Tags: federal reserve | greece | europe | carry trade

Never Accept Numbers at Face Value

Monday, 30 March 2015 07:59 AM Current | Bio | Archive

Federal Reserve Chairman Janet Yellen has confirmed “prudence” will remain the name of the game at the U.S. central bank for an extended time to come.

Anyway, a few lines that tell us something: “… I anticipate that real gross domestic product is likely to expand somewhat faster than its potential in coming quarters, thereby promoting further gains in employment and declines in the unemployment rate … I expect that conditions may warrant an increase in the federal funds rate target sometime this year … we must be reasonably confident at the time of the first rate increase that inflation will move up over time to our 2 percent objective, and that such an action will not impede continued solid growth in employment and output … I would expect the level of the federal funds rate to be normalized only gradually…”

Mrs. Yellen refrained from giving the Fed's opinion on the strength of the dollar, notwithstanding she touched the subject "prudently": “… recent appreciation of the dollar is likely to weigh on U.S. exports over time…”

Goldman Sachs was more straightforward in a note to its clients: “… we continue to expect the euro to weaken vs. the dollar over the coming quarters, due to both U.S. cyclical strength and continued QE-driven portfolio rebalancing outflows from the euro area…,” because monetary policies of the Fed and the ECB should continue to diverge further in the foreseeable future.

But, not everybody agrees with Goldman’s view. And that's a good thing as debate is most of the time helpful!

Experts at HSBC seem to have a contrarian view as they wrote in a recent research paper: “… we believe the U.S. dollar rally is nearing its end. This is in contrast to a market which appears determined to envisage ever greater upside for the currency. The U.S. dollar has already rallied more than is typical historically, and many of the arguments currently being used to justify an extension are likely already in the price…”

As is always the case, one of the two will prove to be right.

Until then, it’s a fact so far in March, EPFR (Emerging Portfolio Fund Research), which provides to professionals fund flows and asset allocations (The global “assets” market stands at $24 trillion!) informed on Friday that eurozone equity funds saw almost $9 billion of dollar-denominated inflows, which was the strongest for any month since EPFR started in 1996, but which is still not a mind-boggling number.

Probably more importantly, EPFR also informed at the same occasion, according to Markit, which is a global, financial information and services company since 2003, flows into US-based but euro-exposed exchange (carry trade!) traded funds so far this quarter are already three times the previous quarterly record and that most of the inflows have been into currency-hedged ETFs.

Yes, sophisticated investors enjoy incredibly attractive forward pricing as they are effectively paid to borrow euros, but trades financed in such a way are not risk-free.

As a long-term investor I’d prefer to remain prudent and I’d certainly not become complacent and join those that pretend we are at some kind of a moment: “It’s now or never” for buying (speaking in general of course!) European equities without doing my homework on what businesses you’re really buying and if these companies generate enough dollar-based income to withstand any serious shock, which could be caused e.g. by a “Grexit,” which is still possible but markets haven’t priced in so far, or a geopolitical “black swan event,” which stands for a big surprise literally coming out of the blue that has major impacts and is often inappropriately rationalized after the fact with the benefit of hindsight.

Even if no surprising event happens, markets today, because of divergences, are structured in such a way we should expect volatile trading conditions for the euro to remain in place without setting a clear trend, which is important, until somewhere the beginning of the 4th quarter.

Please keep in mind, volatility as well as liquidity (but to a lesser extend) have never been friendly to carry trades.

As Milton Friedman said: “There’s no such thing as a free lunch.”

To put it simple, investors that don’t understand neither have experience with the risks carry trades imply could be safer off by staying away from it.

As always, never accept numbers at face value and always try to discover what's behind the numbers, which is not an easy task, believe me.

All that said, on Friday we’ll get the main scheduled event of the week, which are the U.S. employment situation numbers that will have real potential of moving U.S. markets, which includes the dollar, one way or another.

In the meantime, we’ll wait for what Fed Vice Chair Stanley Fischer tells us at the Atlanta Fed conference on monetary and financial stability.

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Fed Chair Janet Yellen gave her San Francisco speech "Normalizing Monetary Policy: Prospects and Perspectives" which unsurprisingly confirmed "prudence" will remain the name of the game at the Fed for an extended time to come.
federal reserve, greece, europe, carry trade
Monday, 30 March 2015 07:59 AM
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