Markets at a pivotal point
Abraham George Macro Musings
The central banks have lost the plot. I can count the many flip-flops the major central banks have made in the last year. What I can assure you is as long as the central banks are in power and are in business they will come out with many creative ideas that you and I would have never thought of. Never underestimate the ingenuity of the central banks in saving the global financial system.
All of a sudden there is a discussion in the US administration for the treasury to buy bonds. So far it is only a fact-finding exercise and on Monday the treasury is likely to have some meetings with the banks that are primary dealers of the US treasuries. Mind you it is always the Fed that buys and sells bonds and not the treasury. So if the treasury is buying back bonds to improve liquidity it is a new phenomenon. At least they have the excuse to not call it a QE. Last week Treasury Secretary Janet Yellen announced that there was no liquidity issue in the markets but the very next day she started getting worried about the liquidity.
Why are we in this situation? We should not forget for more than 30 years interest rates were artificially kept low. No doubt outsourcing to China and massive innovations in technology contributed to a worldwide deflationary environment. At some stage that had to reverse but the expectation was that it will be a gradual reversal but it was not to be. The war in Europe, the supply chain issues due to the lockdown, and particularly China taking a hardline on COVID and shutting itself down has complicated things for all policymakers.
The speed at which the interest rates have been raised has created a mess. This is not my opinion. This is what the UN and IMF have warned the US as they are more responsible for the global economy than the US who are more focused on their domestic situation.
The way the dollar has risen has complicated issues for every other country other than the US. If it was not for the dollar rising the US inflation would have been even much higher.
Firstly almost 95 pct of the commodities are priced in dollars and this has put tremendous pressure on all non-dollarized economies. Secondly, the emerging markets’ foreign debts have risen sharply as their currencies have all weakened against the dollar. The biggest issue is the oil is priced in US dollars. It is one thing to pay for higher energy prices but what do you do if your currency is equally weakening against the dollar? It is a double whammy.
Voices challenging the American hegemony in the reserve currency status are already underway. If the USD has attained a pole position as the major reserve currency it is only because of the use of the petrodollars. In 1971 on Aug 15 when President Nixon decided to abandon the dollar peg to gold, his Secretary of State, Henry Kissinger brokered a deal with Saudi Arabia that the US will buy their oil and it will be priced in US dollars. In return, Saudi Arabia will invest those dollars in US treasuries and the US will provide full protection to SA from any foreign invasion. So far so good but now cracks have started to emerge in this relationship that has existed for many decades.
Lately, the Saudis have shown their displeasure with many of the US policies and demands. They have been also very vocal about it. To top it up the Saudis have shown an interest to join the BRICS (Brazil, Russia, India, China, and South Africa) group of countries. The BRICS make up 40% of the world's population. If Saudi Arabia and some other countries also join BRICS what will happen to the petrodollar? Will oil start to be priced differently? If so we will see a top in the dollar in the not-too-distant future. What about Russia being kicked out of the SWIFT system? It looked like Russia was almost anticipating that the west will use SWIFT and the dollar as a weapon against them. Russia was already ready with its SPFS (System for Transfer of Financial Messages) as an alternative to SWIFT.
What is all this pointing out is we are closer to a new financial system or what we can label as a Bretton Woods 2.0 sooner than ever before. The world is moving from a centralized system to a decentralized system in most parts of our activities. Matters relating to money will not be an exception. The new developments in technology are all pointing to a switch, a reset, or a new world order in the usage of money. So much for geopolitics and the future of money. Let’s take stock of the current markets.
A fourteen-year period of quantitative easing and zero interest rate policy had created a false sense of security in the financial world. The stress that is being forced on the financial system with the steep rising of interest rates in the US cannot be tolerated by the rest of the world. We saw the cracks first in Europe when US 10-year yields were hitting about 3.30%. The ECB was forced to intervene to avert a sovereign debt crisis.
Then it was the UK bond market. The Bank of England had to intervene to avert a financial meltdown. The US yield traded up to 4% when the UK bond crisis came to the open. Sadly the prime minister had to leave the office within 45 days of taking office as the blame was solely on the new UK tax cut plan.
On Friday it was the turn of the Bank of Japan. They had it enough. After a decline of more than 30% for the year against the dollar the BOJ decided to defend its currency very aggressively.
This surely has changed the mood of the markets. Meanwhile, US ten-year yields traded up to 4.34%. The intervention surely has helped the stocks and commodities to be higher while yields and the dollar traded lower.
One thing I can tell you with much confidence is that BOJ on its own will not be able to change the tide and defend the Yen. At the same time, I am expecting something significant in policy change from the US authorities and that will be a game changer that should change the present status of the markets.
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Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and multi-billion dollar portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office, and a hedge fund.