At the time of writing this, I was in an airport departure lounge surrounded by Brits coming home from their holidays. Everyone seemed to be have deeply unhealthy sun tans (except me) while also appearing to collectively be suffering from a premature post-holiday blues. That mood was definitely set to worsen amongst the travellers as we returned from 30 degree sun to sub-twenty cloud.
Investors also reacted negatively towards the cooler climate as the US Federal Reserve signalled it did not see risks of the US economy overheating. Asset class returns in sterling and local currency are below; most notable is the difference in returns for sterling and local currency returns as the pound rallied versus the US dollar and Japanese yen while dropping versus the euro.
Table 1: GBP total returns
Table 2: Local CCY total returns
Jackson Hole, the annual economic policy symposium which hosts central bankers from around the world and a key event for many in economic calendars, was hosted last week. The crux of the summit was when the US Federal Reserve indicated that it would continue on its path of gradual interest rate rises but underlined that it did not envisage current inflation accelerating above its 2% target. This dovish tone facilitated an increase in market participants selling the US dollar as expectations around future rate rises lessened.
Chart 1: Chair of the US Federal Reserve Jerome Powell delivered a dovish speech on Friday which resulted in the market selling the US dollar
The speech delivered by the Fed’s chairman came just a week after the US President openly criticised the Fed for its tightening monetary policy. This has seen the US dollar index (measured against a basket of other currencies) appreciate by as much as 9.2% from its recent lows in February this year. Some market commentators view this as a threat to the independence of the US central bank, though reading through the FOMC minutes, we view the timing as coincidental. Many committee members harbour concerns about the potential damage to the US economy to be caused by the escalating trade dispute. On the other side of this dispute, the Chinese government benefits from its central bank acting in concert. The renminbi has devalued against the US dollar by as much as 10.6% in recent months, largely offsetting the impact of trade tariffs to date.
The change in Fed policy is not necessarily bad news for investors, despite the fall in the dollar. Many commentators believe the biggest risk to the US’s current economic cycle is poor central bank policy: namely raising rates too fast causing a contraction in economic activity, or too slowly allowing overheating to occur e.g. inflation overshooting its target. With a string of positive data releases for the US economy in recent months, the Fed’s chair has acknowledged that inflation remains broadly detached from what are traditionally referred to as its fundamental drivers (such as unemployment or wage growth). Thus, the perceived risk of policy ‘overtightening’ has eased. Another beneficiary of a more dovish Federal Reserve are emerging markets which were last week’s relative outperformers (see tables above). With the US dollar integral to global trade and a key funding currency, the prospect of less aggressive interest rate rises in the US is a positive as many EM countries have historically suffered under tighter financial conditions in the US.
Chart 2: Developed markets tend to outperform when the US dollar strengthens, indicating emerging markets benefit from a weaker US currency
Another story that caught my eye last week – though unrelated to the above – was a 95% depreciation of the Venezuelan currency with the newly denominated currency being pegged to the state-run cryptocurrency. This move was the latest in the Venezuelan government’s efforts to curb the hyperinflation that is plaguing the country (see stat of the week). The government backed cryptocurrency, named the petro, will supposedly be backed by the country’s oil and mineral reserves though given it is not quoted on any recognised exchange and it can be issued at will by the government, many have looked through the proposal as a farce. My favourite comment on this was quoted in the Financial Times by Russ Dallen, head of Caracas Capital, an investment bank: “He [Venezuelan President Maduro] might as well have chosen pegging it [the bolivar] to unicorns”.
THE WEEK AHEAD
Monday: Germany Ifo Business Climate
Wednesday: Japan Consumer Confidence, Germany Gfk Consumer Confidence, US Q2 GDP
Thursday: Germany Unemployment Rate, Eurozone Business Confidence, Germany Inflation Rate, Canada Q2 GDP, US Personal Income
Friday: UK Gfk Consumer Confidence, Japan Unemployment Rate, China NBS Manufacturing PMI, Eurozone Unemployment Rate, Brazil Q2 GDP, India Q2 GDP
STAT OF THE WEEK: 1,000,000% – the level of inflation Venezuela is heading for by the end of 2018 (IMF).
Data correct as at 24/08/2018.