David Fuller and Eoin Treacy's Comment of the Day
Category - General

    Is there complacency over Chinese woes?

    Thanks to Niru Devani for this article on China.

    The Chinese markets turned around today from being down around half a percent to rise by over 2% by the close with the renminbi stabilizing. There was some speculation that the authorities had been supporting the currency to slow down the pace of decline. There was also talk that they would add liquidity into the system to support the equity market.

    The yuan has fallen by over 8% since late March and is at a one-year low against the dollar. The renminbi’s fall is partly a catch-up with the other currencies that have fallen against the US dollar. The dollar has been strong this year because of widening interest rate differentials with the Federal Reserve being the only major central bank raising rates. However, the currency has also fallen because of softer economic growth and trade tensions with the US. The Chinese authorities are likely to tolerate a weaker currency as long as it falls in an orderly manner and smoothing its decline from time to time as they appear to have done today.

    The current phase of renminbi weakness has not yet led to a global market panic similar to the one we saw in late 2015 and early 2016. However, it is one of the key concerns on investors’ minds. So far, the pressures have been felt in the commodities markets where copper, often described as the metal with a PhD in economics because of its past record of being a lead indicator of economic growth, has fallen sharply since early June, declining by about eighteen percent over such a short time. The tariff war has clearly been a big contributor as has the strength in the dollar which has negatively affected various other commodities with the exception of oil which is being moved by other factors.  Asian equities and other emerging markets have also been hit hard over the last few months. The Chinese equity market is in correction territory having fallen by 20% from its highs in January while the Hang Seng index is at a ten month low.

    The tariff war is unlikely to come to a resolution before the mid-term Congressional elections. The concern is that the weakness in the Asian and emerging markets spreads to the developed markets. Other than the Nasdaq index, most other major markets have not made new highs since January. The best case scenario is that the consolidation in these markets continues for longer, the worst being that they react more sharply to the falls in Chinese and emerging markets. China is at least as important a factor as the US and merits watching closely.

    This section continues in the Subscriber's Area.

    US President's criticism of the Federal Reserve's interest rate policy

    Thanks to Niru Devani for this timely article.

    US President Donald Trump broke with tradition and levelled criticism at the Federal Reserve about their interest rate policy and its impact on the US dollar as well as economic growth. In an interview on CNBC, he said “I’m not thrilled,” “Because we go up and every time you go up they want to raise rates again . . .  I am not happy about it. But at the same time I’m letting them do what they feel is best.” While presidents appoint the chairman of the Federal Reserve and other committee members, they do not interfere with their management of monetary policy. The last time a president commented on Fed decisions was in the in the 1990s when George W Bush expressed his displeasure with the Fed’s policy after losing the election.  

    With the Fed’s target rate at 1.75 per cent to 2 per cent, the central bank is expected to raise rates twice more this year. Trump’s intervention should not stop them from continuing to raise rates as long as economic growth and inflation justify it. The Fed has faced criticism from both the left and the right in the years following the financial crisis. Mr Trump also expressed unhappiness with the strength of the dollar against the euro and the renminbi. He criticised the Europeans and the Chinese for being passive at best and currency manipulation at worst. The latter point was targeted at the Chinese.

    Mr Trump’s comments triggered a fall in the U.S. dollar which was approaching some resistance against the euro which comprises over 50% of the dollar index. The euro has so far managed to find support around the 1.15 level versus the dollar and it did so again yesterday afternoon following these comments. The dollar has continued to pull-back today.  The index hit its high for the year earlier yesterday at 95.652 and was trading around 94 at its low point today. The president’s unorthodox verbal intervention in the currency markets has so far had the desired impact but it will not change the trend of a higher dollar over the coming months given that the U.S. is the only major developed economy apart from Canada raising rates.

    This section continues in the Subscriber's Area.

    The Most Dis-advantageous Lottery in the World

    Thanks to subscriber Ian Runge for this paper.

    Ian has spent a professional lifetime as an engineer and economist in the resources industry and related capital intensive industries. The products from these industries are the backbone of the world economy; they provide the essentials for life in all economies and underpin the sophisticated lifestyles enjoyed by the advanced world. Yet the efforts, skills, and technology that go to find, produce, refine, and transport these goods are hardly known (and more often than not, unappreciated) outside these industries themselves.

    This is usually a good month to buy gold but it's a tough call this year

    Thanks to Niru Devani for this article on Gold.

    Gold broke down below a key technical support level of 1236 which was the low in December 2016. The trigger was the yield on the three month Treasury Bill which broke through 2%, a level not seen since the summer of 2008. This followed the Fed chairman's testimony on Capitol Hill to reiterate that the Fed remains on track to continue to raising interest rates. In an environment of a rallying U.S. dollar and still positive real interest rates, gold does not prosper.

    I thought the article below, by Dominic Frisby at Moneyweek.com, would be of interest to other subscribers as it offers a contrarian point of view. 

    Summertime, and the gold investing ain’t easy

    Wisdom has it that the summer months – June, July and August – are the best time of year to buy precious metals (and their related stocks) with a view to offloading the following winter or in early spring.

    It’s one of those trades that seems to work better in the rear-view mirror than it does in real time, however.

    If you look back at a chart of gold you can usually find a low sometime in July, and then find a point between the following October and April, where the gold price was 10% or 20% higher, and then declare that the trade worked.

    Buying the low and selling the high in real time is a rather trickier proposition. That said, it is do-able.

    However, gold itself is currently in freefall. In April, gold was re-testing five-year highs at $1,360-$1,370 per ounce. There was a nice uptrend in place. Each low was higher than the last. Talk of inflation was doing the rounds again, and the solution was shiny, yellow-y metal.

    Now it is some $130 lower at $1,227. Each low is lower than the last. Every attempt at a rally is anaemic. The trend is strong and the trend is down. To be buying now and attempting to play the “summer trade” is to try and catch a falling knife. Sometimes it works and the audience applauds – however the risk of self-injury is high.

    Tuesday was particularly brutal. Gold’s enemy number one, the chairman of the Federal Reserve Bank, Jerome Powell, said that the economy was growing at a “solid pace”, that the unemployment rate was expected to fall further, that the recent pickup in inflation, toward the Fed’s 2% target, was “encouraging”.

    The Fed has already raised interest rates twice this year and Powell pencilled in two more quarter-point moves. Stocks duly rallied (a bit), the dollar rallied – and gold took a $20 wallop in the face, sending it to two-year lows.


    This section continues in the Subscriber's Area.

    Please note I am away on holiday until August 1st

    I would like to extend my special thanks to subscribers and friends of FullerTreacyMoney for submitting a number of articles for your kind consideration over the course of the next few weeks. I think subscribers will be pleasantly surprised with their contributions. 

    U.S. Fed's chairman outsources 'neutral' rate decision to the yield curve

    Thanks to Niru Devani for her second article this week.

    A long term subscriber to FullerTreacyMoney, Niru began her career in the financial markets 30 years ago as a trainee fund manager. After spending 14 years in the fixed income sector, she moved to managing commodities and global macro funds. Niru now manages both hers and her families' pension funds and other savings. She also likes to trade. She says, ‘My enthusiasm for my profession is even stronger now and I enjoy the fact that I am constantly learning new things.’

    During a two day testimony to the Senate Banking Committee that ended yesterday, Fed Chairman Jerome Powell said that he runs policy according to what is in front of him and uses a slow, steady approach to keep policy from becoming too restrictive. He is fully cognisant of the risks ahead, be it inflation accelerating from fiscal stimulus or growth decelerating because of trade uncertainty. He rates the chances of both outcomes 50/50, so he isn’t going to react to either until they become actual rather than potential risks.

    What the FOMC is doing is to steadily raise rates, that is, the price of short-term money so that it is better aligned with growth. It will continue with that policy until it sees risks to growth from this path. Two further rate hikes are expected this year. Real growth remains strong although new housing growth is flattening out, but construction is still expected to rise on a year-on-year basis. As the chairman said, the economy was growing at a “solid pace”, that the unemployment rate was expected to fall further, that the recent pickup in inflation, toward the Fed’s 2% target, was “encouraging”.

    The Fed’s first aim is to get interest rates up to their “neutral” level, and then see how the economy is performing. What rate constitutes neutral is a matter of spirited debate among FOMC members. Powell weighed in on the subject during the Q&A portion of his testimony by saying he has  effectively outsourced the resolution of the debate to the credit markets. He will take his cue as to whether the Fed has reached neutral from the shape of the yield curve. This means that as long both the economic news and the yield curve remain positive,  the Fed will keep raising rates.

    It is of course nothing new that the interest rate setting committee watches the bond markets and the yield curve very closely. However, it is the communication style of the current head of Federal Reserve that is a lot more open and direct compared to his predecessors, especially Alan Greenspan who was a master of obfuscation.

    The eventual challenge to the Fed’s policy management will come when core inflation is drifting higher while growth is weakening around the edges because of trade disruptions. Assuming the yield curve is still positive by year-end, the question will be whether the Fed changes tack to counter trade-induced slower growth or stays the course to stem inflation – which, by that time, will probably be testing its tolerance threshold. The most likely scenario is that the Fed is likely to hold true to form and go on fighting inflation, which should mean that growth in 2019 will be slower but still positive in the Fed’s view. As it has a dual mandate, it has to balance its inflation fighting credentials with promoting a supportive policy mix for growth.

    During his testimony, there was no talk about the reduction of the Fed’s balance sheet, which is odd considering the IOER*/fed funds spread is generating a lot of comment and leading some to conclude that quantitative tightening will end sooner than anticipated. The issue is that because the Fed pays interest on reserves, bank deposits at the central bank consist of both the Fed’s reserve requirements and the capital requirements of Basel III. This raises the question of how useful is the normal analysis of reserves at the Fed. The wider issue is one of bank capital adequacy. Powell was pressed about this but avoided answering. No doubt we will hear more on the subject the next time he appears in front of the Senate.

    *interest rate on excess reserves

    This section continues in the Subscriber's Area.

    Some thoughts on the Dollar

    Our second guest contributor today is Mikhail Overchenko. Mikhail has been working at the leading Russian business daily Vedomosti, co-founded by Financial Times and The Wall Street Journal, since its launch in 1999. He is a longtime foreign news editor, specializing in economics, markets and finance. 

    Following recent discussion here on surprising dollar strength this year, I would like to add a factor that wasn’t mentioned. Writing some 18 months ago a story about Donald Trump’s possible policies (I am a journalist), I mentioned that his idea to bring US corporate profits back home could lead to dollar appreciation. Because we had similar example not long ago. George W. Bush’s American Jobs Creation Act of 2004 allowed companies to bring foreign profits to US while paying significantly lower tax. He hoped that they would invest these funds at home but they mostly bought back their shares, paid dividends and did mergers and acquisition (they seem to do the same now). 

    So, in 2005 US companies repatriated approximately $300 billion. This resulted in almost 13% growth of dollar vs euro as well as of Dollar Index that year. As you can see on the chart, this was the most significant correction during overall dollar long-term bear trend of 2001-2008. 

    While obviously there are other factors in play that determine currencies’ dynamics, the factor of repatriation of profits seems to prevail and possibly will continue to play a significant role till the end of the year.

    This section continues in the Subscriber's Area.