Tag: ECB

Charts, Ideas and the Euro

 

“There is nothing more deceptive than an obvious fact.” ― The Boscombe Valley Mystery by Arthur Conan Doyle

 

Gold vs. US 10 Year Treasury Real Yield

 

Gold10Y.png

Source: Bloomberg

 

The above chart compares the year-over-year change in the US dollar price of gold versus the year-over-year change (inverted) in the real yield on US 10-year Treasury Securities. (The deflator used to calculate real yields is core inflation.)

 

Ever since the gold-bubble popped in 2011, the year-over-year change in its price has been negatively correlated with real 10-year yields. Intuitively, this makes sense given gold is a non-yielding asset and the lower the real yield on bonds the more attractive a non-yielding asset becomes on a relative basis.

 

Real yields can, of course, decline either due to nominal yields in bonds declining or by inflation picking up. In either case, if the relationship between gold prices and real yields holds, gold prices should move higher. With little seeming desire on the part of the Federal Reserve to jawbone rates higher — especially with a Twitter-happy president and global trade uncertainties rising — precious metals, other than their customary volatility, could be primed to move much higher. Our conviction will be increased if see gold take out its 2016 highs of around US dollars 1375 per troy ounce.

 

Thinking About the Euro

 

Try and go back to the start of the year and imagine:

 

(1) the trade dispute between the US and China escalating;

(2) global risk aversion — measured using the BNP Paribas Global Risk Premium Index — reaching levels last witnessed at the start of 2016;

(3) Italian bond yields blowing out;

(4) economic data coming out of Germany deteriorating;

(5) systemically important European banks, such as Deutsche Bank, crashing to new lows; and

(6)  the positive carry (higher interest rate) for the US dollar over the euro sustaining.

 

Given the above scenario, most investors would want to be long the US dollar and short the Euro. And, indeed, positioning in futures markets suggests that investors are indeed long the greenback and short the euro. Yet, the US dollar is not moving higher. What gives?

 

EURUSD Curncy (EUR-USD X-RATE) 2019-06-07 18-06-14.jpg

 

The above is a monthly chart of the Euro US dollar cross. If we get follow through in the recent move higher in the euro by the end of this month, the probability is the euro strengthens from here at least to 1.20 and possibly higher. If, however, the recent move fails and the US dollar strengthens, then we may well get the doomer scenario of a US dollar that is too strong for the rest of the world to handle.

 

Our base case view is that a weakening greenback finally gets us the blow-off top or ‘market melt-up’ in US equity markets that many have been waiting for.

 

Watch the euro-US dollar cross and position yourself in stocks accordingly.

 

The ECB: Not Doing Enough to Prevent the Worst

 

At this week’s governing council meeting, the European Central Bank (ECB) left the deposit rate at -0.4 per cent and extended forward guidance into 2020, with rates expected “to remain at their present levels at least through the first half of 2020”.

 

The ECB also confirmed that the proceeds from maturing bonds in its portfolio will be reinvested to keep the stock of assets steady. Details of a third Targeted Longer-Term Refinancing Operation were also revealed: it will be held quarterly from September at interest rates as high as main refinancing operation rate (currently at 0 per cent) + 10 basis points and as low as the deposit rate + 10 basis points. The precise rate will depend on banks hitting their lending targets.

 

The ECB’s measures should support the European economy and potentially slow down the upward pressure on the euro from an increasingly dovish Fed. However, we do not think the ECB has gone far enough to address the challenges faced by its banks and a further deterioration in global trade activity. It might be that Mr Mario Draghi is passing the buck onto his yet to be named successor but we think the ECB may have at least one trick left up its sleeve: Open Monetary Transactions.

 

The Open Monetary Transactions (OMT) facility, established during the European crisis, has never been utilised. Currently, the ECB can only buy government bonds according to member states share of its capital. Under an OMT program, however, it would have the power to buy bonds of a specific member state if said member’s government accepts conditionality along the lines demanded by the International Monetary Fund for countries in its funding programs.

 

If the ECB eventually, albeit reluctantly, comes through with an OMT like programme or another measure to reduce the burden of negative interest rates on European banks, that too could push global stocks much higher.

 

 

Sharp Recovery in Healthcare Stocks

 

Take a look at the relative chart of the SPDR Health Care Select Sector ETF $XLV to the S&P 500 in the second panel below. After a more than four-moth period of drastic under performance by the healthcare sector, we have witnessed a sharp recovery in recent weeks.

 

We think healthcare stocks might be ripe ground for stock pickers.

 

XLV US Equity (Health Care Selec 2019-06-07 18-21-02

 

Some of the names we are tracking closely in the space are highlighted below.

 

Novocure $NCVR

 

Research and development company focused on developing cancer treatments with a market capitalisation of US dollars 5.3 billion. We recommend a small position here with a view of adding if it breaks to new highs, above US dollars 56.67.

 

NVCR US Equity (Novocure Ltd) VE 2019-06-07 18-44-57.jpg

 

AbbVie Inc $ABBV

Pharmaceutical behemoth $ABBV is starting to looking interesting to us at current levels. A move up US dollars 81.50 and we would be buyers. We recommend buy stops at the level.

 

ABBV US Equity (AbbVie Inc) VEEV 2019-06-07 18-50-15.jpg

 

Repligen Corp $RGEN

 

Massachusetts based $RGEN is engaged in the development and production of materials used in the manufacture of biological drugs ― substances made from a living organisms or its products and used in the prevention, diagnosis, or treatment of cancer and other diseases.

 

We are long here.

 

RGEN US Equity (Repligen Corp) V 2019-06-07 19-18-03.jpg

 

 

This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

Currency Markets: “You can’t put the toothpaste back in the tube.”

“When you strip away the genre differences and the technological complexities, all games share four defining traits: a goal, rules, a feedback system, and voluntary participation.” Reality is Broken: Why Games Make Us Better and How They Can Change the World by Jane McGonigal

 

“The dollar used to be a gold standard currency. And the dollar is really good in the last century, I mean in the 19th century.” – John Forbes Nash Jr.

 

“The thought experiment of Adam Smith correctly takes into account the fact that people rationally pursue their economic interests. Of course they do. But this thought experiment fails to take into account the extent to which people are also guided by noneconomic motivations. And it fails to take into account the extent to which they are irrational or misguided. It ignores the animal spirits.” – Animal Spirits by George A. Akerlof

 

 

When US Treasury Secretary Steven Mnuchin uttered the words “A weaker dollar is good for trade,” at Davos in January, he broke rank and became the first US Treasury Secretary in almost three decades to talk down the US dollar.  And in one fell swoop he ended the cooperative monetary policy game major central banks had been engaged in since the renminbi devaluation scare in January 2016 and transformed it to a competitive game.

Mr Mnuchin’s comments sent President of the European Central Bank (ECB) Mario Draghi and Governor of the Bank of Japan (BOJ) Haruhiko Kuroda into a state of frenzy. Both were quick to react and proceeded to talk down their respective currencies – Mr Draghi hinted at the ECB delaying its exit from monetary easing while Mr Kuroda‘s language became decidedly dovish.

Capital markets, to state the obvious, do not like volatility. Markets like boring. The cooperative monetary policies of the last two years have been exactly that, boring. As central banks sucked volatility out of currency markets, capital markets of all forms became buoyant.  Tech stocks climbed higher. Emerging markets came out of their prolonged slump. Cryptocurrencies soared. Even the much maligned commodity markets rallied. Coincidentally, most markets peaked soon after the détente between global central bank was broken by Mr Mnuchin.

Should we be surprised that a member of the US administration led by President Donald Trump has done away with the niceties of a globally coordinated détente and unleashed competition amongst global central banks? Mr Trump is nothing if not competitive and he is doing his part in stoking global competitive spirits as he did in announcing his plans to impose tariffs on steel and aluminium imports.

One man voluntarily abstaining from the competitive game it seems is newly-appointed Federal Reserve Chairman Jay Powell. Chairman Powell, by striking a hawkish tone during his inaugural testimony on 27 February, extended an olive branch to his fellow central bankers and they gladly obliged. Mr Kuroda this morning suggested that the BOJ could exit from its easy monetary policy as early as next year. The central banks, it seems, want to return to the comfortable climes of a cooperative game world.

The market appears to be giving Messrs Powell and Kuroda due credit with the dollar moving sharply higher after Mr Powell’s hawkish comments and the yen strengthening following Mr Kuroda’s remarks. While the central banks will do their utmost to re-establish a cooperative regime, the reality is “you can’t put the toothpaste back in the tube”. The major central banks of the world are now in a competitive game. While markets may enter an interim phase where the Fed’s hawkish posturing leads to a strengthening dollar, this phase, in our opinion, is likely to be short-lived.

The line in the sand beyond which we would consider our view to be invalidated is a sustained move above 96 on the US dollar index.

 

Investment Perspective

 

One major central bank that has conspicuously remained on the side lines during the recent sharp moves in currency markets is the People’s Bank of China (PBOC). The PBOC rarely, if ever, publicly expresses its desired direction for the renminbi. Its statements are generally limited to reaffirming its commitment to promoting a stable exchange rate regime. The PBOC, however, has been known to actively intervene in markets to influence the direction of its currency – such intervention too has been absent recently.

The PBOC, we think, finds itself at a difficult crossroads with respect to the renminbi. Much like the one the BOJ was at with respect to the yen in the late 1980s. The BOJ, in hindsight, favoured short-termism and opted to keep monetary policy far too easy, which sent Japanese asset prices rocketing higher. The Japanese boom, as well known, was followed by an all-mighty bust. The Chinese Communist Party (CPC), it is said, thinks in decades not years – so one would think that the Chinese will not follow in the footsteps of Japan. Short-termism, however, can afflict anyone and there is, we think, a non-zero probability that China goes down the path of too much easing, which would send Chinese asset prices sharply higher. For this reason we would maintain some allocation to Chinese equity markets.

The more probable scenario, we think, however, is that of the PBOC opting to strike a balance between tightening and opportunistic easing and the PBOC may even let the renminbi strengthen some more – especially if said strengthening is driven by US dollar weakness as opposed to PBOC’s interventions.

As we argued in our piece on China in January, China wants to increase its influence in Asia and that stability is a necessary condition in order to achieve further influence. Therefore, given China’s global ambitions, we think it is unlikely that the PBOC repeats the mistakes the BOJ made in the late 1980s. And if this indeed turns out to be the case, given the current differential in US and Chinese interest rates and bond yields, the Yuan carry trade may be amongst the best trades to put on today.

 

This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.