and it is important. With Covid-19 R0 was estimated to be around 2.2. To serve as a source of comparison, the R0 for the common flu for example is approximately 1.3). So, at an R0 of 2.2, for every one step forward we take in successfully treating an infected individual we can expect to have already taken two (in fact 2.2) steps back given the spread of the disease that has taken place in the lifecycle of this infection episode. This figure is consistent with a doubling in infected numbers every 3-to-4 days; a pattern that we have seen unfold in the United Kingdom over the past few weeks.

 

The London School of Hygiene and Tropical Medicine has modelled how it thinks the all-important reproduction rate has evolved since the UK has undertaken social distancing measures. This type of analysis I will concede is incumbered by the scarcity of relevant and timely data. Given the extent of the social distancing measures implemented by the government and the uptake and adherence to those rules it is projected that R0 in the United Kingdom is now 0.62. Given the scarcity of data there is a significant margin for error meaning that the real post-lockdown figure of R0 could be anywhere between 0.37 and 0.89. Wherever we are in that range we can still conclude that the virus is on the back foot already and is therefore receding. So instead of moving backwards in our combat of the virus for every step forward we now take we only take an estimated 0.62 steps backwards. As a nation we are therefore making positive progress towards our target of eliminating the coronavirus. This analysis, apparently not seen by the news agency that will not be named, means that the exponential phase of virus growth cannot be considered endless; the SKY is not the limit for infection.

 

Following a tumultuous two weeks in Sterling markets, the Pound looks remarkably directionless as markets await evidence of progress (or lack thereof) in the battle against the virus. The Pound has regained some 60% of the value lose against the US Dollar during the sell-off earlier this month. The jury is still out on whether this move is a fleeting retracement or a meaningful correction.

 

 

 

Discussion and Analysis by Charles Porter

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US banner

Morning Brief – Tunnel vision

Tunnel vision

 

The coronavirus epicentre has migrated from Wuhan, Hubei province, through China, before migrating to Europe with Italy and Spain the best observable example of the exponential growth phase. The next epicentre of the coronavirus will be the United States having now recorded more confirmed cases than China. A fall in the number of cases reported in Italy in the last 24 hours to its lowest level in almost two weeks is being read as a positive sign of light at the end of the tunnel. In fact, the pan-European stabilisation in Coronavirus infection rates has prompted the World Health Organisation to conjecture that Italy and Spain’s outbreak may have peaked.

 

Daylight we see from the sun is about eight and a half minutes old having left our nearest star and taken this amount of time to race through space to our eyes. In more distant galaxies we observe pictures from millions (if not more) years ago as the light emitted from this distant region of space has taken that long to reach our planet. Delays in observation are apparent with the epidemic too with symptoms and potential hospitalisation arising around two weeks after initial exposure to the virus. Quarantine and lockdown which have been underway for as much time in Europe should begin to flatten the so-called curve and now measurably control the infection rate. The improving data in these beleaguered nations should be a signal of such an event.

 

So, what does the light at the end of the tunnel look like? In China, the economic machine has begun to burr once again. That’s not to say that the nation is back to full capacity and consumption – far from it. The threat of now imported new-strain coronavirus infection from abroad is considerable and as such the country remains far from full import and export capacity. Positively, soft data is beginning to reflect the improving coronavirus statistics. The Purchasing Managers’ Index – a widely recognised piece of survey data that collects responses from purchasing managers throughout the economy – has risen from a trough of 35.7 in February, when fear abounded, to 52 this month. A 50+ reading indicates expansion and improving conditions pointing to a fragile but recognisable improvement in the economic environment. With a (moderately) generous stimulus package in place to capitalise banks and promote lending and economic activity, the People’s Bank of China is also supporting economic recovery.

 

The United Kingdom, which began lockdown measures sometime after Italy and Spain having witnessed a slower spread of the disease, have yet to show evidence of curve control. This is not to say that the UK response has been inferior to those of Italy and Spain despite many criticisms levied to this effect. The rate of inflection and hospitalisation that a nation can support in addition to the spread which the virus has already recorded vary between populations demanding different responses. Nonetheless, positive signals for the UK observation rate and recovery rate must be recorded I suspect before investors turn bullish on the UK economy.

 

A quick update on South Africa: a downgrade to junk status in the nation has left the Rand trading at all-time lows versus many of its peers. The sell-off in the sovereign bond market leaves the domestic interest rate at unsustainably high levels as the country battles the outbreak of the virus. Social unrest and quarantine enforcement problems continue to undermine the South African economic outlook and ability of the government to finance the nation through this difficult time.

 

 

 

Discussion and Analysis by Charles Porter

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SGM-FX View of london

Morning Brief – Lekke to be lekke

Lekke to be lekke

 

An Afrikaans ish phrase meaning it’s nice to be nice.. or so I’m told. In the times we find ourselves in, there seems to be value in examining exactly how nice is nice enough. Take the UK government’s call for citizens to volunteer to support the NHS. As Boris Johnson spoke to the nation yesterday we learned the government had expected 250,000 volunteers in a number of days. In less time than the government had expected, some 405,000 pledges to help had been received. That’s fantastic and I thank those that have been able to do so for their commitment. Unfortunately if we take things like this in isolation we approach our analysis of the population with rose-tinted spectacles.

 

As Rishi Sunak explained in his defence of the lack of financial coverage for self-employed workers there remains the concern that individuals and corporations will take advantage of the provisions that are being put in place to cushion the public through the Coronavirus pandemic. It’s unavoidable and a shame given that every pound borrowed by the government to fund these unprecedented spending plans will leave us with an enormous fiscal deficit that must be paid back. Look elsewhere: there was a huge spike in Companies House registrations for limited companies and individuals to be sole traders as covid-19 emerged as a pandemic. Whilst some of these certifications will have been granted to pursue philanthropic efforts, the vast majority of them are, I’m sure, to take advantage of people’s fear during this time. Testing kits for thousands of Pounds, toilet rolls for 1000% of their normal prices and hand sanitiser that looks set to rival saffron’s per unit cost are testimony to this belief!

 

The question of how nice is nice enough is set to become even more important for South Africa in the next 48 hours. We’ve been talking about Moody’s rating decision in South Africa for a long time. Since October when their last decision was to issue a negative outlook ahead of the Q1’20 budget speech, this Friday has been a focal point for the Rand. South Africa’s debt has been held at ‘junk’ status by two of the three major ratings agencies, Fitch and S&P. The classification by Moody’s, as all you Rand buyers and sellers will know, is Baa3- i.e. investment grade by the skin of its teeth. Given the worsening of South Africa’s credit outlook amidst the shutdown that comes this Friday it seems inevitable that a downgrade will take place.

 

Most economic commentaries out there authored domestically and internationally focus upon two themes. 1) Should and could Moody’s downgrade in good conscience given the state of the global political economic amidst Coronavirus; 2) does a downgrade even matter given everything else that’s going on? I find these two strains of thought defeatist in principle with the second more offensive than the first. Let’s address the first one: for every borrower of money, the debtor, there is a lender of money, the creditor. The very point of these ratings agencies is to create a level of consistency and transparency to lubricate the credit market. If an inevitable downgrade was to be held up it could therefore have the very effect of constraining the lending market, making the situation even worse: not only would South Africa’s borrowing costs rise further there wouldn’t be any money on offer to borrow. So, it wouldn’t be that lekke to be lekke in this scenario. To address the second point: Yes! It will still matter!

 

The yield on a 10-year South African note has spiked above 12%. That means that money in South Africa is the most expensive to borrow since 2002. At a time when the government is borrowing to fund the shutdown and the (privatised!) South African Reserve Bank is buying assets such lending rates are damaging to the real economy. Given that Eskom doesn’t generate enough revenue to cover its interest payments in times of ‘normal’ borrowing at rates circa 7%, it seems inevitable that it cannot finance its debt at these levels. The concern around Moody’s downgrade is that index linked bonds frequently have a condition that they must only buy ‘investment grade’ bonds meaning that if South African debt loses its last claim to non-junk status is must be immediately dumped into the market.

 

The magnitude of such debt is estimated, but not known with absolute certainty, to be USD 15bn. I fear that upon realisation of the junk status tomorrow it will not be a ‘buy the rumour sell the news’ non-event given the legal requirement to flog the debt. Yields should therefore climb higher from their already lofty heights. The Rand should spike lower simultaneously. Eventually, the inexpensiveness of the currency combined with the high rate of return for buying it should lead to a correction but, given the uncertainty in the global market at the moment, that correction could be a long time coming and fragile. Those with an exposure to Rand should set price objectives and have a trading strategy in place to take advantage of and also defend themselves from the volatility likely to come with tomorrow’s announcement. Our desk remains fully staffed and is extending our full range of services and we’d be happy to put such a strategy in place for you.

 

 

 

Discussion and Analysis by Charles Porter

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UK buildings

Morning Brief – There goes the kitchen sink

There goes the kitchen sink

 

Markets have been talking about the ‘double punch’ that unsettled the benign and plain financial paradigm that we existed in for many years. The full-on right hook came from the Coronavirus that manifested as a simultaneous shock to supply and demand. The left hook came like some kind of bizarre scissor punch in the form of an oil price collapse. I can promise you that I’m not much of a boxer. But if I were to imagine what a boxer might do inside the ring when faced with such an onslaught I’m pretty sure it would be to respond with a similar act of aggression. Given that I hadn’t already been knocked out that is.

 

Yesterday the market had the opportunity to provide a US-led double punch response to the attack it was facing. The first punch was expected to come from the US government that was debating a fiscal response to the crisis, 25% of which was thought to be spent on Trump’s direct payment to US citizens. There were also provisions for sizeable loans to small businesses, additional liquidity assistance, and investment in healthcare. The second retaliatory punch would have been from the US Federal Reserve in yet another commitment to expanding market liquidity. In the end, the market received only the latter commitment from the Fed as momentum slowed on the $2tn package to support the US economy. The bailout package is still on the table and looks likely to pass but each day of inaction will unnerve the markets further.

 

Ultimately, the Fed’s action was insufficient alone to placate markets. Immediately after the Fed’s commitment there was a stabilisation of the risk fire-sale that had been taking place over the last few days. However, as markets weighed up the policy response to the developing health crisis stock markets continued to tumble to the benefit of safer havens. The Federal Reserve in a historic move opened two new facilities to the market allowing the Bank to purchase corporate bonds. Okay it sounds about as bland as the plain Ryvita consumers have been stockpiling but it isn’t:

 

Central banks are the institution in economies that can literally print money. They buy and sell government debt in quantitative easing and tightening cycles by literally inventing money. Their pockets are infinitely deep and the money they create never has to be paid back or made up. Even in the 2008 financial crisis developed markets central bank’s didn’t step into the corporate debt market – it wasn’t seen as a necessary step. However, the infinitely deep wallet is now being used to fund corporate spending directly.

 

A failing corporation can only stay alive so long as it can borrow in order to fund its commitments. When liquidity dries up in times of economic duress it won’t find people willing to take a risk on it and lend it money. In comes the Federal Reserve, directly funding the debt issuance to provide reasonably priced and guaranteed cash so that they might survive. Despite Trump’s criticism of the Federal Reserve it seems so far that the central bank is doing far more for US citizens than the White House or the US political system.

 

In the United Kingdom we have entered a lockdown as the public largely failed to heed the social distancing advice that the government had issued. Whilst Sterling reacted negatively to the news of lockdown around 8:30 last night, the Pound is bid this morning parring its losses in the overnight session. Markets have opened up constructively in many sectors as news of Wuhan reopening and Italy’s death toll curtailing reassures investors that this crisis will end.

 

 

 

Discussion and Analysis by Charles Porter

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SGM-FX London skyline

Morning Brief – Down, down, down, down, down

Down, down, down, down, down

 

The chorus lyric of Flo Rida’s hit song echo the title of this market briefing. Two confessions: 1) yes I had to google the song to check 2) yes I spelled his name wrong. It might be erroneous to assume that just because the hit song was recorded in 2008 that Mr Rida was commendation on the global financial crisis and Great Recession he saw unfolding before him. But it seems more fun to do so than not, so I will.. After all, his co-star on the track (Ke$ha) even spells her name with a Dollar symbol! Coincidence?! Yeah probably.

 

Self-defamation and flippancy aside, the title of our budding musical FX analysts’ song was “right round”. My conviction to the belief of a sharp and deep recession followed by a period of rapid and unprecedented millennial growth mimicking a V-shape has only grown. I agree therefore with Flo Rida CFA and Ke$ha CPA, we should see valuations come right round.

 

Until the exogenous shock of Coronavirus the one world associated with GBP was Brexit. The most obvious feature of Brexit upon the Pound aside from a massive depreciation following the June 23rd referendum was a tight channel trade for more than three years. The range had a top (around 82.5 on a trade-weighted basis) that had been well tested and proven. It also had a firm bottom that had been reached and tested some three times in the course of post-referendum Britain at around 74 on a trade weighted basis. The average value was about 77.5 on the same scale. We have commented several times that this tight range is not sustainable and, eventually, volatility must come back into the underlying market and the Pound’s tight range broken. We also said that when the range is broken it won’t just crack, it will shatter and price action will be violent.

 

Following a rally at the end of 2019 following the result of the general election it looked as though the overdue range-break could have been to the upside. Unfortunately for Pound sellers and importers, the lack of a trade-deal and a stubborn PM in number 10 who was willing to leave without a deal capped Sterling’s gains in line but ultimately below the upper level. Given the above-average value of the Pound our expectation was for a correction at least towards the median and a move lower in Sterling. Well, we got it but the move was turbocharged by Coronavirus. As such we have broken the post-referendum price floor and Sterling is in free fall. See the graph below to see the Pound’s post-referendum performance and recent fall. Markets in normal times go up like an escalator. In bad times, they perform like a lift. Just in Sterling’s cash we’ve got a loose wire. Within the week, GBPEUR could well trade at 1-1.

 

On the desk we have been asked a lot why is Sterling taking the beating of international market’s angst at Coronavirus. Four reasons.

 

  1. Unpreparedness/Inaction

 

The UK government has been accused of inaction quite rightly. Despite a severe outbreak quarantine has not been enforced. Limitations on social interaction are value and not enforced. On top of that the amount spent and pledged by the UK government is pathetic in comparison with other developed European and US peers. Markets don’t like the UK government’s complacency and think it could deepen the Coronavirus crisis and ultimately the UK economy.

 

2. External deficit

 

Trust me, it isn’t just the Pound that’s taken a beating. All currencies whose underlying domestic economies have a large external deficit – i.e. they import considerably more than they export – are proving vulnerable to speculative flows. A weak current account balance can be likened to an over-leveraged debtor; in bad times their credit line is the first to be cut.

 

3. Brexit

 

With the political change that the UK was already attempting to undertake still underway and the time still ticking on a deal, there is a level of political risk that sours the taste of Sterling in investors’ mouths even further.

 

4. Oil

 

Whilst the UK may not be affected by the value of oil to the same degree as the true commodity currencies (CAD, NOK, RUB), Brent Crude (North Sea Oil) does still have an important influence on the capital flows around Great Britain. The sell-off in Crude Oil prices can still be seen to weaken Sterling slightly.

 

 

 

 

Discussion and Analysis by Charles Porter

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St Mary Axe view

Morning Brief – Deep and sharp

Deep and sharp

 

Alarm bells are still ringing. Households are on lockdown. Authorities are seemingly powerless to overcome the Coronavirus pandemic. Yesterday the Fed’s almost unprecedented 1% weekend cut in the target rate and a $700bn ramp up in quantitative easing failed to placate markets. If you’re not sure what that means it’s the Fed filling more than 116 Air Force Ones with $100 bills and throwing it over Washington DC for spending. Even a G7 commitment in true Super Mario form to do “whatever is necessary to ensure a strong global response” failed to stem the value bleed from risky investments. The problem Coronavirus presents is becoming ever more pervasive. But surely someone’s got to focus on the silver lining…?! I’ll give it a crack.

 

The global economy looks like it is emerging from one of its longest and largest expansions in history. Without sounding like I’ve suddenly converted to a socialist economy ideology, the world was over indebted and that puts a strain on the very growth that facilitated the debt’s creation. The economy’s natural response is to contract – we get a recession – something like that which we saw during the Great Depression of 2007/8. It’s econ101 – a squiggly line on top of a straight one – the business cycle. In 2007/8 the recession and crisis in the real economy was caused by a financial crisis. That’s particularly damaging because the banking system stops handing out money at the very time when the world needs it. Lending for mortgages, asset purchases and business funding dries up because banks themselves are the subject of immense balance sheet strain and need all the cash they can get their hands on!

 

In fact, a financial crisis has often preceded a crisis and recession in the real economy and the two have seldom been separated. The world was due a correction and, in the absence of an exogenous shock like the coronavirus, and like the oil price shock that we’ve been ‘double punched’ by in recent weeks it might not have come for as long as a couple of years. It would have been long and laborious and cost thousands if not millions of jobs worldwide.

 

Now though, because of the sudden collapse in supply chains, travel, consumer spending and productivity, it’s taps open on monetary and fiscal accommodation. What’s more than that is we have well capitalised banks that can still lend to individuals and business to weather the storm. Many have been offered a deposit ratio of 0% to encourage spending meaning that when its back to business as usual (likely in summer once the peak of the virus has been and gone) the global economy should soar in one of the most aggressive periods of growth in modern history. The combination of oil at $20-30 and cash aplenty will mean that business conditions are optimal once the world is back online. The downturn should in summary be deep and sharp with an impressive V-, not U-, shaped recovery.

 

If that wasn’t enough good news for you, never have I had so much room in which to stretch my arms and accommodate the full majesty of a broadsheet on my morning commute… every cloud!

 

 

 

Discussion and Analysis by Charles Porter

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Skyscraper view

Morning Brief – Bears

Bears

 

Last night’s price action was tumultuous. Asian and US trading sessions are normally characterised by widespread, sluggish price moves and limited volume. It’s unsurprising given that some 80% of foreign exchange sales and trading takes place in Europe and the lion’s share of that in London. However, when serious geopolitical or economic events take place, markets are forced to react no matter what the time zone. Algorithmic trading from London and Europe will contribute to the price action but market participants in the active time zone will also play their part. In turn, market orders placed by European market participants will add to the moves.

 

Last night was one of those occasions. President Trump addressed the United States to announce a travel ban and stimulus package. All travel from Europe to the United States for the next thirty days has been banned effective midnight on Friday. Those outside of the Schengen (borderless travel zone) Area will not be subject to the ban – including the United Kingdom. The reaction from the White House comes as the World Heath Organisation declared Covid-19 a global pandemic. To support business Trump also called upon congress to afford a $50bn line of funding to support SMEs through the pandemic.

 

Around the same time last night Italy, a nation under lockdown, ordered the closure of all businesses with the exception of pharmacies and grocery stores. Italy’s reaction came as deaths climbed by 200 in just 24 hours. Earlier on Wednesday Rishi Sunak, Chancellor of the United Kingdom, announced a stimulus package of £30bn to weather the storm. He also took the cap off of NHS funding in order to bolster the national service’s ability to tackle the virus. The taps on financial, monetary and medical support have been opened across the globe to curb the impact of Coronavirus on the world. Yet still, overnight, the same risk-off trade emerged in force. Emerging market currency was sold in droves and equity markets sunk.

 

The risk-off trade emerged despite the strong response and call for economic stimulus. The sell-off has been so severe that many equity markets have entered bear territory – i.e. they’ve sold off in excess of 20%. The Dow Jones industrial average, a US stock index that tracks the performance of 30 large US corporations, has entered bear territory with many others following close behind. Following the announcement by President Trump Asian equities sold off rapidly. US futures point to a sluggish start for the US stock market later this afternoon.

 

Over the last 20 days the Euro has gained close to 7% versus the US Dollar. The majority of this shift has taken place since the Federal Reserve announced a 50 basis point emergency cut in interest rates. Central banks around the globe have come to the rescue of their domestic economies creating a synchronised monetary response. Despite admonitions to the world the ECB has yet to adjust policy in response to the virus. Today, however, President Christine Lagarde will lead the European Central Bank in a monetary policy decision. The ECB employs three interest rates: the deposit facility, their main refinancing operation rate, and the marginal lending facility. The Bank also conducts huge outright monetary transactions (QE to you and me). The ECB can and should adjust the majority of these instruments to provide support to the ailing European economy. In turn, the ECB will hope, the Euro will weaken in order to provide further stimulus to the ailing economy.

 

 

 

Discussion and Analysis by Charles Porter

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SGM-FX View of london

Morning Brief – How to cure Coronavirus

How to cure Coronavirus

 

Taking lead from the US House of Representatives, Italy, China, and now the IMF, apparently the cure to Coronavirus is to print a ton of money. In fact, more; much more! Ten tons of $100 bills is worth approximately a billion dollars. That means the IMF’s pledge of $50bn for Coronavirus afflicted nations is equal to 500 tons of three-figured green notes. The US House of Representatives is discussing an $8bn (80 ton) relief package of its own following Italy’s discussions of a €5bn Euro spending plan (12 and a bit tons if you use those purple €500 notes!). Yes, I’m being facetious and, no, I’m not trying to incite a metric versus imperial measurement war… But the message is important, the raising of cash for government spending, its dispersal, funding and allocation will all have important impacts upon the global foreign exchange market.

 

Thanks to central bank action that kickstarted on Tuesday, the money being raised by each nation will be essentially free. It will have little impact other than to add another drop into an already enormous pool of liquidity and debt. The Fed’s surprise cut two days ago precluded similar cuts in the cost of borrowing in Australia, Malaysia and Canada. Canada’s decision to mirror the Fed’s 50 basis point cut weakened the Loonie yesterday against its neighbouring Dollar. The way an exchange rate reacts to interest rate decisions is simple; it changes the fundamental cost/reward for getting into respective currencies and therefore appetite for them. But shifts in the rate currencies trade at with respect to each other have huge impacts in determining how effective those very rate decisions will be.

 

Consider this: the United States’ Federal Reserve cut rates in order to nurture a flickering flame of late-cycle US economic expansion. In particular, it did so to buffer firms whose global supply chains that frequently originate in or prevalently involve China. Additionally, companies exporting from the United States get some respite from the headwinds of a flagging global economy when their currency conveniently depreciates, making it cheaper to purchase internationally. This really does happen – the expectations and realisation of an interest rate cut in the US saw the Dollar lose about 4%. Great! But at the same time the Canadian Dollar, lost 1% versus it’s US counterpart meaning that the relative cost of trade across the US-Canada border moves in favour of the latter, partially limiting the demand stimulus to US exporters. The diminished impact of US monetary easing means that yet further cuts are priced in this year and even as soon as their next scheduled policy announcement in a little under two weeks. All that could equal a yet-weaker US Dollar.

 

Central banks and nations alike will therefore be very careful to call the easing cycles that they have wholeheartedly embarked upon as a coordinated global policy response. Not, as some might more pragmatically conjecture, a race to the bottom in monetary policy and exchange rates. The BoE so far has been left out of this race largely explaining its trend-breaking 1.5% appreciation so far in March. With incoming Governor Andrew Bailey pledging to take ‘swift action’ to soften the economic impact of Corona virus, that could all be due to change.

 

 

 

Discussion and Analysis by Charles Porter

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Figures

Morning Brief – Loose footing

Loose footing

 

Equity markets have been a good barometer of the risk associated with the Coronavirus. Thanks to numerous developed markets and indices being ‘late-cycle’ they are proving to be particularly sensitive to exogenous risk; more valuable in my opinion than many purpose-built indices. In the UK yesterday, the FTSE100 kicked off to a good start. The daily high was reached within minutes as short sellers took some profit from the near-thousand point sell-off. Sentiment waned into lunchtime before rebounding in afternoon trade to close 1% up. European equity markets this morning have continued yesterday’s rally so far.

 

Markets in the US performed even better yesterday with the tech-heavy Nasdaq up nearly 5%. The complexion of the recovery, one that has benefitted internationally orientated firms with complex supply chains can be taken either as a meaningful improvement in risk or a correction in last week’s severe over-pricing. Time will tell. For now, the OECD has revised this year’s global growth forecast from 2.9% to 2.4% with warnings of a further tumble to 1.5% should the infection become more widespread and intense. In markets, research teams are entertaining the idea of the first quarterly contraction in global growth since the 2008 financial crisis. The fragility of yesterday’s rally and the dynamics that these episodes produce in financial markets should not be underestimated therefore.

 

In foreign exchange markets there have been upsets to three key safe havens: Gold; JPY and USD.

 

Gold: despite risk climbing and equities tumbling the price of gold has taken a sudden and severe fall at the end of last week. The reason for the sell-off has been blamed on forced selling by investors who, long in riskier products including equities, had to liquidate gold holdings to meet margin calls in other markets. That has been the story for now but I’m not convinced. Look out for more gold vulnerabilities in the future.

 

JPY: the safehaven. Safer than houses! Probably. The Yen has lost a lot of value despite risk ratcheting up to extreme levels across markets. But it’s not as bizarre as it seems. As has been said here before, partially by legacy and partially thanks to the ultra-consistent monetary and fiscal policies in the nation, the Yen is a long-standing asset that markets flood to first in a storm. Not this time. The reason for yesterday’s sell-off in the Yen was a promise by the Bank of Japan to, “provide ample liquidity and ensure stability in financial markets”. In conjunction with additional threats to domestic growth, the Yen has lost some of its pulling power.

 

USD: The (relatively) high yielding US currency had attracted strong flows for the last few years particularly as a reaction to risk. In reaction to the equity market sell-off and exacerbation in risk markets have begun to anticipate the Fed to step-in. It’s ‘central bank to the rescue’ time again which has created expectations that the reward for holding the dollar will fall as the Federal Reserve’s easing cycle continues. This has undermined the dynamics that have benefitted the Dollar (particularly when compared to the Euro) and cash has flowed from the Dollar in the past week despite increased risk.

 

As with most of the last decade, the legacy of the recovery in the financial crisis is dictating global trading conditions. With central banks full to the brim with debt, someone, somewhere is going to start talking about the next financial crisis…

 

 

 

Discussion and Analysis by Charles Porter

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team discussion

Morning Brief – Cool, but how?

Cool, but how?

 

If you want the simplest of summaries to yesterday’s budget speech in South Africa then read no further than the title. Tito Mboweni mostly said the right things as he laid the budget before the nation yesterday. The one thing he missed out was how!? What the review promised was more parsimonious compensation for government workers. We learned how much the Treasury expected to save and therefore the support it would provide to efforts of fiscal sustainability. What was missing is how they’re going to achieve such cuts, limiting the positive impact the announcement had on the Rand yesterday.

 

As with any budget review the Minister opened by painting the scene. With broad strokes the image that emerged wasn’t pretty. The biggest deficit in 28 years was the conclusion. Not a good start!

 

A deficit of 6.8% is forecast for 2021 facilitated by shrinking economic output (GDP) meaning that any shortfall in spending is exaggerated in percentage terms versus the size of the economy. The 2021 forecast deficit is the largest hole in South Africa’s coffers since 1982/3 when the figure soared to 7.2%. European readers living under the harsh constraints of the ECB’s six-pack of fiscal rules legally limiting their budget deficits to 3% upon threat of Billions of Euro’s of fines must be surprised at South Africa’s forecast.

 

Kicking off with such dire news the Minister was on the back foot to placate markets who were chomping at the bit to sell the South African currency. And so the Treasury delivered:

 

To contain the budget deficit and move towards debt stabilization, the 2020 budget proposes a significant reduction in government expenditure growth, mainly as a result of lower growth in the public-service wage bill.

 

The long and short of it is nominal spending is forecast to be down 2.7% for this year and 3.3% for two years after that. The big question: will that outweigh the burden placed on the nation by the debt of Eskom. The big answer: NO! And the Rand’s price action yesterday reflected a discount in domestic assets still representing the headache that the state owned utility creates. With fear around the Coronavirus intensifying, Rand trading was overwhelmed in the latter half of Wednesday’s session by a broader emerging market sell-off. Whilst the pattern emerging in the global infection rate is motivating risk decisions, Trump’s admonitions regarding infection on the continent of North America jolted markets. The President offered an hour long press conference yesterday afternoon on the subject, appointing Vice President Mike Pence as the man in command of coordination.

 

Markets will now turn their focus to Moody’s for any indication on the path of South Africa’s sovereign debt rating. The rating decision will arrive in one months’ time and global risk factors as well as details on the implementation of Tito Mboweni’s cost-cutting plan will be pivotal to predicting the Rand’s movements.

 

 

 

Discussion and Analysis by Charles Porter

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