September 2015 FX market Commentary
Currency markets continued to feel the effects of a volatile August. While major pairs such as EURUSD and USDJPY were relatively calm, emerging markets continued to suffer, led by Brazil which witnessed a further 17pct drop at one point in the month. Stock markets remained volatile, with the biggest loss hitting the Nikkei, down 7pct as the S&P and DAX dropped 2.3 pct and 3.1pct respectively. Major sovereign rates closed on their monthly lows. The RJCRB commodity index had a 1 pct loss.
So for the year to date scoreboard as we end Q3 2015. THE EURUSD is down 8pct, the Yen is unchanged. The dollar has risen 38pct against BRL and 14 pct. Versus AUD. Gold is down 6pct, crude – 16pct and the CRB index -19pct. The S&P was down 8pct, more than China which is down 5.6pct.
What is driving these markets, and why the sudden upsurge in volatility recently? Much has been written about liquidity issues such as bank regulation, capital requirements, Central Bank absorption of debt instruments, and the pressures caused by ETF popularity but at the end of the day, direction has other factors – all the while exaggerated by the above themes.
Two factors are clear. The first is the knock-on effect of a Chinese slowdown which has severely altered the economic outlook for many of its commodity trading partners. It is clear that Chinese markets are suffering from traumas – margin-based speculation, opaque international reporting and losses for many international investors which by themselves can have severe secondary effects. Other countries have suffered reputational risk due to internal scandal – Brazil, Malaysia to name two.
The second factor is the assumption by many investors and economists that interest rates in western countries will shortly begin to diverge. Raising rates will be the Fed and Bank of England while the ECB is struggling with the idea of yet more QE. And here we have the terrible dichotomy of today’s global economy. Cheap money is an unsustainable economic tool which leads to poor allocation of capital. Unfortunately, ever since the prevention of a financial collapse in 2008/2009, the global economy has been sustained ultimately by the Fed and the ECB. In theory, The Fed should have begun to raise rates 3 years ago but has not for fearing of causing tension in other markets. But tension is what we have because the Fed keeps openly setting up markets for just such an event but then does not pull the trigger. The Bank of England has displayed a similar if less significant tendency.
Which leads us to consider the following: Will the Fed actually do anything at all? Various members are considered hawks, others the doves. Chairman Yellen seems uncertain. The time has passed for action and just as August and September showed, markets are increasingly unstable. The Fed wishes to remove uncertainty. Perhaps they should declare victory and close the door.
The point is this: The Fed is concerned about the strength of the dollar, meaning the weakness of certain Asian and LATAM currencies. They are concerned about volatility. What better course of action than no action? Under this scenario, it is not impossible to see EM currencies stabilize and once more become yield-enhancing plays. Similarly, as already appears to be the case, EURUSD should strengthen against the dollar. In fact a period of dollar weakness is what the US secretly wants and if their central bank keeps up this good cop/bad cop routine for much longer, markets will give them just that.
Naturally other countries will not be too pleased with this development. A stronger Euro is not the way to cure the ECB’s deflation fears so we should expect stimulative monetary measures to continue in the Eurozone. We do not see this as being negative for the Euro however, as a rebound in growth in Europe will find favour with the pool of reserves and investments that remain at large.
Currency markets have been subdued in recent years until a year ago and further roiled by a full-blown EM panic. Investors should be looking at how they may take advantage of what is going to be an active time in FX.
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Absolute Return Strategies Ltd. (“ARS”) is an SEC Registered Investment Advisor and CFTC Commodities Trading Advisor specializing in multi-manager, multi-strategy currency alpha programs. The firm has staff in London and Cincinnati. ARS management has been researching and selecting FX strategies for over 30 years in order to identify investment teams capable of delivering superior performance based on high caliber management and long-term market experience.