Of Currency Markets and Central Banks

These are my views of where we are in markets right now:

  1. The Fed is more committed to the abstract notion of normalization than the market, still, in the aggregate, gives it credit for.
  2. We now know with very high likelihood that they want to start with the balance sheet reduction ASAP, and will, in the first instance, push hikes out further as need be to see how well it goes.
  3. Grinding global growth (by historical standards, not recent ones) is likely to continue as global demand continues to work its way out from under the Global Credit Boom. This means the ECB, BOJ, and BOE will be talking more, not less, about their own normalizations. And they too would love to normalize.
  4. Central banks normalization, New Normal-style global growth, and EM muddle-through is likely to be the dominant backdrop theme for the foreseeable future.

The implications of these beliefs:

  1. On balance, a weaker USD. The US shifting to the balance sheet from rates as the front-burner tool, and global CBs ‘catching up’ to the Fed are the major drivers. EUR, AUD, EM all good. The positioning/psychology in the USD doesn’t strike me as too extreme, so USD weakness doesn’t have to be dramatic.
  2. Bond yields should go higher in Europe and be flat-to-marginally higher in the US. The ECB catching up with the US should bring European yields up off the floor, but the Fed pushing out rate hike should take the pressure off fixed income sellers, who have been under a little bit of pressure of late. I don’t think, in the event, the tapering of Fed reinvestment will have a material impact of yield levels over the short-to-medium term.   Only longer-term, when the taper might be faster and the cumulative amounts greater, should we see any discernible impact.
  3. Weakish USD and weakish bonds put precious metals in a box. They tend to respond positively to the former and negatively to the latter. Of the two, they tend to be more responsive to bonds than the big dollar, but both matter.
  4. Central Bank normalization means they have won and the doomsday scenarios lost. Basically. This too drags on precious metals over time.
  5. Grinding global growth means ‘slower for longer’ in the equity market. Up over time with earnings, down with the occasional (and lately infrequent) corrections. Not sexy. But positive —more positive than prevailing market sentiment at least–and certainly not tragic.

Long-term chart of $EURXAU (long euro, short gold):

AUD over the past 5 years:

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