President Trump is set on the economy to grow beyond 5 percent real GDP. But high growth has a natural ‘side effect’ and that is a strong dollar. Reducing the trade deficit to spur growth increases domestic investment and appreciates the dollar. Trade tariffs hurt other economies and weaken their currencies. That too raises the value of the dollar. Resolving lower tariffs and trade barriers by invest and build in the U.S. will drive up demand for the dollar. Thus, a policy of targeting a lower t
The Turkish Sudden Stop
The plunge in the Turkish Lira attributed to a tweet and a defiant speech. But underneath there was a “sudden stop” in the Turkish currency. In 1997 this happened in Indonesia that went from a darling in the eyes of foreign lenders to a nightmare. The rupiah crashed and Indonesia’s debt to GDP soared to 170 percent. Capital flows to Indonesia ‘stopped’ leaving financial markets in disarray. What followed next was contagion spreading across the South East Asia region. A key reason for contagion
When Markets Face Cross Currents
If there is a word to recap past months in markets, then it is “chaos.” Recent tensions in Italy were a reminder Europe could break up at some point in the future. Investors responded by seeking “safe havens” like U.S. Treasuries and the Japanese Yen. When uncertainty reached a climax in June, Italian interest rates spiked above those of the U.S. (see Figure 1). A situation like this can lead to a political resolve. Markets were for example discounting the Federal Reserve to hold off on interes
When the Yield Curve Reaches Limits
There is a lot of attention for the yield curve lately. Several Fed officials like James Bullard and Neel Khaskari have warned the yield curve could “invert.” That would be a bad signal because historically when the yield curve inverts, a recession could follow a few years later. During the testimony to Congress, Fed Chairman Powell said flattening of the yield curve was a sign of long term rates figuring out when the Fed would stop tightening. Now President Trump has weighed in on that point sp
How a Yuan Devaluation May Play Out
Market focus has been notably on Trump’s tweets on the subject of geopolitical tensions. Investors do have some experience how Trump’s handles such a situation. Think of North Korea that looked quite threatening but has resulted in a future Summit with Kim Jong-Un. The same may happen with Russia where Trump plans to meet with Putin but uses his “punch in the face” strategy to get meaningful dialogue. The "unknown-unknown" of missile attacks causes the oil price to go up but other traditional sa
A Different Message From The Fed
New Federal Reserve Chairman Jerome Powell’s first congressional testimony made it clear to markets that it’s no longer business as usual. Under Powell’s predecessor, Janet Yellen, developments in the labor market drove monetary policy. And since employment is a lagging economic indicator and slack in the labor market was large, it was an easy message to convey. Monetary policy would gradually adjust as the labor market showed steady improvement. As a result, market volatility was subdued becau
When the Next Cash Nexus Arrives
Cash can be a valuable commodity when returns on financial assets turn negative. After all, cash is easy to manage, has no volatility and doesn’t result in losses. Yet, cash is not abundantly available judging from global surveys such as by Bank of America. Those surveys are conducted among a diversified base of global investors. Respondents see excessive valuations and yet, portfolio cash levels have fallen to pre-crisis (see Fig. 1). A growing wedge between the perception of valuations and cas
The Relative Value Between Stocks and Bonds
Past week’s sell off in equity markets was one of the largest in recent years. When something like that happens, market analysts like to look at indicators such as the “Relative Strength Index.” This index is a technical indicator used in the analysis of financial markets. It is intended to chart the current and historical strength or weakness of a stock or market based on the closing prices of a recent trading period. The relative strength or weakness is known as “overbought” or “oversold” cond
What Shutdowns and Debt Ceilings Say About Returns
For the all the tensions in Washington D.C. over who’s the blame for the shutdown of the government, investors are going to be quite happy. A shutdown of government sounds negative but is viewed by investors as a wrinkle rather than a big fork in the road. This is seen from bond and stock returns that have been uniformly positive during and after shut downs and debt ceilings negotiations end. U.S. political risk is seen an investment opportunity and there are several reasons why. According to a
Bitcoin Futures : What this Market Means
Bitcoin futures were launched on the Chicago Mercantile Exchange in follow on to last week’s introduction on the Cboe. The result of these formal introductions is liquidity in the market for Bitcoin may pick up quickly. Naturally that would compress the price between futures and the underlying Bitcoin which is called the “the basis.” Currently the Bitcoin basis is around $450 to $800 which suggests there remains a significant liquidity difference between Bitcoin and futures markets. But now that
Deficits, Taxes and the Trump Agenda
Financial markets once again embraced President Trump’s tax reform with euphoria. Although details lack and uncertainties remain, the impact of reform was priced in as a positive outlook for the U.S. economy. This was seen from a strong rally in small cap stocks and companies with a current high effective marginal corporate tax rate. The dollar received a boost and Treasury yields rose on the prospect of higher GDP in the coming quarters. Now the question rises whether tax reform is an “inflecti
Somewhat Rich Valuations
In her sit down discussion in London, Federal Reserve Chair Yellen presented a milder version of what Alan Greenspan once dubbed 20-years earlier as “irrational exuberance” to describe the state of the stock market. Fed Chair Yellen said valuations appear to be “somewhat rich” when measured on traditional models. The model she referred to is the “Fed model” of stock valuations, introduced by Alan Greenspan at the Humprey Hawkins testimony in 1997. The model uses the 1-year forward earnings yield
Is the U.S. experiencing shadow deflation?
The latest Consumer Price Index release was the third consecutive inflation report that came out on the soft side. The economy has been moderately growing at 2 percent average with wages around 2.5 percent and unemployment around 4.3 percent. An economist who advocates the “Phillips Curve” (the relationship between unemployment rate and inflation) would argue the U.S. economy is on the brink of a burst in inflation. And yet, the actual inflation is benign and even shows ingrained deflationary tr
Where are 10-year yields going?
Yields are falling despite the Fed, the Bank of Canada and the Bank of England, want to hike interest rates. The long end of the yield curve responds with natural defense because soft inflation and hikes means the Fed will not meet the inflation target. Indeed, the Treasury Inflation Protected Securities (TIPS) curve discounts a below target inflation for the next 30-years. This expectation has been in place since late 2014 since QE3 ended. Since that time, the 10-year has been in a downtrend wi
The Benefit of Post U.K. Election Uncertainty
Once again, British polls turned out to be unreliable, and the political fallout may linger for some time. While Brexit negotiations are about to get under way, the Conservatives position in the House of Commons has weakened on May’s mandate backed by a slim majority. This is the uncertainty the Pound Sterling reflected on Friday by falling 1.5 percent against major currencies. A currency that expresses political risk may serve as a reflation backdrop because it can loosen global financial cond