The Fed, the ECB, the UK: Foregone Confusion

Mid Week Bond Update

The Fed, the ECB, the UK: Foregone Confusion

Few doubted that the FOMC would raise its Fed Funds target rate to 2.0% on June 13th, or that the ECB would remain resolutely vague about the timing of its next hike and the wind-down of its bond-buying program in its monthly press conference on June 14th. For Brexit, the only certainty is...


...continued uncertainty, as Prime Minister May’s support in the Cabinet continues to weaken and the multiparty conflict about the Ireland/Northern Ireland border remains unresolved.

There’s still scope for further surprise. The Powell Fed could still misread the current temperature of the U.S. economy, or miscommunicate its willingness to make accommodations for the challenges the rising dollar is posing for EM economies like Brazil, Argentina, India, Turkey and South Africa. And ECB President Mario Draghi could inadvertently fill the upcoming summer break with uncertainty about the central bank’s intentions come autumn.

But one source of speculation appears to have been removed by the new Italian Finance Minister Giovanni Tria, who stated in an on-the-record interview that the “position of the government is clear and unanimous…there is no question of leaving the euro”. EU Budget Commissioner Guenther Oettinger said the statements were “far-sighted and create confidence.”


On the Rise: The Dollar vs. EM Currencies

There was no pullback for the greenback this past week, making the plight of EM central banks even more challenging. As EM currencies fall in value relative to the US dollar, EM government and corporate bonds – many of which are payable in U.S. dollars rather than local currencies -- exert a sizeable drain on foreign currency reserves and encouraging said banks to raise their base rates to stem the flow.

But EM currencies don’t trade in lockstep. The Brazilian real bounced back as the crippling truckers’ strike wound down, allowing the country to resume its lifeline exports of sugar to the rest of the world. But Brazil’s dollar challenge is far from over.  Even after the bounce, the real is down 10.75% year to date, which is good news only in comparison to the Turkish lira (‑18.11%) and the Argentine peso (‑27.48%) over the same period.

As for the U.S., the rising dollar has been accompanied by the CBOE VIX Index  returning to its tranquil 13-15 range while the Citi Economic Surprise Index[1] for the European Union has plummeted to -100 in 2018 so far – prompting some to suggest that in 2018 the most important U.S. export is volatility.




Emerging Market Currencies vs. U.S.  Dollar, 6/6/18 - 6/13/18

Source: Bloomberg, June 13, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

On the Slide: The power of Argentina’s Central Bank

The International Monetary Fund provided a $50 billion standby credit facility to Argentina, its biggest ever guarantee of that type. At the time, it seemed that the deal was a reward to the central bank for having taken a successful stand against capital outflows at 25 pesos per dollar. But the guarantee may have been seen by currency traders as a revenue opportunity rather than a warning shot; June 8th saw the peso break down below the 25-per-dollar level.

Argentina doesn’t have the world’s best track record when it comes to surviving this sort of trading onslaught; Argentina’s currency broke through previous record lows in 2002, 2014 and 2015.

 

Argentine Peso per U.S. Dollar, 5/7/2018 - 6/11/2018

Source: Bloomberg, June 13, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

 


1 The Citi Economic Surprise Indices measure data surprises relative to market expectations. A positive reading means that data releases have been stronger than expected and a negative reading  means that data releases have been worse than expected.

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