Global Investor debate
There are three key features of today's market, Simmonds said. First, the liquidity-drenched happy days are over. With liquidity constraints, currencies with high external funding requirements are more volatile. "If you haven't saved well or acted prudently then at some point you will suffer."
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The panel discuss the macro picture. From left, Paul Bednarczyk,
Luca Bindelli, David Simmonds, Simon Derrick and Rich Mahoney |
Secondly, many participants believe a high Consumer Price Index is good, where in fact it is potentially very bad. And finally, players are dealing in world of positive output gaps.
"Emerging markets are no longer exporting disinflation, they are exporting inflation, and grappling with their own inflation problems." Investors need to focus not on rate spread, but real rates and what the currency response to inflation is.
Derrick backed Simmonds' sombre outlook, agreeing that inflation is going to be a major factor. Six years of very low interest rates across currencies like the Yen is ending, and investors are fleeing. The emergence of real inflation is exacerbating this so it seems unlikely there will be the rate hikes needed to deal with the problems.
The panel was then joined by Luca Bindelli, before Chair Paul Bednarczyk invited questions from the floor.
Audience member: David, I like your opening bias of selling deficit and high inflation countries. But how do you tackle Asian currencies with high inflation and little funding: they're net creditors.
David Simmonds: Both in Asia and more widely, currencies of countries with flexibility to respond more actively to inflation threat will be bought, and those that don't have this flexibility - or don't chose to use it - will be sold. In Asia, Singapore or - more debatably - Korea has that perceived flexibility.
Audience member: I'm interested in real valuation interest rates, but how do you measure these for a currency like Sterling: do you decide is it high because you have a high CPI (Consumer Price Index) or is it low because you have a low RPI (Retail Price Index)?
Simon Derrick: It's not just about the willingness of the central bank to act. It's also about their ability to do so. Thus the Bank of England is caught in the worst of all worlds. Irrespective of its desire to control inflation, it can't act aggressively to fight it because of its concerns about the broader economy. It is caught by circumstances: there is no fiscal tool to take up the slack.
Luca Bindelli: I agree, the Bank of England is borrowing heavily on its credibility at the moment with inflation being a long way from its target.
Audience member: So what is the trade in this market?
SimonDerrick: I'm still a euro bull so would go Euro Sterling. I feel there's still space for the Euro to make that final surge.
LucaBindelli: if you believe that volatility will stay elevated, as I do, then there's room for risk aversion trades such as the Swiss.
David Simmonds: Immediately I would say long euro sterling; short sterling yen. That means long Euro sterling for the next week or few, but beyond that, Sterling Swiss or short Sterling Yen. Then looking towards the end of 2009 – a cop out, I grant - short cable is the trade as Sterling Dollar will go lower.
David Simmonds then asked Rich Mahoney to comment on Fed Chairman Ben Bernanke's recent remarks on the US dollar. This, Simmonds suggested, was of special interest both because Bernanke's comments represented a different position to that expressed by the Fed up to now, but also because it was Bernanke and not the Treasury who had commented.
Rich Mahoney: I don't disagree with you David. Typically the Fed does not comment on the dollar, deferring instead to the US Treasury secretary. I agree with what all three of you have said. The large central banks are paralysed by severe economic headwinds and commodity-driven price pressures. The Fed made those comments because they wanted the yield curve to steepen without tightening. The fact is the US recovery will be L-shaped and not V-shaped. US economic activity will stay slow for three to four quarters and we're midway through the housing and credit crises. It's very difficult for the Fed to tighten in that environment, but what they can do is talk about their concern and steepen the yield curve. The truth is there are limitations to what central bankers can do since monetary policy is a broadly blunt instrument. Also when I referred to the risk of policy independence in my opening address, I was referring to the fact that we have fairly lame-duck governments in the G7 countries, so we won't see much leadership on the fiscal side.
The truth is there are limitations to what central bankers can do since monetary policy is a broadly blunt instrument.
Luca Bindelli: I agree with Mahoney. And don't forget we're in an election year. The new President will not favour too much tightening.
Simon Derrick: The fact that we saw Mr Bernanke speaking shows US changed currency policy from benign neglect. In the last two months I point to the G7 changing the currency communiqué; it's clear in Paulson use of the word intervention. But will it make any difference. Moreover after six years of ignoring pleas from the Eurozone, China and Japan to do something about the declining dollar, would there be support from other finance industries. I doubt it.
Paul Bednarczyk: I was surprised that no one reminded him of his last comment back in February, when he said that the weak dollar was having a positive effect on the current account deficit and that was a positive development. Can we just finish on the question of sovereign wealth funds (SWFs): are they good or bad for FX markets?
Luca Bindelli: They provide the potential for market stabilisation. They're publicly owned meaning they're accountable to their shareholders (the citizens), and have longer investment horizons. In terms of the emerging market SWFs, these markets have been much less subject to the financial crisis - in large part due to their build up in FX reserves – another argument for their stabilising effect. The final point concerns oil, and the fact that some of these SWFs are just commodity funds. Because the risk of oil in the ground is roughly six times the risk of extracted oil I think we should think, again, about SWF being a stabilising force here. However, SWFs do face strong pressure to invest domestically. Now this may be de stabilising in so far that there is political uncertainty there.