Wednesday, April 20, 2016

Every country seems to want a weaker currency

The critical longer-term question to my mind is whether the Fed is going to re-introduce QE and/or cut rates ultimately into negative territory. This takes us into the realm of when and what would the necessary pre-conditions need to be. This in turn takes us into the realm of credibility. My view – and it is only my view, as nobody can know the answers to these three questions for sure, is still that the Fed does not actually do anything more than jaw-bone until or unless the S&P500 cash index is into the 1500's and the outlook for growth, employment and inflation get significantly worse – perhaps with the unemployment rate inching higher not lower. Timing wise late Q2 or Q3 is still my target, though the closer we get to the US presidential election the more the Fed will be hampered. In terms of credibility, while I think the ECB and the BOJ are scrapping the barrel, the Fed still has the ability to influence things, at least for now.

I do not think that this current rally leg has much left in it – the power of Fed speak without Fed action is already waning I think. Consecutive weekly closes above 2116 (possibly) and/or 2135 (definitely) would force me to reconsider my views for the rest of Q2 and Q3. Until or unless these levels are crossed I would urge investors to be extremely cautious about getting too long risk and getting overly complacent.

The underlying global growth and earnings outlooks are poor and deflation is still running rampant, albeit right now perhaps more so (at least in terms of perception) in Europe and Japan than in the USD-bloc (which includes almost all EM economies, as well as the usual economies such as Canada and Australia). 

As everyone wants a weaker currency, I do not expect the period of USD weakness we have seen since early March, and which has been the real catalyst for the latest ramp-up in risk assets and hope, to last unabated for much longer without much more explicit easing/explicit promises of easing by the Fed which, as I have said above, is unlikely until things get much worse. 

More likely are fresh attempts by the ECB and/or the BOJ to ease to drive down the EUR and JPY before the Fed can actually do anything explicit. In my view, this, of course, will put Chinese devals back on the table. The global FX war continues, which on any meaningful timeframe is ultimately a destructive outcome for the global economy. It seems sad that central bankers are so focused on transitory and largely illusory wins, which have served the global economy so badly over the last decade.