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.

Top

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Important Information

 

All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. 

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.  Unless otherwise noted the “$” (dollar sign) represents U.S. Dollars.

This material is only for distribution in those countries and to those recipients listed.

All investors and eligible counterparties in Europe, the UK, Switzerland:

In Europe (excluding UK & Switzerland) this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office 6th Floor, Building Three, Number One Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4, D04 EP27, Ireland. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

In the UK this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London, EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorised and regulated by the UK Financial Conduct Authority.

In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH, authorised by the Swiss Financial Market Supervisory Authority FINMA.

Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information Documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People’s Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia:

This material is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827) (“Legg Mason”). The contents are proprietary and confidential and intended solely for the use of Legg Mason and the clients or prospective clients to whom it has been delivered. It is not to be reproduced or distributed to any other person except to the client’s professional advisers.