Apologies for the lack of commentary last week, but even a Badger needs an occasional week on the slopes to recover his sense of up, down and sideways. (There was quite a lot of all of these last week.) And it feels like I’ve got back to a week of confusion, wrack and ruin in markets… the US stock markets tumbling on fears that a US interest rate hike may be imminent (fears triggered by very strong US employment numbers last week), and European bonds rallying like there is no tomorrow.
Of course, it’s probably not as bad as it initially looks. If I step back and consider the market from the depths of the den, it all makes a certain kind of curious sense. It almost feels like spring is coming to markets as the signs of growth in the US continue to blossom, and even in the Eurozone we’re seeing upside improvements in growth forecasts. What’s changed?
Well, it’s largely about currencies.
The weakness in the Euro gives hope that low rates, low wages and low interest rates will finally nurture growth across Europe’s starving masses. Meanwhile, although the weakness in US stocks follows a strong market, it is also about rising fears concerning the consequences of the strong dollar. US exporters are beginning to hurt as their goods become more expensive for foreign buyers. And the jobs that are being created in the US are still pretty low-quality Mac-Jobs which are unlikely to trigger a feel-good consumer spending binge on cheap foreign imports.
That said, I still think it unlikely the US Federal Reserve will do anything precipitous to upset the markets – like announcing an early rate hike. The smart money is betting the Fed will start raising rates this year, but probably not till later in the year, and even then it will be marginal.
But, as I’ve said many times, it’s not what the Fed does, but what the market thinks the Fed will do that counts.
That’s why markets are so vulnerable to anticipating rates on every piece of economic data. They try to second guess what the Fed will do next. The one thing Mr Market is certain about is the likely ongoing strength of the dollar.
As a part-time Fed Watcher, I could just say be patient or “hurry up and wait”. Although rate markets are excitable, the smart money still says… “lower for longer”, and that’s likely to support the stock markets (on the basis nothing will be done to overturn sentiment), bonds (because we’re still seeing buyers), and the dollar (because everyone knows growth in the US means rate hikes are coming).
On the other side of the Atlantic we have the Eurozone, where the Euro is tumbling.
And quite rightly so. It was massively overvalued, holding back economies from making the necessary adjustments and reform, and as it approaches parity with the dollar I would not be in the least surprised to see it go lower still. Investors see the start of European QE as the moment to exit the Euro markets. Conveniently the ECB is buying Euro 60 bln of bonds per month – of which we can guess about a quarter will be German bunds.
Even at negative yields the ECB will keep buying. And foreign holders should be happy to sell, and look to park their assets outside the Euro… in dollars I suggest. Selling Euro bonds and buying dollar and sterling bonds with the proceeds makes a lot of sense because Euro yields are less than zero and the currency is tumbling. (If you need me to explain that again – consider a new career in flower arranging.)
We won’t see a slide in Euro bond prices – the ECB stands there as a backstop, but flows into dollars and even sterling will support both these markets – at least until its all change time again. That will come when rates do rise, when we get an oil price spike triggering sudden inflation, and when the market wakes up to the madness of zero rates.
So trade of the week… same as it ever was. Sell Euro Govies and Buy Gilts and Treasuries.