Bedrock’s Newsletter for Friday 17th of August, 2018

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 Friday, 17th of August 2018

Another week gone by. The illiquid summer months are coming to an end. Arguably, the return of liquidity will manifest itself in less exaggerated market reactions. Clearly the “flavour-de-la-semaine” has been Turkey. In GDP terms, Turkey was the 63rd largest economy in the world in 2017 producing 1.37% of Global GDP. On a GDP per capita basis, which is more relevant (at least for Erdogan), Turkey ranks better, at 42nd. More importantly still, Turkey is a member of NATO and sits at the crossroads of the major dangers of this world – Russia, Iraq, Syria and Iran.

 

Trump’s rhetoric against Turkey (to some extent justified), together with sanctions and tariffs, have hit the Turkish Lira with a vengeance. This fall in turn taxed local markets where both bonds and stocks plunged…Ugly… Then our thin summer markets thought some more about this and decided that, as European banks are exposed through hard currency lending to Turkish entities, these institutions should be punished too. Talk of ‘contagion’ started to spread over the wires… Those who tried to hedge political risks by owning gold didn’t fare very well: gold prices hit 19-month lows on Thursday before bouncing somewhat on news that China and the United States will hold trade talks this month. On Thursday, spot gold was flat at $1,173.91 per ounce, up from an earlier low of $1,159.96. Gold prices have tumbled more than 10% since their April peak above $1,365 an ounce.

 

Turkey imposing capital controls could quickly exacerbate the exposure of other emerging market economies, an analyst at Goldman Sachs told CNBC on Thursday. Turkish officials are currently trying to contain the country’s worst currency crisis since 2001, with the lira tumbling to a low of 7.24 against the dollar at the start of the week. The lira has since pared back some of its losses, trading at around 5.79 against the dollar on Thursday afternoon. However, the currency has lost more than 40% of its value against the dollar this year, sparking fears of contagion and a sell-off in emerging markets — particularly if Turkish officials move to introduce capital controls. “Full-blown capital controls that everybody is worried about I think have a pretty limited chance of success, partly because they have a big external funding requirement … So, I don’t think capital controls here are the solution,” Kamakshya Trivedi, co-head of emerging markets and foreign exchange research at Goldman Sachs, told CNBC’s “Squawk Box Europe” on Thursday. The week’s turmoil has jolted assets globally, pulling down equities across developed market indexes and hitting the MSCI emerging markets index particularly hard. Trump might get his slowdown in rate hikes, but for the wrong reason.

 

Among the unintended consequences of President Donald Trump’s trade war could be a slowdown in the pace of interest rate hikes by the Federal Reserve. While Trump has spoken out against the central bank’s policy tightening, and might be pleased if it stops raising rates, the move would be for the wrong reason, namely due to a slowing economy. “If you have a situation where tariffs have a significant enough knock-on effect and real growth is impacted in a sustainable way, it’s a prescription for them to [follow a] shallower path for the funds rate,” said Jacob Oubina, senior U.S. economist at RBC Capital Markets. As things stand, the Fed has indicated that it plans to hike the benchmark funds rate twice more this year, with the market pricing in moves in September and December. In addition, officials have indicated that three more hikes could be coming in 2019. “If the U.S. dollar is going to keep going up, I think the Fed will have to stop raising rates,” said Jim Paulsen, chief investment strategist at the Leuthold Group. “I also wonder if we’re getting close to two things that might force Trump’s hand a bit to water this down. One is the midterms are coming up and [the trade war is] going to become a bigger and bigger issue for Trump, even from his own party.” And if the economy starts to slow down, particularly the housing data, and that broadens out, I think that will bring a lot of pressure to bear on this trade war strategy” he added.

 

Just a few months ago, optimism was order of the day among Chinese technology investors. Beijing was going to welcome home U.S.-traded Chinese tech stars by allowing them to dual-list on mainland exchanges, while Hong Kong opened its arms to the hottest unicorns by removing requirements that companies have a track record of profits before going to initial public offerings. How things have changed. Even before a Bloomberg News report Wednesday of a government shake-up of game licenses sent tech stocks sliding, China’s tech companies have been throwing out nasty curve-balls. That suggests it’s worth asking whether the country’s tech entrepreneurs are as good at running their businesses as they like to boast. An ETF which tracks U.S. and Hong Kong-listed Chinese tech firms is down 17 percent since its late July high. According to the latest fund manager survey by Bank of America Inc.’s Merrill Lynch unit, tech stocks such as Baidu Inc., Alibaba Group Holding Ltd., and Tencent, and their U.S. counterparts, remain the most crowded trades for the seventh straight month, suggesting there’s a way to go before we hit bottom. Tencent alone has shed market cap similar in scale to the total market cap of Netflix…

 

On the other side of our globe, in the Western hemisphere, it was pay day on the 15th for $1.125 billion of Venezuelan sovereign bonds. But no one is expecting to get any money. After all, the bond in question is already in default due to a missed interest payment back in February. Why would Nicolas Maduro’s government fork out hundreds of millions of dollars it can’t afford to part with when the nation and its flagship oil company are already about $5 billion in the hole with creditors? The one new thing about this missed payment is that it will mark the first default on government bond principal, rather than solely on interest. The notes are already trading at just 28 cents on the dollar, indicating the low level of hope among investors. Elsewhere in Latin America, Argentina took emergency steps to stabilize its currency in the wake of an emerging-market rout caused by Turkey’s crisis, jacking up its already highest-in-the-world interest rate by 5 percentage points and announcing it will sell $500 million to support the peso. Policy makers set the rate for seven-day notes at a record 45% and pledged to keep it at that level at least until October. The Peso has taken a 30% hit this year. It isn’t good in the periphery…

 

Beside gold, which hasn’t behaved as many owners expected, the self-touted insurance products against such geopolitical events i.e. Bitcoin and its Crypto-brethren have not fared much better. The latest digital coin rout came following bitcoin’s rally above $8,000 last month. News of institutional interest in the space by the likes of asset management giant BlackRock, as well as a collaboration between New York Stock Exchange owner Intercontinental Exchange, Starbucks, and Microsoft on a digital asset platform, had lifted market sentiment. However, Bitcoin traded as low as 5,900 on Tuesday.

 

On the other hand, a Labour Department report showed last Friday that the core measure of the Consumer Price Index, which excludes food and fuel, rose 2.4% from a year earlier, the biggest advance since September 2008. On the prior month, both the main CPI index and core rate rose 0.2% – matching expectations. The overall CPI gauge rose 2.9% in the 12 months through July, matching the survey median, the report showed. Core CPI was projected to advance 2.3% on an annual basis.

 

Is inflation back? Maybe, but it sure looks like the bond market doesn’t think so: ten-year treasuries are trading merrily at 2.86%… Stable, as is the Dollar Index at 96.22. Oil has drifted downwards to 65.70 or so and the Fear Index, the VIX is up somewhat to 13.10, still an amazingly low level. We are eagerly waiting the return of all the bigwigs, so we may well see new consensus market levels.

 

A closing thought this week: to explain taxes to your children, take a 30% bite out of their ice-cream…

 

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