Back to Basics

July 24, 2017

Back to Basics

Last week I tumbled down the rabbit hole of quantitative finance, so this week I thought that I would take stock on some of the main themes. In addition, I am going on holiday soon, which means that you will have to survive without my mishaps for a couple of weeks. The continued woes of the greenback are probably the main story for markets at the moment. It is driven by a number of factors as far as I can see. Firstly, economic data in the U.S—in particular core inflation—have remained underwhelming, which have forced markets to roll back on their expectations for Fed rate hikes. September, which was a done deal only a few months ago, has now become a long shot. Secondly, just as the Fed’s hiking cycle potentially has hit a snag, other central banks have stirred.

The Bank of Canada and Reserve Bank of Australia recently hiked rates, and in the Eurozone, Mr. Draghi’s attempts to talk EURUSD back into range last week failed. Markets have even speculated about a pre-emptive hike by the Bank of England to prevent a further slide in sterling, although the recent CPI data likely have put that particular genie back in the bottle. Bloomberg’s First Word strategists are not convinced; 

Yes, the “QE and low-rate party” has to come to an end at some point. And market participants are understandably worried about how they will be weaned off the current highly-liquid environment. With global inflation still looking anaemic, monetary tightening, if there’s any in the near-term, is likely to be at a very gradual pace


The Reserve Bank of New Zealand is unlikely to want to repeat the episode of 2014, when it raised rates only to end up cutting them again. Given second-quarter inflation came in below estimates this week, hawkish commentary doesn’t appear a viable option at its August meeting, particularly as it would in all likelihood send the kiwi higher


It’s even questionable how hawkish the Bank of Canada was last week. Yes, they raised rates and signaled that another one may be coming, but as always it appears it’s data dependent. Any disappointment there may see Stephen Poloz and his cohort singing a different tuneIf this keeps up, investors may very soon be watching the birth of a new breed of central bank bird: the “dovish hawk.”

That’s all well and good, but the end result of all this is that the headline DXY index is off almost 9% since the middle of December 2016. This is highly amusing given that the continuation of the dollar bull market was the strongest consensus trade at the start of the year. If we zoom out for a minute, though, the big picture hasn’t necessarily changed that much. The chart below shows that the DXY is still within the range established following the initial rise, in 2014, out of its post-crisis range. A break below 93 would force many to rethink their world views I imagine. We’re getting closer, but we’re not there yet. 


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