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Editor's Note: Hamish Risk | September 23, 2020
In a world of yield suppression there is increasing interest in the currency market. As Exante Data explains in today’s Macro Briefing, whether it is from hedge funds, real money, corporates or private clients, the common theme is a recognition of the superior liquidity and diversification properties FX currently has to offer. Of course within FX, as Exante also highlights, there is a new regime, with many of the old correlations no longer applying in the post-Covid world. Staying with currencies, MRB Partners makes the long-term case for the euro as the pandemic shores up economic and political co-operation in the eurozone, while Deutsche Bank warns that the dollar has not looked this vulnerable for fifty years. Elsewhere, while rates may be effectively staying at zero for the foreseeable future, Cornerstone Macro cautions against ignoring the Federal Reserve, which has plenty of instruments up its sleeve to create new investment opportunities, and Capital Economics sets out why the coronavirus pandemic will mark the high-water point for the current wave of globalisation.
correlations currencies Rates Exante Data
1. Fixed income is dead, long live FX – a new regime with different risk characteristicsBack in August, Jens Nordvig at Exante Data declared the death of fixed income amid widespread yield suppression and extolled the virtues of the FX market to investors, a theme that has enjoyed widespread coverage since. Now, as he sees a heightened engagement in FX across a wide spectrum of clients he has returned to the subject, describing how the regime for FX has changed. Not only is the era of dollar carry effectively over as interest rate differentials have closed across the globe and realised and implied volatility have risen, says Nordvig, but long-standing correlation properties in the currency market have started to breakdown. He points to USDJPY, which has become decidedly less “risk-on” over the course of the year. In a world of generally zero rates, it is logical that correlations that were normal for decades, will no longer apply, says Nordvig. In other words, he says, the world has changed, and risk properties associated with currencies are evolving too. This, says Nordvig, is a natural implication of the suppression of yield volatility, which is set to persist, and as this crossover occurs, it is crucial for investors to understand that the FX landscape itself is evolving, and that the data and analytics required to manage well are also changing as a consequence. He believes that detailed, rich and timely capital flow analysis is the key, and a still underutilized well of data.
currencies euro MRB
2. The multi-year case for the euroThe recent spike in daily cases of Covid-19 in the eurozone has reignited economic pessimism in the region, which has triggered a risk-off period that has halted the rally in the euro, but the single currency remains undervalued versus the dollar says Santiago Espinosa at MRB Partners. He says the euro had lacked a catalyst to appreciate in recent years, but this is shifting with Covid-19, as the pandemic is unifying politicians in the region. Evidence of greater fiscal collaboration in the eurozone is bullish for the euro by supporting relative growth and reducing its long-run risk premium, argues Espinosa. He adds that while the structural backdrop for the euro is gradually becoming more appealing, the cyclical offset is that the region remains dependent on global trade and the currency will be held back until export demand firms. Nevertheless, Espinosa says while the euro may be overbought from a short-term perspective, in the longer term he recommends staying overweight in the single currency versus the dollar, developed market commodity currencies and the pound.
currencies EMFX Deutsche Bank
3. Worst policy mix for the dollar since Bretton WoodsGeorge Saravelos at Deutsche Bank says a combination of the most negative real rates on record and the widest peacetime twin deficit leaves the dollar vulnerable to further weakness, and the two key event risks for the rest of the year risk accelerating these trends. On the political side, he says, a Biden Blue Wave would lead to a big fiscal stimulus that would widen the US trade deficit while discouraging capital inflows. This – combined with a reorientation of foreign policy towards a more multilateral and predictable approach – has the potential to weaken the broad dollar by removing the sizeable “Trump premium”, says Saravelos. A vaccine announcement, in the meantime, can further encourage global growth upgrades, positive risk appetite and dollar weakness, he adds. EURUSD should break $1.20 in an environment of dollar weakness, but Saravelos sees few euro-specific positives. The ECB will be unhappy with further gains, he says, while there is no evidence of accelerating portfolio inflows into the single currency and Europe is battling with a second COVID wave. In contrast, Saravelos sees greater scope for EM FX strength: it is cheap on financial fair value metrics, liquidity is abundant, external balances have improved, positioning is light and the EM – DM growth differential is peaking.
Fed policy Rates Cornerstone Macro
4. The common misconceptions about future Fed policyRoberto Perli at Cornerstone Macro says after conversations with many clients, he feels the general message that the Federal Reserve is trying to send seems well understood, but three significant misconceptions seem to persist. First, he says, clients understand that the period of zero rates entered into in March will last for years, but many have trouble fathoming exactly how long such a period is likely to be and have estimates that are generally too short. Second, says Perli, a number of clients seem to think that Fed policy will be on hold throughout the zero-rate period, but nothing could be farther from the truth, as the experience of 2008-2015 has shown. Third, he says, several clients seem to think Fed policy will be ineffective going forward. However, although he agrees that the impact of Fed policy on the economy is likely to be limited, Perli says the impact on financial markets will be as strong as ever. The bottom line, he says, is that Fed policy will continue to evolve as it has always done, only with different instruments, and it will also continue to provide investment opportunities and/or create risks for investors. Thinking that the Fed will be irrelevant, in other words, is dangerous.
de-globalization Capital Economics
5. Globalisation will stall in the wake of Covid-19As part of a series of reports exploring how the coronavirus pandemic will change the global economy, Mark Williams at Capital Economics has issued a note outlining why he believes Covid-19 will forever mark the high-water line for the current wave of globalisation because of the wedge it is driving between China and the rest of the world. Antipathy to China has risen around the world, for its early failure to contain the disease and for its behaviour since, he says, and as a result, mainstream views towards China have become more hawkish in all major economies. The widening rift between China and the major developed nations will see new limits on market access, on flows of technology (and, possibly, finance), and new opportunities for countries that are able to position themselves as alternative manufacturing bases to China, according to Williams. This decoupling, he warns, will ultimately have a much bigger impact on the distribution of global supply chains than the pandemic.