Even The Dog Has Its Day

Despite the massive negative news flow and publicity USD as measured by the DXY Index fails to fall to pre-crisis levels. At the same time, the negative correlation established between the markets and the greenback seems to continue. There has been much debate as to why this could be the case. Dollar’s “safe haven” status view appears to be getting traction. It is difficult to reason with the almost daily moves between these two asset classes but we believe the current deflationary bias in the world economy has something to do with this relationship. Rising dollar leads to USD GDP growth of the world economy ex-US to fall taking aggregate demand with it. Consequently commodities remain in the forefront of this negative correlation. In fact lately oil has become the “risky asset” to follow to ascertain the direction of the markets and hence the USD.

We do not subscribe to any one model or variable that explains the direction of any foreign exchange and argue that fx remains the most difficult to forecast asst class. In fact we often remind investors that fx should not be considered as an investment vehicle and should be used to balance one’s assets and liabilities only. That said there seem to be a confluence of factors – such as improvement in current account deficit, growth recovery, recovering RoC -- that support the USD against other major currencies in the medium term. EM currencies appear to be in much stronger position to appreciate but gauging by the recent market action USD tends to move against all other currencies at the same time. As such and given the still mercantilist policies of Asia – at least in the short term – A USD revival across the board looks reasonable. However, we do not rule out the “policy decoupling” that ought to have impact on the direction of currencies. Sterling, for example, got a beating minutes after BoE is announcement to extend the QE. In that regards currencies of countries where interest rate policy normalisation can be better supported in this process.

Overall, current market rally can be the only impediment left for a broad based dollar bounce. We continue to advocate buy on dips to accumulate for a Q4 strength.

Sweet Spot

We can trace back the beginning of this equity rally in March to various factors: extreme pessimism about the world economic outlook; G20 reassurances and IMF funding, particularly for Eastern Europe which reduced the risk premium for Emerging Markets as a whole as well as the European banks; cheap valuations; USD weakness (causality here is difficult to gauge though) etc. Clearly all these played an important role turning the markets around. However, what really propelled asset markets was undoubtedly the massive amount of liquidity released into the system by world central banks. We have had a great spectacle of how markets run on liquidity in the short term. As the rally progressed equities moved into the “sweet spot”. On the one hand is huge liquidity and on the other hand the advent of economic recovery – at least this is what the markets wanted to believe in. The severity of the last recession and the spectre of a double dip ensure that central banks around the world will wait to see the white of the eye before shooting i.e. monetary policy will err on the side of keeping policy relaxed. However, come autumn we are likely to see the first signs of “decoupling” but of policy. Given the slew of upward revisions to GDP monetary policy in some parts of the world, particularly in some EM countries, look far too easy. Extraordinary liquidity will be quickly drained and interest rates will be normalised. Although this will not be across the board – as BoE proved it last week -- it will be enough to spook the markets. Just look at how Chinese local markets are performing as the loan growth numbers half from 1H. The irony is that the more markets rejoice the recovery the higher the chances that the most important pillar of this rally – liquidity – will disappear. Some of you will say that earnings will take over and sustain the rally but equity prices already seem to be reflecting the earnings recovery and valuations are not longer particularly attractive. So enjoy the rally while it lasts.... Enter the USD.

Policy Decoupling -- Episode I

We have been arguing that the new theme for the markets will be the policy decoupling. China moved first. They tinkered with their version of QE. The impact on the equity markets was profound. So they stepped back and ensured policy sustainability in the near term. However, yesterday saw the most obvious sign of monetary policy decoupling. Bank of Israel is now crowned as the first central bank to raise interest rates in this cycle. It was 25bps with a tightening bias... Markets frowned but did not move much on the news. As all EM managers know Israel is a hybrid market in the sense that it is in the EM universe but not exactly an emerging market economy with more obvious developed economy characteristics. So nobody really owned this move. At the same day Monetary Council in Hungary decided to cut rates by 50bps on the back of continued weakness in the economy. With a further easing bias. So most analysts now expect several cuts to follow. It is a well deserved cut and analyst are right about the direction of next moves. Alas Hungary is not living in a vacuum. These cuts somewhat rely on the strength of the currency and the optimism in the global economy and the markets. The irony is when the sentiment turns both of these parameters will change at the same time. So there is indeed a risk that Hungary may be come under pressure again. Besides let’s not forget the potential Latvian devaluation and regional contagion. Opportunistic cuts may be short lived.

Guncelleme

Son Ekonomist yazimdan bu yana piyasalar hakkinda fikirlerim degismedi. Hisse senetleri bir sure daha guclenek ve dustukce yavas yavas dolar toplanir diyorum. Yine de iki onemli konuya deginmek istiyorum:

Haftasonu yapilan merkez bankalari toplantisinda bankacilarin kendilerini kutlamaya basladiklarini okudum. Tam anlamiyla duzluge cikilmadigi konusunda fikir birligi var gibi. Yine de asiri gevsek para politikalarindan "cikis stratejisi" sik sik gundeme gelmis. Bircok ekonomist bu konuda zamanlamanin mukemmel olmasi gerektigini iddia ediyor. Ben bu konuda biraz daha rahatim cunku kisa vadede buyuk bir enflasyon riski olmadigini dusunuyorum. Aslinda enflasyon var da hepimizin begendigi cinsinden: finansal varlik fiyat enflasyonu. Eminim merkez bankalari da bu isten memnundurlar. Sonucta global ekonominin bilancosundaki aktifler degerleniyor. Kriz aktiflerin pasiflere gore ciddi deger kaybina neden olmustu.

Kisaca merkez bankalari piyasalar icin yesil isiktan yavas yavas sariya donuyor.

Turuncuya donmesinin piyasalara neler yapabilecegini Cin'de gorduk. Asiri kredi buyumesinin ardindan hafif bir fren bile ciddi panige neden oldu hisse senetlerinde. Oyleki otoriteler ger adim atip cikip halki yatistirmak zorunda kaldilar. Bu butun yatirimcilar icin guzel bir prova oldu. Piyasalar ekstra-ekstra likidite ile cikiyor. Bu yuzden sik sik burda olabilecek degsiklikleri gundeme getiriyorum.