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15-10-2014, 10:22 PM
US attractions grow as investment destination
CHRIS WESTON THE AUSTRALIAN OCTOBER 16, 2014 12:00AM
US attractions grow for investment
The US economy is looking up and the US dollar is likely to remain well supported, offering an opportunity to invest. Source: AFP
IN the week ending October 10, speculative forex funds (such as hedge funds) held a net currency position of $US45.5 billion ($52bn), surpassing the record of $US44.9bn achieved in 2012.
Naturally, there are many other players in the forex market (such as exporters and reserve managers), but it’s clear the more aggressive faction of the market has seen something fairly special in the US economy, causing the $US5.94 trillion a day market to act in such unison.
The fact is, whether you’re looking at the absolute performance of the US economy, or the ballooning monetary policy divergence between the US Federal Reserve and other G7 currency central banks (with the exception of perhaps the Bank of England), the US is the best house in a deteriorating neighbourhood.
This was highlighted in the recent IMF economic update, which forecast a 40 per cent chance Europe could slip back into recession (and a 30 per cent chance of deflation), while upgrading US growth by 50 basis points, although the previous projections were woefully pessimistic.
The US dollar index (the dollar relative to a weighted basket of currencies) has rallied about 8 per cent since the May low, breaking the 2005 downtrend in the process. The euro contributes 57 per cent to this index, so the fact the European Central Bank penalised institutions for parking funds on its balance sheet was a key component here, as it drove many European countries’ two-year bond yields below zero (investors had to pay governments for the right to lend to them). In turn, this created massive capital outflows from the eurozone.
We have also seen the central bank embark on a journey to expand the balance sheet on both the asset and liability sides of the ledger. Traders remain sceptical this will actually create inflation through the desired expansion of credit. What’s more, looking at inflation expectations (through swaps pricing), we can actually see expectations actually falling aggressively despite these measures. The capital markets are screaming that more needs to be done, which can only be a longer-term euro negative.
Japan follows in a similar vein — the economy is weak and inflation expectations are well below where they should be, given the extent of policy easing. More has to be done and, if it wasn’t for the recent falls in the yen, the Bank of Japan would surely be set to increase the level and scope of its asset-purchase program.
So while the Fed controls the levers by which all other asset classes are responding, it’s clear European growth comprises the biggest macro risk right now — although ignore Japan and China at your peril.
As things stand, manufacturing is in contraction in France, Germany, Austria and Greece, with German manufacturing holding the largest underperformance compared to US manufacturing since mid-2012. Germany, Italy and France recently downgraded growth projections. France went one step further and has effectively ripped up plans to comply with the European Stability Pact once again, rejecting plans for a deficit of 3 per cent or less until 2017 — though the European Commission is likely to reject Francois Hollande’s budget. His popularity falls by the day.
However, it’s not just growth and falling inflation expectations that are a concern. There is such little cohesion within the ECB that one would be hard pressed to understand how quantitative easing (QE) could ever become a reality, even if deflation occurred.
It all points to further outflows from Europe, with the US the likely recipient.
It seems logical that 2015 will be remembered as the year that currency wars really came to life, with the US and China most likely at a disadvantage. With such low growth and inflation expectations in developed economies, having the weakest currency becomes a sizeable advantage and 2015 could be the year where things become ugly. The question is how the US reacts, given its growth. Does the stance of its central bank and economic infrastructure stand out positively on a relative basis?
We immediately turn, then, to the September minutes of the Federal Open Market Committee, which effectively portrayed a growing concern about global growth, with continued US dollar strength pushing back on inflation expectations.
Judging by the 50-basis-point fall in five-year inflation expectations over the last few months (with the bond market currently pricing US inflation to average 1.52 per cent over the coming five years), there seems little reason to raise short-term rates anytime soon.
The strong initial gain in US equities after the September minutes was premised on the belief the Fed is happy to join other developed economies’ central banks in their disdain around its currency. The fact that more than 50 per cent of S&P 500 companies achieve revenue outside the US is another input for the Fed, given the negative impact a stronger US dollar has on valuations.
The market believes October 2015 will be the month the Fed lifts rates, which should keep the US dollar in check for now. But with the BoJ expanding its balance sheet to nearly 60 per cent of GDP and the ECB’s own unconventional easing plans, it’s hard to see any major downside for the USD.
For investors, it means one can invest in the US. Growth is compelling on a relative basis and, with the US dollar likely to remain supported, investors should have the confidence to hold stocks unhedged.
Chris Weston is the chief market strategist with IG
CHRIS WESTON THE AUSTRALIAN OCTOBER 16, 2014 12:00AM
US attractions grow for investment
The US economy is looking up and the US dollar is likely to remain well supported, offering an opportunity to invest. Source: AFP
IN the week ending October 10, speculative forex funds (such as hedge funds) held a net currency position of $US45.5 billion ($52bn), surpassing the record of $US44.9bn achieved in 2012.
Naturally, there are many other players in the forex market (such as exporters and reserve managers), but it’s clear the more aggressive faction of the market has seen something fairly special in the US economy, causing the $US5.94 trillion a day market to act in such unison.
The fact is, whether you’re looking at the absolute performance of the US economy, or the ballooning monetary policy divergence between the US Federal Reserve and other G7 currency central banks (with the exception of perhaps the Bank of England), the US is the best house in a deteriorating neighbourhood.
This was highlighted in the recent IMF economic update, which forecast a 40 per cent chance Europe could slip back into recession (and a 30 per cent chance of deflation), while upgrading US growth by 50 basis points, although the previous projections were woefully pessimistic.
The US dollar index (the dollar relative to a weighted basket of currencies) has rallied about 8 per cent since the May low, breaking the 2005 downtrend in the process. The euro contributes 57 per cent to this index, so the fact the European Central Bank penalised institutions for parking funds on its balance sheet was a key component here, as it drove many European countries’ two-year bond yields below zero (investors had to pay governments for the right to lend to them). In turn, this created massive capital outflows from the eurozone.
We have also seen the central bank embark on a journey to expand the balance sheet on both the asset and liability sides of the ledger. Traders remain sceptical this will actually create inflation through the desired expansion of credit. What’s more, looking at inflation expectations (through swaps pricing), we can actually see expectations actually falling aggressively despite these measures. The capital markets are screaming that more needs to be done, which can only be a longer-term euro negative.
Japan follows in a similar vein — the economy is weak and inflation expectations are well below where they should be, given the extent of policy easing. More has to be done and, if it wasn’t for the recent falls in the yen, the Bank of Japan would surely be set to increase the level and scope of its asset-purchase program.
So while the Fed controls the levers by which all other asset classes are responding, it’s clear European growth comprises the biggest macro risk right now — although ignore Japan and China at your peril.
As things stand, manufacturing is in contraction in France, Germany, Austria and Greece, with German manufacturing holding the largest underperformance compared to US manufacturing since mid-2012. Germany, Italy and France recently downgraded growth projections. France went one step further and has effectively ripped up plans to comply with the European Stability Pact once again, rejecting plans for a deficit of 3 per cent or less until 2017 — though the European Commission is likely to reject Francois Hollande’s budget. His popularity falls by the day.
However, it’s not just growth and falling inflation expectations that are a concern. There is such little cohesion within the ECB that one would be hard pressed to understand how quantitative easing (QE) could ever become a reality, even if deflation occurred.
It all points to further outflows from Europe, with the US the likely recipient.
It seems logical that 2015 will be remembered as the year that currency wars really came to life, with the US and China most likely at a disadvantage. With such low growth and inflation expectations in developed economies, having the weakest currency becomes a sizeable advantage and 2015 could be the year where things become ugly. The question is how the US reacts, given its growth. Does the stance of its central bank and economic infrastructure stand out positively on a relative basis?
We immediately turn, then, to the September minutes of the Federal Open Market Committee, which effectively portrayed a growing concern about global growth, with continued US dollar strength pushing back on inflation expectations.
Judging by the 50-basis-point fall in five-year inflation expectations over the last few months (with the bond market currently pricing US inflation to average 1.52 per cent over the coming five years), there seems little reason to raise short-term rates anytime soon.
The strong initial gain in US equities after the September minutes was premised on the belief the Fed is happy to join other developed economies’ central banks in their disdain around its currency. The fact that more than 50 per cent of S&P 500 companies achieve revenue outside the US is another input for the Fed, given the negative impact a stronger US dollar has on valuations.
The market believes October 2015 will be the month the Fed lifts rates, which should keep the US dollar in check for now. But with the BoJ expanding its balance sheet to nearly 60 per cent of GDP and the ECB’s own unconventional easing plans, it’s hard to see any major downside for the USD.
For investors, it means one can invest in the US. Growth is compelling on a relative basis and, with the US dollar likely to remain supported, investors should have the confidence to hold stocks unhedged.
Chris Weston is the chief market strategist with IG