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David Fuller and Eoin Treacy's Comment of the Day
Category - Fixed Income

    US Policy Mix Flips and Will Take the Dollar with It

    This article by Marc Chandler for Bannockburn Global Forex may be of interest to subscribers. Here is a section:

    The policy mix of tighter monetary policy and looser fiscal policy provides a steroid-like boost to currencies.   This is what the US had under Reagan-Volcker.  It is was the policy mix in Germany after the Berlin Wall fell that led to the ERM crisis of the early 1990s and then Maastricht Treaty and the euro.  It helped fuel the dollar's gains last year.  Now that policy mix is reversing.  Fiscal policy is tightening, and monetary policy is poised to loosen.  That policy mix is associated with under-performing currencies.  

    The third significant dollar rally since the end of Bretton Woods is in jeopardy.  Coordinated intervention marked the end of both the Reagan-Volcker and Clinton-Rubin dollar rallies.  Intervention in the foreign exchange market won't be necessary; the self-proclaimed "Tariff Man" has found another way the proverbial cat can be skinned.  

    The last phase of a significant dollar rally has been marked by the movement of interest rate differentials against the US.  This been happening.   The two-year differential between the US and Germany peaked last November a little above 355 bp, which appears to be a modern extreme. It finished last week below 250 bp, the lowest in more than a year.   Similarly, the US two-year premium peaked against the UK around the same time a little shy of 220 bp.  It is now approaching 125 bp.   Against Japan, last November, the US two-year premium of nearly 310 bp was the largest in 11 years.  It is threatening to break below 200 bp.  

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    Transcript of Felix Zulauf's interview by Grant Williams -

    Thanks to a subscriber for this summary of the discussion at the recent Mauldin conference which may be of interest. Here is a section:

    Bets on July Fed Rate Cut Gain Momentum After U.S. Jobs Report

    This article by Susanne Barton, Katherine Greifeld and Liz Capo McCormick for Bloomberg may be of interest to subscribers. Here is a section:

    Bond traders’ conviction that the Federal Reserve will cut interest rates within months in response to a weakening growth outlook and escalating trade tensions firmed after a batch of weaker-than-expected U.S. jobs data.

    Fed funds futures show a quarter-point cut almost fully priced in for July, and indicate about 70 basis points of easing by the end of 2019. The two-year Treasury yield fell as much as 11 basis points to 1.77%, close to the 2019 low reached Wednesday, and it was on course for its fifth weekly decline.

    The last time that happened was back in July 2016, when the U.S. central bank’s target range was 2 percentage points lower than right now.

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    Investors Signal Draghi Is Running Out of Time and Ammunition

    This article by Paul Gordon, John Ainger and Piotr Skolimowski for Bloomberg may be of interest to subscribers. Here is a section:

    While Draghi is using similar tactics to U.S. Federal Reserve Chair Jerome Powell in promising to react to any deterioration in the outlook, the challenge is that he’s seen as having less room for maneuver. ECB rates are still at record lows and the balance sheet hasn’t started to be wound down.

    Moreover, he has less than five months left in office and there’s no clear sign who his successor will be, nor whether they’ll have the same commitment to the radical measures that hallmarked the Italian’s eight-year term.

    “The market believes Draghi’s take on inflation is wishful thinking,” said Christoph Rieger, head of fixed-rate strategy at Commerzbank AG, which predicts the ECB will cut the deposit rate toward the end of this year and extend its low-rate pledge to mid-2021. “The talk about contingencies is cheap, but to reverse the decline in inflation expectations he will have to walk the walk.”

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    Could Stock Picking Matter More Than Sector Positioning This Year?

    Thanks to a subscriber for this report from UBS which may be of interest. Here is a section:

    Trade Not the Only Risk; Markets Agree Adjusted Yield Curve Is Inverted; Higher Volatility Is Coming

    Thanks to a subscriber for this report from Morgan Stanley. Here is a section:

    Europe's Populists Don't Look So Healthy Now

    This article by Leonid Bershidsky for Bloomberg may be of interest to subscribers. Here is a section:

    According to the new parliament’s seat distribution based on preliminary results, 15 PINE parties throughout the European Union made gains in the election and 12 lost seats. In total, they gained just 25 seats – 3.3% of the total of 751. Without Italy, they would have come out even with the 2014 result. In a small number of countries there has been no change in PINE support.

    The rise of Italian nationalism and what one could call an anti-establishment revolution there make the country the EU’s biggest trouble spot for the next legislative period. It’s unclear what the bloc can do about it except wait for Italians to become disappointed in Matteo Salvini’s League (and the national conservative Brothers of Italy, or FDI, party) – something that might come with painful economic side-effects.

    The U.K. is the other obvious problem, but perhaps a receding one – either because Brexit will eventually happen or because it won’t. Last week’s election delivered a net loss of seats to British PINE parties. The success of Nigel Farage’s Brexit Party was as spectacular as the downfall of his former project, the U.K. Independence Party, and the ruling Conservatives faced a catastrophic loss that doesn’t augur well for them in the next general election. All this is for the British voters to sort out, though: The EU can hardly help at this point and it’s wise for it to wait out the crisis.

    Other than the two obvious hot spots, eastern Europe remains somewhat problematic for the “ever closer union” project because of the strength of Hungary’s Fidesz and Poland’s Law and Justice (PiS). These aren’t exactly euroskeptical parties, but they are focused on not giving up any more national sovereignty, and they’re resolutely illiberal. The parties work to defang the independent media and build up propaganda machines that make them immune to scandals (PiS survived a whole strong of them in the run-up to the European election) and they tighten the political control of the courts.

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    The hardest Post to Write

    This blogpost by Kevin Muir may be of interest to subscribers. Here is a section:

    Last October there was a full hike priced in, but now those expectations have completely collapsed to the point where there is two cuts already embedded into the Eurodollar futures curve.

    Although it’s not quite this simple, to make money at the short end, the Fed will have to cut more than twice in the next year and a bit. Could that happen? For sure. No doubt about it. Maybe the economy hits a real air pocket and the Fed cuts aggressively. Or there is some geopolitical event and the Fed is forced to slash rates.

    But the point to ask yourself is whether that is a good bet? I contend that with everyone leaning so heavily one way, the surprise will not be how much money they make, but instead if things don’t play out exactly as ominously as forecasted, how quickly the trade goes sour.

    There is little room for error. Or put it another way, the global economy better collapse as quickly as these bears believe as even a lengthening of the process will make their trade unprofitable.

    And in case you are bullish the long end of the curve and believe a slow-to-cut Fed is your best friend, don’t forget what Tariff Man has done to inflation. Next year should see a rise of 50 basis points across the board to core inflation. Sure commodities are falling hard, but that helps more with China’s inflation situation than with America’s.

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    Email of the day on the impact of currency on global investment decisions:

    Again, very grateful thanks for the very interesting and thoughtful comments you post each day. They are helpful to both newer investors and the more experienced who may get locked into their way of thinking. I count myself in that category! One factor that does not get mentioned perhaps as often as it should is the impact of currency movements on investment portfolios. Those of us using pound sterling as our home currency may feel particularly sensitive to this at this time. Those of us that assess gold as a possible investment often check gold in different currencies to determine whether a broad-based uptrend is evolving (eg compare gold in USD, Euro where the pattern looks quite different.) But I suspect fewer investors factor in currency movements when buying stocks in the USA, Europe, India, Japan and China. What are your thoughts on this?  

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