After the “flight to safety” panic of last year which saw investors flocking to government bonds among a dwindling choice of “save haven” investments, the mood appears to be turning nearly 180 degrees against government debt – as seen in the FT’s latest survey of leading asset managers and strategists, reported Tuesday.
Along with the steady thaw in credit markets and some new resilience in equity markets, there are many signs of a financial system heading out of intensive care, as Gavekal, the Hong Kong-based research and asset management group, notes in a client newsletter on Tuesday. All of which reinforces Gavekal’s view that “government bonds today are in fact the most dangerous asset class out there”.
Interestingly, most of the clients that we have met or chatted with in recent weeks seem to subscribe to the above views; but where there is widespread divergence of opinion is on the impact that the above will have on the currency markets.Indeed, looking at recent trends in currency markets and taking a brief (and weary) glance at the tide of research reports and investment newsletters to hit our desks since the new year, there seem to be as many views on the direction of forex trading and investing as there are currencies.
Gavekal has frequently referred to the currency game as an “ugly contest” whereby investors have to pick the “least worst” option. Now, as interest rates around the world converge to zero, and as governments unleash an unprecedented and unforeseen wave of spending in a bid to boost economic activity, there’s a sea of uglies jostling out there.
So which currencies will outperform in 2008? In Gavekal’s view, Asian (ex-Japan) currencies, with relatively healthy banking systems, limited debt problems, positive demographics and undervalued currencies should be the natural harbour for fundamentally-driven investors.
The problem hurdle, it correctly notes, is that Asian governments are unlikely to allow their currencies to rise substantially, “at least until the global economic picture improves, or domestic inflation becomes an issue”.
Commodity currencies, such as the Brazilian Real, Norwegian Krone, or Canadian dollar, offer characteristics akin to those in Asia and it is hard to imagine that, should our hopes on Asian currencies prove valid, the commodity currencies will not participate in the rally.
As for the US dollar:
While the fundamentals are undeniably wobbly (a Fed printing aggressively, a widening list of firms receiving government bailouts, growing government intervention in the economy…), valuations are by and large not demanding, and technically, the dollar is holding up remarkably in the face of tremendous bad news (terrible economic data points, Madoff scandal etc…).
And sterling:
It’s hard to get “too excited” amid what will likely be a prolonged financial sector recession. Still, the currency is now increasingly attractively valued and with a Bank of England which will most likely prove less dogmatic than the ECB, the UK has a chance of coming out of its current recession before Europe does.
As for the euro:
The important question of 2009 will be whether Milton Friedman’s prediction that the euro will not survive its first recession intact will turn out to be prophetic.After all, concludes Gavekal, spreads between Europe’s sovereigns continue to widen and political tensions between the various European governments are mounting.
Of course, there is an easy way out of the current predicament:
Germany needs to cut consumption taxes and go on a spending binge, facilitated by an aggressive easing of monetary policy from the ECB. Will this happen? Perhaps…but if it does, the euro is more likely to collapse than to surge. The euro now looks increasingly ugly: after retracing some -50% of its June to October loss in the last few weeks of 2008, it now seems to be retracing again. If the recent weakness continues, we would not be surprised to see the October lows taken out in short order.
Over at CMC Markets, meanwhile, chief forex analyst Ashraf Laidi notes the dollar’s recent gains across the board, disregarding the activity in global equities and risk appetite while dragging down gold by $30 from its $883 high.
The long-established market wisdom of “buying when the news is turning less bad” may not yet apply in the current environment as macroeconomic reports, business surveys and diffusion indices from service and manufacturing sectors remain mostly at 15-20 year lows in Europe, US and Canada. But the bullish side continues to gradually amass solid arguments including: (i) global stocks are up 20-20% from their November lows; (ii) fuel prices are down 50%-60% and crude oil is down 68% from the high; (iii) US long term mortgage rates are at record lows (down by 100 bps from Nov).
But these positive developments must not be confounded with renewed evidence of business and economic deterioration, he warns, “especially as the transmission mechanism from the credit crunch across the various consumption channels has yet to run its full course”.
Finally, on the best currency of all, a quick word from Marc (aka Dr Doom) Faber, in his recent client newsletter, who says:Let me be very clear. There is nothing positive about the US dollar, but the same can also be said of most other paper currencies. But along with a rebound in commodity prices, some commodity related currencies (Canadian, Australian dollar and Norwegian Kroner) could rebound while currencies of countries that are experiencing losses in their foreign exchange reserves or are likely to default could weaken further.
For the longer term, Faber’s favourite currency - you might guess - remains gold.
