Blondemoney has been agonising for days, worrying about what forecasts to carve out on the blog-stone. The joy and tragedy of a public forum such as this is that it’s all there, all in print, for all time, for all to see. Sure, there have been some past positive pronouncements; but also there are those that may have led you astray. And we don’t want you led astray. Blondemoney wants you full of insight, bursting to brimming point with good information. In the end, the year ahead comes down to these three points:
1. Forget the monetary policy divergence obsession
Everywhere you look, there is still a debate over how many hikes the Fed might deliver this year; over how the ECB and the BOJ remain the uber-funders, what with negative rates and all. That’s fine, if it wasn’t for the glaringly obvious point that a) monetary policy has reached its limits and b) inflation is back. A)+B) means all rates are going up, everywhere. The ECB and BOJ are preparing to taper. They’re holding their hands up and admitting defeat. The BOJ’s “Yield Curve Control” might as well be called “You Take Control”. Sure, some might go up more than others, due to economic growth prospects etc, but the divergence is not what it once was…. In fact, the world isn’t even that divergent. HSBC have moved their Global growth and inflation forecasts higher for the first time in 5 years. Manufacturing PMIs are going up everywhere:
Yesterday, as the surge in US yields was alleged to have pushed the US Dollar higher, note that UK and German yields rose step for step alongside it:
Divergence is not what it was.
2. Watch the VIX
However, the monetary policy divergence obsession holds if volatility remains low, because then Carry is King. Effectively the entire world has been involved in a carry trade ever since the central banks mandated us all to take that trade. Restoring animal spirits after the Lehman bust meant that they wanted us to go out there and find risk, buy it, hug it, hold it close and tell it we would never leave it. Last year Warren Buffett made $32m each day. Now, Warren is a proven investor, and Blondemoney has no beef with the old chap. But 32 million actual dollars income a day is as sure a sign as any that a rising tide lifts all boats. By September of last year, “lower-for-longer” had metamorphosed into “lower-forever”. We have only just begun to see this unravel. It’s not even really started, because volatilities have remained subdued. Bond vol is up, but it hasn’t contaminated other asset classes. One of the assets that fell the most last year was the VIX:
Selling vol has been the trade for years – not least because it’s now the hedge of choice to own over any volatile event. Which means that as soon as the event risk materialises, you want to dump that insurance ASAP, if the world doesn’t end. The #FOMO of last year meant the insurance was worthless almost instantly. The open interest in the VIX has exploded since the financial crisis, as everyone tries to use it as a hedge, and also to sell it as part of the carry trade:
In other words, it is the core of the carry trade. It is the proverbial canary in the coalmine. Once this blows up, everyone will realise the monetary policy divergence obsession is over. But what, pray tell, could cause it to spike?
3. Political Risk should be your only focus
Ah yes, Tweeter-In-Chief, Donald Trump. Yesterday he tweeted twice and got two almost instantaneous results: Ford scrapped its Mexico factory, Republicans drop their plan to scrap the Ethics Cttee. Meanwhile Marine Le Pen launches her Presidential bid by promising a referendum on France’s relationship with the EU within 6 months of her taking office, and argues France could ditch the Euro for the ECU. Now, note that these are more nuanced positions than just “Quit the EU and Quit the Euro” – all the more likely to help her win over voters who are nervous of too big of a change. Or who agree with her immigration views, but not on leaving the EU completely.
Forget monetary policy. Think instead about this possible scenario:
* Le Pen questions the very framework of the European Union, charges ahead in the polls, wins the Presidency and then the Euro falls as much as GBP did after the Brexit vote
* Meanwhile Donald Trump slaps tariffs on anyone who gets in his way, everyone brings foreign money home, and Donald’s Treasury declares a “Let’s Make the US Dollar Great Again” policy
Unlikely? Maybe. Impossible? No. EUR/USD sliding to 0.8000 should surely be on everyone’s agenda this year as a possible scenario. And that’s not because the ECB mess about with moving to -0.50% interest rates as the Fed anaemically hikes 3 times. Stop watching the data. It’s going to be all about who is making what political pronouncement; when; why; and how likely it is to come to pass.
Blondemoney at your service….