Colin Lloyd – featured on Linear Talk
Colin Lloyd is the author of macroeconomic investment letter service ‘In the Long Run‘. Serving as Linear Talk’s co-presenter along with Linear’s Chairman, Jerry Lees, Colin regularly reviews the markets, hedge fund performance, and prevalent macro events in his macro roundup.
August is generally a quiet month for financial markets and this year was no exception. The S&P 500 Index made new all-time highs at 2191 on 23rd but the ascent was grindingly slight. The US$ Index held on to recent gains but it appears that some of the initial safe haven post-Brexit flows have reversed. The Eurostoxx Index was dragged higher (3063 – 15th) on the US market’s coat tails but has yet to shake off Brexit.
EURUSD hit a post-Brexit high of 1.1367 on 18th but the markets are beginning to focus on the next ECB meeting on 8th September. Governor Draghi has remained silent for more than five weeks – he didn’t even attend the Federal Reserve meeting at Jackson Hole – as a result of this sententiousness, economic data has assumed greater importance. The data, as always, has been mixed. Eurozone (EZ) lending data was stronger, with household lending up 1.8% and, more encouragingly, lending to businesses was up 1.9% – a five year high. Defying expectations of a post-Brexit decline, the EZ PMI was also stronger in August whilst Eurostat reported a marginal uptick in inflation to +0.2% y/y – still well below the 2% ECB target but encouraging nonetheless. However, EZ M3 weakened to 4.8% from 5% and, despite German corporate profits for Q2 coming in 10% above estimate, the IFO Index hit a four month low reflecting expectations, among German business leaders, that Brexit would, take its toll. French and Italian data suggests that GDP growth stalled in Q2 whilst Spain, despite stronger growth, is focussed on a confidence vote today.
GBPUSD was range-bound in the post-Brexit environment but EURGBP made new highs at 0.8727 on 16th – putting this in perspective, this is only back at the level it was trading in July and August of 2013. The 4th August, Bank of England (BoE) rate cut and additional measures, including an expansion of their Asset Purchase Programme to allow the acquisition of up to £10bln of Corporate Investment Grade bonds, made little impact on the value of Sterling, but the corporate bond market has reacted positively. Vodafone, who had issued a 33yr maturity bond at the end of July with a yield of 3.4%, returned to the market, within 24 hours of the BoE Asset Purchase announcement, with a 40yr issue which priced at 3%. Including Investment Grade bonds alongside their Gilt purchases marks a further move towards “qualitative” in addition to “quantitative” easing by the BoE.
With a capitalisation of £285bln the UK Investment Grade bond market is relatively small, so the impact of the BoE decision is more pronounced. Euro denominated bonds total Eur1.5trln whilst the US$ market is nearly $4.5trln. I mention this because the most discussed paper at this year’s Kansas City Federal Reserve symposium in Jackson Hole was entitled “The Federal Reserve Balance Sheet as a Financial Stability Tool”. Among other things the paper, written by three Harvard Professors, one of whom is ex-Fed Board member Jeremy Stein, argues that the Fed should maintain its balance sheet at around $4.5trln but that it “should use its balance sheet to lean against private-sector maturity transformation.” In layman’s terms this is a “call to arms” encouraging the Fed to seek approval from the US government to allow the purchase a much wider range of corporate securities. It would appear that the limits of central bank omnipotence have yet to be reached.
The other news coming from Jackson Hole was rather more hawkish. Board Governor Yellen suggested the chance of rate increases was getting stronger. Her task is not made easy by the conflicting range of economic data. The labour market remains strong and consumer spending is
rising. The Conference Board Leading Index came in at +0.4 in July versus a forecast of +0.3. However, the Q2 GDP revision was downward, services PMI came in at a six month low and manufacturing PMI was also weaker at 52.1 versus 52.9 in July. The bond market had already begun to anticipate the Fed rhetoric, US 10yr yields backing up slightly, from 1.46% to 1.61%, during the month.
Japan has been an interesting portfolio diversifier over the summer months. JPY has remained strong despite increased QQE from the Bank of Japan (BoJ) and the largest fiscal stimulus package ever from the re-elected Abe government. BoJ Governor Kuroda, who unlike Draghi attended the Jackson Hole symposium, said there was “ample space for more stimulus”. The BoJ meet on 20th September to discuss an extensive internal review of the effectiveness of their monetary policies to date. In the interim, 10yr JGBs have been range-bound between zero and -020%, but well above the pre-stimulus range – consistent with the market’s increasingly held view that NIRP is no longer a viable solution to Japan’s dismal economic growth. The Nikkei has performed well, considering the persistent strength of the JPY, trading around 16,700. This is well below the “double top” of June and August 2015 around 20,950, but the price action has been constructive.
Gold and Silver, strong performers during the early summer, gave back some of their gains this month. Expectations of an imminent US rate hike are thought to be the reason for the setback but the magnitude of the rally, especially in Silver (now at $18.50, off a July high of $21.20 and a May low of $15.83) combined with the typically thin trading conditions associated with August, may be as good a reason for the pullback as anticipation of Fed action.
Oil, by contrast with the precious metals complex, rallied sharply after breaking $40 to the downside on 3rd August. By 19th it had reached $48.75 amid rumours of a deal to limit supply by Russia and Saudi Arabia. As we headed into the month end, however, the rally was tempered by renewed expectation of Iranian export increases and the lack of any deal from Russia and Saudi Arabia.
Copper ($2.09) finished the summer near the bottom of its recent price range. Chinese growth is still anaemic and USDCNH tested recent highs around 6.69 as the PBoC added liquidity to the domestic money market via a series of reverse repos. This action, ahead of the, Chinese hosted, G20 summit on the 4th September, may be cause for concern from industrial metals in general. With more stimulus anticipated from the ECB and BoJ, the PBoC will not wish to be left out in the game of competitive debasment.
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