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

    Global Dollar Shock Threatens Fresh Financial Storm, Warns Watchdog

    The soaring US dollar is causing mounting strains for the global financial system and ultimately threatens to set off a full-blown banking crisis in emerging markets, the world’s top’s economic watchdog has warned.

    “We have all the symptoms of a dollar shortage,” said Hyun Song Shin, chief economist at the Bank for International Settlements.

    The warning came as the closely-watched dollar index (DXY) appeared close to breaking through key resistance levels to a 14-year high, a move likely to trigger a stampede into the US currency as hedge funds and momentum traders join the chase.

    The danger is that the powerful and immediate effects of financial tightening will “swamp” any trade benefits for the rest of the world from Donald Trump’s stimulus plans and a stronger dollar, even for countries that export heavily to the US. “It may not be very good news for anyone,” Mr Shin told a specialist forum at the London School of Economics.

    The BIS estimates that dollar debt outside US jurisdiction - and therefore lacking a direct lender of last resort - has risen five-fold to $10 trillion over the past 15 years.

    It has spiked to $3.3 trillion in emerging markets. This is chiefly due to the leakage of cheap dollar funding from the US while quantitative easing was in full flow. The debts will have to be rolled over in a stronger currency and at a much higher rates.  

    What is less understood is that the surging dollar automatically squeezes the balance sheet of banks in Europe and Japan through the complex structure of swap contracts. “The dollar is everywhere,” said Mr Shin.

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    A $900 Billion Oil Treasure Lies Beneath West Texas Desert

    In a troubled oil world, the Permian Basin is the gift that keeps on giving.

    One portion of the giant field, known as the Wolfcamp formation, was found to hold 20 billion barrels of oil trapped in four layers of shale beneath the desert in West Texas, the U.S. Geological Survey said in a report on Tuesday. That’s almost three times larger than North Dakota’s Bakken play and the single largest U.S. unconventional crude accumulation ever assessed. At current prices, that oil is worth almost $900 billion.

    The estimate lends credence to Pioneer Natural Resources Co. Chief Executive Officer Scott Sheffield’s assertion that the Permian’s shale endowment could hold as much as 75 billion barrels, making it second only to Saudi Arabia’s Ghawar field. Pioneer has been increasing its production targets all year as drilling in the Wolfcamp produced bigger gushers than the Irving, Texas-based company’s engineers and geologists forecast.

    “The fact that this is the largest assessment of continuous oil we have ever done just goes to show that, even in areas that have produced billions of barrels of oil, there is still the potential to find billions more,” Walter Guidroz, coordinator for the geological survey’s energy resources program, said in the statement.

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    Email of the day

    On Markets Now and the markets (from Australia):

    The dollar, bank leverage and the deviation from covered interest parity

    This article by Stefan Avdjiev, Wenxin Du, Catherine Koch for The bank of International Settlements may be of interest to subscribers. Here is a section:

    Our focus, therefore, is on the banking sector, and the ability of banks to take on
    leverage. The key message of our paper is that the value of the dollar plays the role of a barometer of risk-taking capacity in capital markets. In particular, it is the spot exchange rate of the dollar which plays a crucial role. Deviations from CIP turn on the strength of the dollar; when the dollar strengthens, the deviation from CIP becomes larger. To the extent that CIP deviations turn on the constraints on bank leverage, our results suggest that the strength of the dollar is a key determinant of bank leverage.

    The cross-currency basis is the difference between the dollar interest rate in the cash market and the implied dollar interest rate from the swap market when swapping foreign currency into dollars. The cross-currency basis measures deviations from the CIP condition. Figure 1 plots the broad dollar index (in red), which is the trade-weighted US dollar exchange rate against its major trading partners. When the red line goes up, the dollar strengthens. The blue line tracks the average cross-currency basis for the ten most liquid currencies vis-à-vis the dollar. We see that the cross-currency basis is the mirror image of dollar strength. When the dollar strengthens, the CIP deviations widen. This is especially so in the last 24 months, reflecting the stronger dollar.

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    China's Yuan Tumbles to Eight-Year Low as Banks Weaken Forecasts

    This article from Bloomberg News may be of interest to subscribers. Here is a section:

    “The pressure for the yuan to decline could be stronger next year as Trump’s policies could lead to a dollar rally and amid concerns about China-U.S. trade relations," said Harrison Hu, chief greater China economist at Royal Bank of Scotland Group Plc in Singapore. "The People’s Bank of China can curb high volatility with stronger fixings and intervention, but it won’t do so unless outflows surge, as such measures could add great pressures to the foreign reserves."

    A record $44.7 billion left China in September in yuan payments, while the nation’s foreign-exchange stockpile shrank the most since January last month. Chinese officials have taken a series of steps to plug capital control loopholes, such as a potential plan to curb transactions that use the bitcoin digital currency to take funds out of the country. UnionPay Co. late last month limited mainlanders from using its cards to buy insurance in Hong Kong.

    HSBC Holdings Plc, UBS Group AG and Australia & New Zealand Banking Group Ltd. lowered their yuan forecasts on Tuesday, predicting that the currency will end this year at 6.9 per dollar, compared with earlier estimates of 6.8 for the first two lenders and 6.75 for the third. BMI Research, a unit of Fitch Group, downgraded its year-end forecast to 6.85 from 6.8, while Norddeutsche Landesbank said it has revised its view to 7 from 6.8.

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    Go Figure

    Thanks to a subscriber for Howard Marks’ latest memo to Oaktree clients focusing on the outcome of the US election. Here is a section: 

    That brings us to the outlook for bonds. Just as the U.S. stock market has celebrated Trump’s election, the bond markets have been discouraged. Interest rates rose very rapidly last week following Trump’s election, bringing big losses to bond holders. The FT wrote the following, citing Henry Kaufman, the Solomon Brothers chief economist who correctly called the bond bear market in the 1970s:

    “It’s a tectonic shift”…the end of a three-decade bond bull market, because of the likelihood of unfunded tax cuts, infrastructure spending and a radically reshaped Federal Reserve. “I would say the secular trend is going to be upwards now” he told the FT “Secular swings are hard to forecast, but the secular sweep downwards in interest rates is over, and we are about to have a gentle swing upwards”

    I always feel it takes a degree of innate optimism to be a devotee of stocks (with their reliance on conjectural returns awarded by the market) as opposed to bonds (which bring contractual returns guaranteed by their issuers). Thus U.S. equity investors have exhibited an optimism regarding the Trump administration that virtually no one foresaw a week ago. 

    Equity investors like inflation because it pumps up profits. Bond investors dislike it because it raises interest rates, reducing the value of the bonds they hold. But the two can’t go in opposite directions forever. At some distant point, higher interest rates can cause bonds to offer stiffer competition against highly appreciated stocks. 

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    CNBC Transcript: GE Chairman & CEO Jeff Immelt Speaks with Carl Quintanilla on Squawk Alley

    IMMELT: HERE'S HOW I LOOK AT INFRASTRUCTIURE IT BOTH CREATES JOBS IN AND OF ITSELF BUT IT ALSO MAKES US MORE PRODUCTIVE WHICH IS A GOOD THING. I LOOK AT TAX REFORM, CARL, AND SAY BASICALLY WHAT'S BEEN SITTING OUT THE PAST DECADE IS CAPITAL INVESTMENT BACK IN THE U.S. IT'S A GOOD CHANCE THAT TAX REFORM IS KIND OF THE MISSING INGREDIENT THAT CAN HELP DRIVE SOME OF THAT CAPITAL INVESTMENT BACK. THAT'S THE DIFFERENCE BETWEEN A 3% GDP GROWTH U.S. AND 2% GDP GROWTH. WE HAVE HAD 0% INTEREST RATES FOR A DECADE NOW. IF YOU'RE A CONSUMER AND HAVE A JOB, YOU FEEL RICH. BUT THAT'S NOT ENOUGH TO CREATE THE KIND OF ECONOMIC GROWTH THAT I THINK THE PRESIDENT WANTS TO CREATE AND MOST PEOPLE WANT TO SEE. I THINK TAX REFORM IS ACTUALLY QUITE IMPORTANT WITH TERRITORIAL SYSTEM, REPATRIATION IS PART OF THAT.

    QUINTANILLA: YOU SOUND OPTIMISTIC.

    IMMELT: I'VE BEEN THROUGH EVERY CYCLE KNOWN TO MANKIND OVER THE LAST 15 YEARS. I THINK THE SENSE IS THAT THE U.S. HAD BEEN IN A SLOW GROWTH MODE. THERE'S ENOUGH GROWTH AROUND THE WORLD TO BE ABLE TO KEEP US GOING FORWARD. AND I THINK IF YOU COULD JUST SOLVE A FEW THINGS IN THE U.S. -- IT DOESN'T MATTER WHO DOES THEM, BUT IF YOU COULD JUST GET A FEW THINGS GOING, THERE'S LOTS OF PENT-UP DEMAND AND OPPORTUNITIES FOR GROWTH.

    QUINTANILLA: TRADE HAS BEEN A BIG PART OF THIS STORY. AND THIS CARRIER PLANT IS TURNING INTO SOME SORT OF CAUSE CELEB RIGHT? A TEST OF WHETHER OR NOT A TRUMP PRESIDENCY CAN ACTUALLY KEEP PRODUCTION FROM GOING OVERSEAS OR BEING REVERSED, COMING BACK IN. HOW LIKELY IS THAT? VOTERS WHO VOTED ON THAT, IS THAT A FOOL'S BET OR NOT?

    IMMELT: SO, I THINK PROTECTIONISM HAS BEEN GOING ON FOR A DECADE OR MORE. PRESIDENT TRUMP ISN'T THE FIRST ONE TO TALK ABOUT IT. IT'S BEEN GOING ON IN EUROPE, CHINA. THE WORLD I GREW UP IN WITH THESE FREE TRADE DEALS AND THINGS LIKE THAT, I THINK ANYBODY THAT WAS PLANNING ON THAT GOING INTO THE FUTURE IS -- THAT'S NOT THE WAY WE'VE THOUGHT ABOUT GE. I THINK IT REMAINS TO BE SEEN EXACTLY WHAT THE NEW TRADE RULES ARE GOING TO BE. AND I THINK WE HAVE TO WAIT AND SEE. FOR SOMEONE LIKE US THAT'S AN EXPORTER, REALLY, WE MAKE AND SELL THINGS AROUND THE WORLD. WE CAN NAVIGATE THE WORLD ON OUR OWN. BUT IF YOU WALK THROUGH WALMART, HOME DEPOT, DO ALL THOSE PRODUCTS HAVE TO COME BACK TO THE UNITED STATES? DO ALL THE HAIR DRYERS AND SNEAKERS AND REFRIGERATORS HAVE TO COME BACK -- IS THAT WHAT'S GOING TO, YOU KNOW, MAKE THE ECONOMY GROW AGAIN? I THINK PEOPLE HAVE TO SIT AND THINK THROUGH EXACTLY WHAT THE PUTS AND TAKES ARE. FOR US WE'RE A GLOBAL COMPANY. WE SELL IN 190 COUNTRIES AROUND THE WORLD. WE DO IT FROM A LOCAL STANDPOINT. WE'RE GOING TO KEEP GLOBALIZING. WE'RE AN EXPORTER. I THINK THE WORLD WE LIVE IN TODAY IS SO DIFFERENT THAN IT WAS 10, 15, 20 YEARS AGO. YOU KNOW, I BELIEVE IN TRADE DEALS. BUT WE DON'T NEED TRADE DEALS IN GE. I THINK WHAT THE PRESIDENT WILL LEARN, WHAT PRESIDENT TRUMP WILL LEARN IS THAT AS HE TRAVELS THE WORLD, TRADE DEALS GIVES HIM POWER. THE ABILITY TO USE TRADE AS AN ECONOMIC, LET'S SAY, NEGOTIATING TECHNIQUE, MAKES HIM MORE POWERFUL.

    QUINTANILLA: BECAUSE HE'S SPEAKING THE LANGUAGE OF OTHER COUNTRIES. WHO ARE TRYING TO DO THE SAME THING?

    IMMELT: EXACTLY. I'VE TRAVELED THE WORLD, CARL, FOR 35 YEARS. PEOPLE CARE ABOUT SAFETY. THEY CARE ABOUT GROWTH. IF THE PRESIDENT OF THE UNITED STATES TRAVELS AROUND THE WORLD AND HAS NOTHING TO OFFER FROM A STANDPOINT OF ECONOMIC CONNECTION, YOU LOSE HALF OF YOUR NEGOTIATING POWER. THIS GUY IS A NEGOTIATOR, A DEAL MAKER. SO I THINK LET'S JUST WAIT AND SEE WHAT HE DOES.

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    Donald Trump said Amazon and Jeff Bezos have a huge antitrust problem. Now they may.

    Let’s state the obvious: Donald Trump and Amazon CEO, and Washington Post owner, Jeff Bezos do not see eye to eye. And that becomes a more concerning prospect for Bezos and Amazon now that Trump is president-elect.

    In May, after learning of the large team of Washington Post reporters looking into his past, Trump told conservative TV commentator Sean Hannity that Bezos was using the paper to damage Trump’s chances because he feared what a President Trump would mean for Amazon.

    "He thinks I'll go after him for antitrust," Trump said at the time. "Because he's got a huge antitrust problem because he's controlling so much, Amazon is controlling so much of what they are doing.

    "He's using the Washington Post, which is peanuts, he's using that for political purposes to save Amazon in terms of taxes and in terms of antitrust."

    Trump’s campaign later reiterated this narrative in a statement claiming that the Post was being used as political leverage so Amazon doesn’t “get sued for monopolistic tendencies that have led to the destruction of department stores and the retail industry.”

    In response, Bezos has appeared undaunted in public. Bezos told an audience at Recode’s Code Conference in June that “a presidential candidate should embrace” the media coverage that the country’s democracy allows for rather than fight it. More recently, Bezos called out Trump for his threats of retribution against media organizations he feels have wronged him.

    In the wake of Trump’s win, I asked an Amazon spokesman if Bezos planned to comment. I was told he doesn’t.

    Investors seem to be unsure about what a Trump presidency means for the online retailer. Amazon’s stock was down 2.68 percent as of 11:25 am ET on Wednesday morning. Other tech stocks like Apple, Facebook and Alphabet were also down, but all less than 2 percent.

     

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