Hi all, I have been in Denver and Breckenridge over the last two weeks sorting a bunch of family and business details, and am back in Singapore since Friday. I have made a couple of media appointments this week including a spot on CNBC today, to discuss markets, so I have been doing a bit of deep-diving into the markets again while appreciating some rare time with my parents visiting from Australia.
As an Australian, I often take the pulse of the market with the Australian dollar. And in planning a big move to the USA with cash still sitting in Singapore and some in Australia, I mentally still convert the cost of living into these currencies, finding that the USA is no longer such a cheap place anymore.
The performance of the Australian economy is also showing the benefits of a weaker AUD. The AUD fell on the weaker GDP data and retail sales data two weeks ago that dovetailed with heightened fears of Chinese economic and financial system woes. However, surveys of business confidence, business credit growth, housing market data and employment growth suggest that the Australian economy is finding strength outside of the resources sector. The weaker exchange rate boosting foreign investment demand in Australian property, encouraging more tourist and education services inflows, and a recovery from a low base in investment in non-mining sectors, albeit less strong than officials may like, is keeping the economy chugging along.
There may be a down-trend in the AUD, but it is no longer clear that it needs to fall sharply further. The down-trend may start to get a lot more choppy and harder to find in the period ahead. It may start to look like a long bottoming out.
We may have reached a point in the markets where fear of global economic decline and asset price corrections have reached an interim peak. The market has essentially priced in a weaker outcome for the Chinese economy. For markets to be significantly more spooked they need to think that a financial system problem will arise in China, such as uncontrollable capital flight and credit crunch. Such concerns may sit in the background, but the most likely scenario is that China will use its still significant controls, direct and market, and massive FX reserves to maintain a fair degree of financial stability.
Having now factored in a higher risk of major financial stress in China, the market needs to now also consider the risk that the Chinese economy stabilises in the fourth quarter in response to policy easing implemented to date and further measures that may unfold.
The broader outlook may remain for a long-term slowing in the Chinese economy and this may drag on the region and global economy, but provided it is gradual, it may still allow for stronger performances in major economies that are steadily recovering and some other emerging economies, such as India, to take up the slack from a retreating China, and sustain global growth.
We may now head into a more stable global asset environment for a time.
The big question still overhanging the market is will the Fed or wont they. The smart move is to proceed with the first tightening. Even though the rates market and many commentators have backed away from expecting a cut, all must admit that they have now been given fair warning. So there will not be universal and genuine surprise if the Fed proceed this week.
My guess is that the overall market is now well positioned for the hike, asset markets have built in some policy tightening. As such, if the Fed refrain now, they add to, rather than reduce, global market certainty. If they handle the tightening well, as they know how to do, by emphasizing the slow pace of future tightenings and willingness to respond to global market conditions, then a small hike this week may in fact turn out to be a boost to global market confidence rather than a problem.
I doubt that a hike by the Fed will make a big difference to currency markets at this point, although some knee-jerk positive USD reaction may arise, it is not clear to me that that 24 hours later the gains will last against the weaker commodity and emerging market currencies that have been beaten up significantly over recent months.
Sure the Fed run the risk of triggering further global market upheaval and being accused of jumping the gun and subsequently being forced into an embarrassing back-track. But there is always risks that policymakers must face. The risk-based assessment is more nuanced this time; some may council caution and holding rates steady, but others will see the benefits of a bold step that demonstrates confidence in the sustainability of the US recovery and keeps in perspective the global influence of the adjustment underway in China.
In the currency markets we are seeing recovery underway in the AUD and several commodity currencies. A hike by the Fed may cause a pause in this. But I sense a hike will not derail this period of recovery from earlier weakness over the last month or so. As such I would be inclined to trade for further gains near term in higher beta currencies, and use a Fed hike to provide a dip to buy into.
It may be worthwhile trading for gains in higher beta currencies vs the EUR and JPY. These later currencies may weaken more sustainably on a Fed hike as they have been strengthening on risk aversion over recent months.
Overall, I don’t see a hike by the Fed having a big impact on the US yield curve beyond 2yr maturities, as such we may not see big moves in major FX markets in the near term.