x

Investec FX – The other side of the Dime

08-Jan-2016

Global financial markets have been abuzz with opinions since the Federal Reserve raised interest rates in December for the first time in 9 years. Everybody has a view.

The market is uncertain how far and fast the US interest rate will rise. Pricing in swap markets remains more subdued than the Fed’s forecasts from their December ‘dot plot’ guidance, where members anonymously predicted where they expect interest rates will be at the end of each calendar year. The Investec Economics team believes the Fed will raise interest rates at a steady pace, by 75bp this year taking the Federal Funds Target range up to 1.00-1.25%, faster than financial markets are currently pricing. As is always the case around such major inflection points in the market, there are opposing views among some of the world’s biggest and most influential investors. As they say, ‘that’s what makes a market’.

Renowned ‘Market Wizard’ Ray Dalio, founder of the world’s largest hedge fund Bridgewater, last year famously stated that although the Fed may raise interest rates one or two times, he believes they will need to reverse course and embark on a fourth round of QE as their economy ends a ‘Super cycle’. Larry Summers, a previous US Treasury Secretary and current Harvard professor seemed to agree, with similar calls that renewed QE will be needed.

IMF Chief Christine Lagarde last September warned the Fed against raising interest rates prematurely, not only because the American economy isn’t ready, but also because of the global implications. Rate rises would start a rate normalisation path that could trigger further Dollar demand, particularly to fund global Dollar liabilities for Sovereign and Corporate borrowers outside America. This group according to the last BIS report owe a record 9 Trillion US Dollars, much of which will need repaying in coming years, and could cause significant outflows from emerging market economies that risk currency blow-outs and defaults.

In fact, influential Economist Carmen Reinhart penned a Dec 31 opinion piece asking the question, will 2016 be a year of sovereign defaults? Reinhart concluded that “from a historical perspective, the emerging economies seem to be headed toward a major crisis. Of course, they may prove more resilient than their predecessors. But we shouldn’t count on it.” This week famed billionaire investor George Soros said he sees a crisis unfolding in global markets that echoes 2008 as the developing world finds it difficult to return to positive interest rates. With China struggling to find a new growth model, its currency devaluation is transferring problems to the rest of the world.

While the Federal Reserve continues along the path of interest rate normalisation as their economy recovers, it is worth bearing the counter-arguments in mind. A shaky start to the year for Chinese Equities causing risk aversion, oil prices hitting 12 year lows continuing to add to deflationary pressures, and nervous trading in Emerging Markets are all stark reminders how finely balanced the US recovery is. Currency wars are rife as central banks competitively devalue their currency to gain a competitive edge and import elusive inflation. This week the minutes of the Federal Reserve’s December rate lift-off meeting showed concern of the impact of further Dollar strength and soft inflation outlook. Will further strengthening of the greenback cause the US to join in the currency race to the bottom?

Latest commentary

  1. Migration deal over the line

    The world outside these four walls the big news is that EU leaders managed to come to an agreement in the early hours of the morning on how to deal with rescued migrants.

  2. New BoE member strikes cautious tone

    As luck would have it, when I hit shuffle on my Spotify this morning Mungo Jerry’s “In the Summertime” came on. 

  3. The big question: where's Boris?

    Is it a bird? Is it a plane? Well your second guess was close enough, it’s a 3rd runway for Heathrow.

  4. Crude Oil Prices Rally

    On the last trading day of the week, the most notable development in markets was a sharp lift in crude oil prices, with WTI and Brent rising 4.6% and 3.4%, respectively.

  5. BoE Set to Hold

    The pound inched higher yesterday afternoon as news broke Theresa May had managed to avoid a Tory rebellion and avoid defeat in Parliament over her flagship Brexit bill.