Friday, 31st of August 2018
Last day of August and even the weather here seems to acknowledge the end of summer- cool and overcast. We can’t say we like this… Well, this is normal seasonality. In our world of economics and finance it doesn’t seem like a change of season, but we can detect several tropical storms developing… Some of these show signs of becoming full blown hurricanes. Well, this is the Atlantic Hurricane Season… We all have been watching the storm named Venezuela, then the one named Turkey, to which we just added the new one named Argentina.
The Turkish storm caused a collapse in the Lira, the Bolivar has disintegrated and now, the Peso. Investors are increasingly concerned Latin America’s third-largest economy could soon default as it struggles to repay heavy government borrowing. This comes after Argentina’s government unexpectedly asked for the early release of a $50 billion loan from the International Monetary Fund (IMF) on Wednesday. The Argentine peso crashed to record lows on the news. It saw steep losses in the previous session and collapsed another 15% to hit 39 pesos against the U.S. dollar on Thursday morning. The peso is down more than 53% against the greenback this year, exacerbating pre-existing fears over the country’s weakening economy while inflation is running at 25.4% this year. On Thursday, the central bank said it was increasing the amount of reserves that banks must hold, in a bid to tighten fiscal policy and shore up the currency. It hiked rates by 15% to 60% and promised not to lower them at least until December. A number of emerging market countries, including Argentina, Turkey and Brazil, are feeling the impact as tighter monetary policy from the U.S. Federal Reserve has boosted the dollar. Or has it? The Dollar which had finally started to edge up (as we have been harking it should for months now), suddenly took a dive back to levels of quite some time back- The DXY, the Dollar trade weighted index is at 94.50 as we write. It had been at 96.85 on August 15th, having rallied from a 91 level as the year started. Do recall that it was at 103 at the start of 2017!
This year the Argentine Peso has dropped over 53% against the US$, followed by the Turkish Lira down 44% or so, then Brazil’s Real down 20%, the South African Zar off 16% and the Russian Rouble at a close 15.6%- And these falls are against a softened US$. Quite strange all this… Gold is quiet, playing in its own sandbox in a narrow band around $1’200, down $100 for the year and $160 off its highs in April. The other ‘safe haven’ (self-proclaimed here) Bitcoin has been drifting in a band around $7’000.
What’s wrong with the dollar? Barely two weeks ago the Bloomberg Dollar Spot Index reached its highest since June 2017. President Donald Trump tied the strength to confidence in the U.S., boasting in a tweet on Aug. 16 that “money is pouring into our cherished DOLLAR like rarely before.” But since then the greenback dropped as much as 2.2%, reaching its lowest of the month on Tuesday before recovering to end the day slightly higher. At a time when the U.S. is embarking on a borrowing binge to pay for trillion-dollar federal budget deficits, any weakness in the currency should concern the government. After all, foreigners might have second thoughts about lending money to the U.S. if they expect the dollar to depreciate. That could cause borrowing costs to rise regardless of whether the Federal Reserve raises interest rates or not. Complicated… everything is complicated… There is the ongoing “Trade Wars” between the US and China, US and NAFTA, US and Europe and yet, the US stock indices are at all-time highs (less a smidgen). Nicholas Colas, co-founder of Data Trek Research, said in a note the recent breakout is “a function of a baseline assumption (further corporate earnings growth and low rates) and a fresh input (a US Mexico trade deal means other trade/tariff negotiations are also likely)”. He also said that “Trade has been the biggest overhang on US stocks, so the latter point has some runway to shove large caps even higher in the near term”. On Monday, the U.S. and Mexico announced that they came to an agreement that would replace NAFTA, an accord that currently includes both countries and Canada. And today is Friday and it is the deadline for the Canada/US agreement… We expect that something “absolutely and amazingly wonderful” will be agreed by close of business today. If it indeed happens, the markets will like it and rise some way further. It is all so confusing…
Here is another confusion to add to your general concerns; steel prices have diverged from China’s falling stock market, indicating the world’s second-largest economy is more resilient than many fears. Stock investors have worried about slowing economic growth as Beijing tries to reduce its reliance on debt, especially in the face of rising trade tensions with the United States. Steel prices, on the other hand, are what actually reflect the current state of the economy, while stocks represent market sentiment on the growth outlook, said Larry Hu, head of greater China economics at Macquarie. China’s Nanhua rebar steel futures index is up 22% this year, versus the Shanghai composite’s 16% decline. Despite China’s slow transition from being a manufacturing-driven economy toward one based on consumption, the steel industry is closely watched because it remains an important part of the overall economy. Hu said the stock market decline is probably a bit overdone and noted previous divergences in steel and Chinese stock prices occurred at a turning point in monetary policy toward easing that would help stocks. In any event, Hu said, there is little concern for stagflation — a run-up in prices with slowing growth, reminiscent of Japan. Earlier this week, data showed industrial profits slowed for a third straight month to 16.2% year-on-year growth in July, according to Reuters. What should we believe?
U.S. economic growth was a bit stronger than initially thought in the second quarter, notching its best performance in nearly four years, as businesses boosted spending on software and imports declined. Gross domestic product increased at a 4.2% annualized rate, the Commerce Department said on Wednesday in its second estimate of GDP growth for the April-June quarter. That was slightly up from the 4.1% pace of expansion it reported in July and was the fastest rate since the third quarter of 2014. The government reported on Tuesday that the goods trade deficit jumped 6.3% to $72.2 billion in July as a 6.7% plunge in food shipments weighed on exports. Does this little snippet of data help us understand what is going on with the US Dollar? Maybe. Here goes our explanation- As the US economy grows (GDP is up), consumer spending rises (70% of the GDP is the US consumer). As the US is a net importing economy, as it grows its GDP, the trade deficit grows. What does the trade deficit mean? The US buys goods overseas and to do so, must buy the currencies of the exporters, i.e., sell US Dollars. Clearly, some $72Billion of Dollar sales… Counter-intuitively then, if the US GDP will continue to expand ad a good clip, this might depress the US currency.
Maybe the answer to the Dollar weakness lies elsewhere- The United States is currently waging economic warfare against one tenth of the world’s countries with cumulative population of nearly 2 billion people and combined gross domestic product (GDP) of more than $15 trillion. These include Russia, Iran, Venezuela, Cuba, Sudan, Zimbabwe, Myanmar, the Democratic Republic of Congo, North Korea and others on which Washington has imposed sanctions over the years, but also countries like China, Pakistan and Turkey which are not under full sanctions but rather targets of other punitive economic measures. In addition, thousands of individuals from scores of countries are included in the Treasury Department’s list of Specially Designated Nationals who are effectively blocked from the U.S.-dominated global financial system. Many of those designated are either part of, or closely linked to, their countries’ leadership. From a U.S. perspective, each one of the economic entities is targeted for a good reason be it human rights violations, terrorism, crime, nuclear trade, corruption or in the case of China, unfair trade practices and intellectual property theft. But in recent months it seems that America’s unwavering commitment to fight all of the world’s scourges has brought all those governments and the wealthy individuals who support them to a critical mass, joining forces to create a parallel financial system which would be out of reach of America’s long arm. Should they succeed, the impact on America’s global posture would be transformational. Maybe our longstanding bullishness on the US$ ought to be revisited, carry or no carry…
“Experience is one thing you can’t get for nothing” Oscar Wilde
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