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April 5 2010
I can think of no more intellectually stimulating and (at times) profitable pastime than global macro investing, my profession and my love. The world of finance is all about the power of ideas. The broad American index (S&P 500) is no longer inexpensive at 1,160-1,180.
However, earnings estimates and market strength suggest higher prices are entirely reasonable, with a 1,300 year end target not unrealistic now that job creation has begun, making a mockery of double dip Cassandras. After all, the index is turbo charged by the megacap index colossi, IBM, Apple, Microsoft, GE and Walmart.
These are all in solid uptrends and account for the market’s resilience to Obama’s health care/budget deficits, Chinese monetary policy or the EU-IMF spending bailout package for Greece. Sure, trading volumes are below average and the VIX is far too low at 17 but that is only because so many volatility arbitrage hedge funds have been wiped out on Wall Street since 2008. Yet there are no shortage of macro demons that could derail the bull run of El Torro Supremo on the NYSE. The economy could have a double dip. The Bernanke Fed could make a major policy mistake (did not Uncle Ben assure us that house prices never fall, that subprime mortgages were contained in 2007?).
Fiscal woes or a US-China trade spat could trigger a spike in US Treasury long duration bond yields. With $3 trillion in money market funds, EPS upgrades to $80 on the index, US economic growth momentum, the highest corporate cash flows relative to capex and merger mania on Wall Street, “buy on dips” is the only credible strategy. The next correction in the S&P 500 could be 100-150 points. Yet this correction can and will be bought big time.
I have long argued in this column that the yen is the most overvalued G-7 currency on the planet. Yet as my favourite global macro strategist Dr Bluford Putnam (ex New York Fed, Chase Manhattan) assures me, even a monetarist Bank of Japan governor (a Chicago Ph.D no less) can ignore deflation risk any longer. Even Milton Friedman’s ideal inflation rate was 2 per cent, not 0 per cent. Japan’s economy is weakening at the same time as the American economy is strengthening. With fiscal repatriation over, the DPJ government crippled by political scandal. The breakout in dollar-yen above 90 is all too real. Mrs. Watanabe (Japanese margin FX speculators) and Japan Inc corporate exporters have both scented blood. A 100-104 target on the Japanese yen is my base case scenario, though periods of market panic attacks could lead to a stronger yen. Emerging markets’ currencies can have specific catalysts to move them higher in the next six months. The Singapore dollar can rise to 1.35 if the Chinese yuan revalues and the MAS incorporates an appreciation bias in its basket. The Mexican peso benefits from Chinese tightening and higher US growth.
The euro-yen cross is a buy at 124 for a 130-132 target. I would sell Aussie against the loonie (the Canadian dollar) at 0.93 for a 500 pip move. After all, the financial markets obsess about RBA rate hikes but what will happen to Aussie-Canada if the RBA pauses in Canberra but the BOC tightens in Ottowa? Sterling has crept up above 1.52 on cable but I still believe the Tories will win the general election and a hung parliament in Westminster is not credible.
The US Treasury yield curve is an accident waiting to happen, even though it has flattened from 295 basis points in February to 284 now. The Wall Street consensus is that the Fed will continue to remain dovish and the front end of Uncle Sam’s yield curve will remain benign. This is nonsense. The FOMC language of “extended periods” is conditional on economic softness — and 5.6 per cent GDP, a spike in non-farm payrolls, 57-58 on the ISM, a rise in consumer spending, 8-10 per cent growth rates in Chindia, $85 crude oil do not exactly spell a scenario of economic softness to me. Au contraire. The FOMC language will change in June. Reverse repos will become routine by July. The financial markets will resurrect the “bond vigilantes” until the Fed begins to hike interest rates in December. The 2 year Treasury note, the security most sensitive to even the slightest shift in the Fed’s monetary policy, could well surge to 2 per cent as hedge funds all scramble in unison to take off their yield curve steepening trades. This will only amplify the pain in the leveraged crapshoot that is the two-year US Treasury note, whose yield will spike amid a monetary bloodbath reminiscent of the bond massacre in 1994.
Japan’s 200 per cent public debt to GDP, a legacy of the Keynesian extravagances of successive LDP governments during the post bubble “lost decade” of the 1990’s, has not triggered an international crisis because 95 per cent of bidders at Japanese government bonds auctions hail from the Empire of the Rising Sun, the Honourable Dai-Nippon. Yet safe havens will unwind, the Nikkei drifts higher, JGB yields head higher to 1.60.
NYMEX crude oil futures have now touched $85 for the first time since October 2008. The Chinese PM, the US GDP/industrial production, the Japanese Tankan, the eurozone manufacturing indices all show global macroeconomic strength, a bullish metric for crude oil. While US oil inventories are huge and natural gas prices are sluggish, the success of Opec production cuts, the prospects of new sanctions against Iran and political risk in the Niger Delta all suggest higher crude oil prices. However, I am reluctant to chase crude oil higher as the fundamentals of the physical market are not at all stellar. Moreover, the Goldman and Reuters/CRB indices were both a disappointment in the first three months of 2010. In any case, with futures markets in contango, investors take a hit when they roll contract positions. I also believe that gold will be a classic short when the yield curve begins to flatten and three month Libor rises above 1 per cent, as it surely will in the next six months.
While Brazil has been a spectacular FX and equities winner for all of us who love Rio/samba/Iphamena Beach, I am nervous now that the BRL is at 1.76 and the Bovespa is above 7200. However, the departure of the Central Bank chief Henrique Meirelles, the heir to the Real Plan and the President Lula’s tenure coupled with tighter global liquidity and overvalued commodities (Vale/Petrobras dominate the Bovespa index) make me a seller of EWZ, though not a naked short.
The tsunami of emerging markets debt new issues flashes a macro SOS to me. With Third World sovereign borrowers selling $157 billion of bonds in the first three months of 2010, the most since the Asian debt horror show in 1999, it is obvious to me that there is no room for error in the JP Morgan EMBI Global Index, which trades at a rock bottom 6.22 per cent. Yet how long can emerging bond credit ignore the fiscal black holes and Central Bank tightening all over the world? What happens if the FOMC removes its “extended period” language in June and the leveraged chickens of Bondistan come home to roost? When Mexico can raise $1 billion in ten year money at 5 per cent or Poland raise €1.25 billion at 3.85 per cent, I get very very worried. Sure, sovereign default risk is the lowest in a decade. Putin’s Russia plans its first dollar eurobond sale since Yeltsin’s rouble devaluation in 1998. Can EM spreads compress even now? Yes. Yet the scrable to borrow also reflects the plain a unavoidable fact that the world’s smart money expects US Treasury bond yields to creep higher in the second half of 2010. After all, Uncle Sam yield curve is the planets alleged risk free cost of capital.
Risk free? Dream on.
Views expressed by the author are his own and do not reflect the newspaper’s policy.
Khaleej Times hold no responsibiity for views expressed here
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