The rising dollar means all bets are off for Emerging Markets

Analysts were convinced that Emerging Markets would out-perform as the dollar and US interest rates continued to fall. But their New Year optimism has been disproved by events, as both have instead risen strongly.


Oil

Brent hit our “technical targets” during the week after the missile attacks in Saudi Arabia, but then fell back to close unchanged at $69.23/bbl.

✦  HIGHLIGHTS

  • The market is starting to focus on the Green Deals that will be finalised at COP26 in November
  • The Biden administration has abandoned Trump’s political support for fossil fuels
  • Instead, it will let the data drive decisions – and the data shows major emission cuts are now economic in the USA
  • Cuts of 50% from 1990 levels now appear realistic by 2030. As think tank RethinkX note, this means:
  • “A large and rapidly expanding global financial bubble now exists around conventional coal, gas, nuclear, and hydro-power energy assets.” 
  • “Few, if any, coal, gas, nuclear, or hydropower facilities will survive this transition without aggressive government intervention.”

WATCH FOR

A growing realisation that many traditional energy assets may well become worthless, and will have to be written off by energy companies..


S&P 500

The S&P rose to a new record at 3943, with the VIX volatility index lower at 21, as the rise in interest rates paused.

✦  HIGHLIGHTS

  • Investors went back into ‘business as usual’ mode, assuming that equities will always rise
  • High-profile tech names shared in the relief rally, prior to Friday’s sudden sharp rise in bond yields
  • But the Nasdaq bubble stocks will now be under pressure again from bond market moves
  • Asset managers have started to highlight the risks with passive investment via Exchange Traded Funds, as Bridgewater’s Bob Prince has warned:
  • “It has the look of a Ponzi scheme. Because if you can sell it on to someone else that’s fine, but what happens if you can’t?”

WATCH FOR

Rising bond yields to continue to undermine ‘bubble stocks’


Interest rates

Rates eased early to 1.50% on Thursday night, before suddenly jumping to 1.61% on Friday morning. Somebody in Asia needed cash in a hurry and was selling fast. Rates then closed higher at 1.63%, with the MOVE volatility index up at 71.

✦  HIGHLIGHTS

  • The US Treasury successfully issued $120bn of 3-yr/10-yr/30-yr bonds during the week
  • Wednesday’s $38bn auction of 10-yrs was well covered (2.38x), with good foreign interest (c20%)
  • The yield premium over € bonds attracted European buyers, underpinning demand in near-term
  • Friday’s yield-leap mirrored similar behaviour after February’s Treasury auctions and suggests there will be mounting pressure on bond prices
  • A tsunami of debt issuance will be required to support Biden’s spending plans (those approved + those yet to be announced)

WATCH FOR

Bond yields to continue pushing higher in reaction to the impending wall of debt issuance


US dollar index

The US$ is continuing to rally in line with higher interest rates, contrary to consensus expectations for both to fall.

✦  HIGHLIGHTS

  • A stronger dollar reduces global liquidity, pressuring financial markets, as we discussed earlier this month
  • The Dollar Index fell to 89 at New Year, with most forecasters expecting it to take a major dive as interest rates went negative
  • Instead, rates have pushed higher and the Index has rallied, closing at 91.7 on Friday
  • A higher dollar increases the cost of most major commodities for buyers using their local currency, as oil etc are normally priced in dollars
  • In turn, slowing commodity demand will pressure today’s high-flying Emerging Markets
  • It also makes foreign currency borrowing more expensive – a major issue for weaker borrowers who were attracted to lower dollar interest rates

WATCH FOR

Analysts to start “updating” their forecasts for Emerging Market growth as their core assumption is challenged.


Summary

Global markets are becoming more complex. Investors are having to revise core assumptions as result – just as the Federal Reserve is refocusing on supporting jobs rather than markets, in line with Biden’s priorities.

Oil

S&P 500

Interest rates

Market view today

Some concerns

Some concerns

Expecting inflation

Our current view

Negative

Reversion to mean inevitable

Expect long-term deflation

Positioning began

December 2020

December 2020

December 2020

Confidence level
Initial
Today

.

.

.

Relevant positioning

Waiting for reality to dawn

Waiting for reality to dawn

Expecting higher rates for the 10-year and longer-dated Treasuries

Confidence level: = 100%,  = 75%, = 50%, = 25%


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This Research Note has been prepared by New Normal Consulting GmbH for general circulation. The information contained in this Research Note may be retained. It has not been prepared for the benefit of any particular company or client and may not be relied upon by any company or client or other third party. New Normal Consulting GmbH do not give investment advice and are not regulated under the UK Financial Services Act. If, notwithstanding the foregoing, this Research Note is relied upon by any person, New Normal Consulting GmbH does not accept, and disclaims, all liability for loss and damage suffered as a result. The pH Report and pH Outlook are published by New Normal Consulting GmbH.
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