Central Banks show their cards, currencies on the move
Last Tuesday, Nov 2nd, of our last absolute return strategies expired reaching the return aimed on October 6th. This is a 4.2% annualized, or 0.35% in the month.
A month with great equity outperformance more than offsetting losses seen in September. The same goes for real state, and fixed income lost what was gained a month ago.
October has been a month marked by roaring energy prices, supply shocks, and inflation expectations as not seen in years.
We embark in new strategies targeting around 4% annualized return for the next few weeks, aiming to final full year return around the same figure.
The macroeconomic uncertainties are on the rise, and the response from different monetary policy makers starts to play its role on currencies.
The inflation debate is firmly on the table, and the two camps “more transitory versus less” is getting more attention as central banks show their views. Last FOMC statement on Nov 3rd considers the rise in inflation as “largely reflecting factors that are expected to be transitory” as opposed to the statement of September 22: “largely reflecting transitory factors”. The last economic data out of the U.S, weekly jobless claims falling to 19 months low, five straight weeks of falling data, the upside surprise in Q3 unit labour costs to 8,3% annualized (7% expected), the biggest increased since 2014 may challenge the Fed transitory view on inflation. With 10,4 million of jobs unfilled as per several reasons, the pressures on wages may add fuel to the inflation debate.
The BOE surprised the market last Thursday with no alteration on its monetary policy provoking a big fall on the Gbp against the Usd (-1.3%) and the euro (-0.90%). In its statement the BOE seemed firmly in the transitory camp, recognising that inflation may peak in April next year at 5% (materially higher than in the august report) before receding to 2% level or below in two years’ time. The argument lies on supply disruption to ease, global demand rebalances, and energy prices to stop rising…also on the fact that there is a lag between changes in monetary policies and their effects on inflation and therefore they focus on medium term prospects rather than on factors that are “likely to be transient”.
We find the market between a frigid bond market, and a torrid equity market. With 24% of world debt in negative nominal yields equities are still attractive by liquidity and hard to find alternatives (TINA- there is no alternative). Moreover, bond and equity correlations tend to increase in inflationary environments, and basic fixed income instruments are not anymore of any protection against a crash in equity markets, given the low yield they offer.
Construction of global portfolios will need to carefully address what is in front in coming years after this unprecedented crisis in both demand and supply sides. The new economy that will change the shape of the companies of the future, the massive cost and use of minerals in producing new alternatives sources of energy… along with other factors: lack of corporate balance sheet cleansing, ending the pandemic (a big step has been done in learning to live with it), maintaining the economy functioning around bottlenecks and ongoing changes in the labour market, fiscal policies by governments when rates begin to rise, and the elevated debt service that eliminates the current free lunch for governments. Last, but not least, the geopolitical tensions that are on the rise given the shortage of semiconductors producers, and the localization of those few (Taiwan).
It is no surprise that the demand for alternative solutions is on the rise and will find a bigger part in global portfolios as they are known and accessible for the wider investor base. A case matured and sophisticated investors are signalling for several years already.
The Usd index DYX moved in range in October, up versus JPY and EURO and down versus AUD, CHF, CAD, and SEK.
Central bankers start to move as the BoC stopped the QE, the RBA suspended its yield target, the SNB loosened its tight management of EURCHF, the ECB said PPP will end in March and the BOE hold the tightening expected provoking a large move down in the GBP. Only the BOJ has not yet signalled a near term change in its policy stance. Market expectations for interest rates increases in the forward market notable in AUD, NZD, CAD, and GBP followed by the USD, SEK, NOK, CHF and EUR and JPY with almost no expectations for increases in rates.
The EURO is supported by favourable balances, but lag the USD in interest rates expectations, business sentiment and technical levels.
Speculative long positions increased further but are yet not overextended. Still, forward hedging is still cheap generally below 1% per annum, making the case for higher interest markets as the US. Amongst EM, the TRY with a stunning 30% decline versus the USD and the BRL with more than 8%.
In the short term, implies volatilities in EURUSD are close to lowest levels since this year (1 month at 4.7%), and big expirations this week with strikes between over 1.15 and 1.16 would
act as magnets on the spot. Increasing demand for lower strikes protection at 1.15, 1.14 are seen in the market as risk reversals showing more expensive puts than calls note that there is
bigger care for a move down in the pair. Should 1.15 break, the path is opened towards 1.12, although the low volatility environment and lack of extreme positions may make this potential move to be slow.
We continue to check market evolution and analysing the changing drivers behind when designing our monthly absolute return strategies to capture alpha regardless of markets direction, and uncorrelated with the rest of asset classes.
Look for a range bound EURUSD and EURGBP pairs, and low range volatilities to persist, low gamma, and lack of strong positioning as we approach the end of the year and the final meeting of central banks due mid-December.