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

    The World Is Creeping Toward De-Dollarization

    Thanks to a subscriber for this article by Ronald-Peter Stöferle for the Mises Institute. Here is a section:

    A clear signal that something is afoot would be the abolition of the Saudi riyal's peg to the US dollar. As recently as April of this year economist Nasser Saeedi advised Middle Eastern countries to prepare for a “new normal” — and specifically to review the dollar pegs of their currencies: “By 2025 it is clear that the center of global economic geography is very much in Asia. What we’ve been living in over the past two decades is a very big shift in the political, economic, and financial geography.”

    While the role of oil-producing countries (and particularly Saudi Arabia) shouldn't be underestimated, at present the driving forces with regard to de-dollarization are primarily Moscow and Beijing. We want to take a closer look at this process.

    There exist numerous political statements in this context which leave no room for doubt. The Russians and Chinese are quite open about their views regarding the role of gold in the current phase of the transition. Thus, Russian prime minister Dimitri Medvedev, at the time president of Russia, held a gold coin up to a camera on occasion of the 2008 G8 meeting in Aquila in Italy. Medvedev said that debates over the reserve currency question had become a permanent fixture of the meetings of government leaders.

    Almost ten years later, the topic of currencies and gold is on the Sino-Russian agenda again. In March, Russia's central bank opened its first office in Beijing. Russia is preparing to place its first renminbi-denominated government bond. Both sides have intensified efforts in recent years to settle bilateral trade not in US dollars, but in rubles and yuan. Gold is considered important by both countries.

     

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    2017 at the Three Quarter Pole

    Thanks to a subscriber for securing an invitation for me to attend Jeff Gundlach’s presentation yesterday which as always was an educative experience. 

    Another Look at Why the Return to Capital is Low

    Thanks to a subscriber for this highlighting this article by Marc Chandler for Brown Brothers Harriman. Here is a section:

    Similarly, a new strategy to deal with the surplus capital, not within our grasp.  In the meantime, officials are trying to come up with other ways to absorb the surplus, including changes in the regulatory environment.   In some ways, it might be helpful to think about QE itself as an attempt to deal with the surplus capital.

    When farmers have a bountiful crop, and the price threatens to fall below the cost of production, governments often invent schemes to buy the crop and warehouse it and let it agricultural produce come to market when at a better (i.e., lucrative) time.  In some ways, QE can be understood as a similar strategy:  Warehouse the surplus capital.  This is not a permanent solution.  There is a political push back on the grounds that it blurs monetary and fiscal policy.  There is an ideological resistance to the “interference” with market forces.  There are economic arguments against the distortion of prices and the mutation of printing signals.

    Interest rates are low, not simply because central banks are buying bonds and maintaining large balance sheets by recycling maturing issues.  Interest rates are low because there is too much capital.  It is a recurring source of the crisis in market economies.  We should anticipate that returns to capital will remain low until a new strategy to deal with the surplus is devised and accepted, and the risk is that we are still in denial.

     

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    Email of the day on maturity extensions

    Why does the US not shift its bonds to 20 and 30-year duration, increase inflation to, say, 2% and pay back the money in 20 or 30 years’ effectively free of interest? This would really kick the can down the road and give them many years to sort out the mess.  When I asked this of Americans five years ago, they thought it would cause interest rates to spike if the Fed tried to drastically increase the duration.  I think the last few years have proved that the duration could be increased without causing panic in the markets. 

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    Fed Asset-Shrinking to Start Next Month; Rate Hike Seen in '17

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

    “The labor market has continued to strengthen” and economic activity “has been rising moderately so far this year,” the Fed statement said. The FOMC repeated language saying “near- term risks to the economic outlook appear roughly balanced.”

    The decision to leave the target range for the federal funds rate unchanged and begin the balance-sheet runoff in October was unanimous. The Fed reiterated that interest rates are likely to rise at a “gradual” pace, though updated forecasts indicated that officials see the path as less steep than before.

    In their new set of projections, Fed officials estimated three quarter-point rate hikes would be appropriate next year -- the same number they saw in June -- based on the median in the so- called dot plot of interest-rate forecasts.

    Crisis Action
    The Fed's decision to exit from balance-sheet policies comes a decade after the global financial crisis began to tip the economy into a recession at the end of 2007. The reduction in assets will be slow -- just $10 billion a month to start. 

     

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    It's Not Just Toys R Us. More Credit Weak Spots Emerge

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

    Money managers are grappling with an uptick in operational and balance-sheet challenges late in the business cycle, with debt-laden Toys ‘R’ Us Inc. the latest retailer to file for bankruptcy this week, catching bond markets off guard. Just two weeks ago, credit-default swaps, which allow traders to hedge against losses, were pricing in a low probability of near-term default at about 10 percent based on contracts expiring in June.

    "Companies with the weakest fundamentals often show problems first late in a cycle, and the retail sector has many such examples," said Adam Richmond, Morgan Stanley’s chief credit strategist.

    "Investors initially treat those issues as idiosyncratic, and then the problems spread, when credit conditions begin to tighten,” he said. “That is how the late cycle can transition to end of cycle."

    These risks are hard to see at the index level, with the Bloomberg Barclays U.S. high-yield benchmark up almost 7 percent this year, led by CCC-rated names. Still, the latter has underperformed the broader market over the past two months, suggesting investors are increasingly compelled to price-in deteriorating fundamentals -- reminiscent of a market in its late winter, according to the U.S. lender.

     

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    Gold in correction mode

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

    Precious metals: Gold has dropped to a 2½-week low of $1,315 per troy ounce this morning amid increased risk appetite among market participants. Gold in euro terms is trading at only around €1,100 per troy ounce. The Dow Jones Industrial Average and S&P 500 indices in the US had both climbed to new record highs on Friday. The rise in stock markets is continuing in the Asian region today. What is more, bond yields in the US have increased significantly of late, which makes gold less attractive as an alternative investment.

    Presumably this is also why Friday saw the second consecutive daily outflow from gold ETFs. Portugal’s credit rating was upgraded on Friday evening by the ratings agency S&P, achieving an investment grade rating again for the first time since January 2012. Ireland was also upgraded, this time by the ratings agency Moody’s. Wednesday could see further volatility on the gold market, as this is when the US Federal Reserve meeting will take place.

    If the market’s currently low rate hike expectations increase as a result of the meeting, this is likely to weigh on the gold price. According to the CFTC’s statistics, speculative financial investors further expanded their net long positions in gold in the week to 12 September, putting them at 253,500 contracts now. This was already the ninth weekly increase in a row.
    The price rise to a 13-month high of just shy of $1,360 was thus driven largely by speculation. Given that the gold price is now trading considerably lower, positions have presumably been squared in the meantime

     

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    Pound Sentiment Is Now the Most Bullish in More Than Three Years

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

    Currency traders haven’t been this upbeat on the pound in more than three years. 

    The cost of owning one-month call options on sterling relative to puts reached six basis points, the steepest since February 2014, as the Bank of England said the market is underpricing the prospect of rate increases.

    The premium on calls shows the market’s conviction that the currency’s more than 3 percent rally against the dollar this month has legs.

    The key question on investors’ minds at the moment is: where does the pound go from here? To some extent, the currency’s fortunes against the dollar will be influenced by what the Federal Reserve does, and in this context next week’s FOMC meeting will take on added significance. Witness also that stronger-than-estimated consumer-price inflation data out of the U.S. on Thursday failed to damp bullish sentiment for the pound.

     

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    Email of the day on the deflationary impact of technology

    I have noticed from your recent postings that while you recognize all the great outcomes technology will bring, you also recognize the downside consequences of all the displaced labor. Another effect on labor has been the financialization of our economy. Check out this article (open domain) Thank you for your continued great work!

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