If there is a crowded trade out there, then it has to be short the US dollar. But before going any further, let’s remind ourselves that there are two parts to every currency pair and that the exchange rate reflects the relative value of the two currencies to each other.
The exchange rate, therefore, tells two stories at the same time. Thus, as euro/dollar hits the mid-US$1.17s, a 30-month high, one needs to look at the performance on both sides of the parity, assess the way the market is positioned and then decide if US$1.1733 is a buy or a sell.
Bloom in bonds
I happened upon an interview with David Bloom, HSBCs outspoken head of global forex strategy, in which he too appears to believe that the current dollar sell-off looks to be overdone and that the shorts are at risk of being swept up by a snapback in the greenback. Rather tellingly, he also added that forex markets are poor predictors of central bank policy and that if one wants a view in that direction, its best to follow bond markets, which he held up as being much smarter at reading central banks than even they are themselves.
According to Bloom even the Fed has got the Fed wrong. He seemed to be saying that all monetary authorities’ valiant attempts at forward guidance have achieved little other than to have confused themselves while bond markets have seen through them and generally ended up with a better track record of getting them right. Maybe it’s because the markets are playing for money and not for matchsticks where mistakes cannot be verbally reversed but unequivocally show up in the P&L.
Thus, despite all the hawkish talk from the likes of the Fed, the BoE and the ECB, bond prices reflect much less fear of tightening than the varied rhetoric emanating from the top would have one believe. Although it is my personal belief that the escape route of the low-to-no inflation environment ought to be higher interest rates, I have also argued that it is unlikely that monetary policy will go that way.
Contemporary thinking – and not only in the monetary policy space – is that whatever has to be done must, at all cost, be done without anybody getting hurt. We find ourselves, going on 10 years after the beginning of the financial crisis, with a financial system weighed down by eye-watering debt levels that were run up to avoid the developing meltdown in the aftermath of the sub-prime crisis. The financial system survived on the back of interest rates plummeting at the same rate that debt was rising, thus effectively maintaining public sector debt servicing costs.
The elephant in the room is what happens to public sector finances if the cost of interest payments – forget debt repayment – were to begin to rise meaningfully. That very question has been raised in this column before, along with the observation that it would take many years for, say, a 100bp parallel shift north in the entire yield curve to feed through the debt stock, and that the immediate impact of the fiscal equilibrium – or disequilibrium, if you prefer – would be negligible. But just as a seismic event somewhere under the ocean off Sumatra on December 28 2004 ended up killing an estimated total of 280,000 people, most whom were many thousands of miles away, so the fallout of tightening now will not blow up government finances for a number of years. Markets are not very good at doing “a number of years” but as good as they ever are, the bond market comes closer to being able to think beyond the end of its own nose it than does the forex market.
Bond markets are telling us that rates are going nowhere in a hurry and they may well be right. What Bloom thinks a weak dollar might be trying to express in monetary policy terms escapes me slightly, but I do agree with him on the rest. The central banks and their monetary policy are gridlocked and whatever they do they will have to do at the pace of an ageing snail with rheumatism.
Boxer shorts
I picked up Michael Lewis’s “The Big Short” again this weekend. I had bought it and read it when it first came out, recently saw the film and happened upon it again while tidying up some bookshelves last week. There is something about Lewis and his relationship with Wall Street that reminds of a child who has been grounded and then loudly declares that he or she never intended to go out anyhow, although that should not detract from the wonderfully fluent way in which he tells his story. The early pages – I read a bit of it on a plane yesterday –referred to Household Finance and the rather misguided purchase of the US’ largest sub-prime lender to HSBC. Thus HSBC, still my favourite bank, was one of the first to go headlong into sub-prime lending and, thanks to its extraordinary, inward focused culture, was one of the first to acknowledge its issues and to deal with them comprehensively.
In the depth of the crisis in late 2008 chairman Stephen Green announced that HSBC would stand by the liabilities of its wayward subsidiary and I took him at his word. A large block of Household euro paper turned up on the market that no one wanted to touch. I was able to convince one particular investor that reassuring words of an HSBC chairman meant something very different to similar expression by an American peer, and that this was as good as a guarantee. The investor bought the story, bought the paper and his faith paid him a very generous dividend. I must admit that my firm and I didn’t do too badly out of the deal either. It was this cast-iron belief that HSBC ultimately stood for something better that made the trade work.
Douglas Flint has taken Green’s HSBC, turned it on its head, and prepared it for its handover to his successor, the externally recruited Mark Tucker. I have one chum, an old China hand, who knows Tucker of old and who gives him a big thumbs-up. The bank Flint is passing on seems to once again be in rude health with a pretty clear vision of what it wants to be.
Second-quarter results, out this morning in Honkers, stunned in every direction. Consensus was for US$4.6bn pre-tax profit but came in at US$5.28bn. It also announced a share buyback of US$2bn which is justified by a “reduction of US$29bn in risk-weighted assets” during the first half of 2017. HSBC is becoming a leaner, meaner animal without any of the usual public blood-letting so favoured by US banks.
Rather strict rules prohibit me from saying anything that might be construed as investment advice – according to the regulators 35 years in the City apparently don’t qualify me to make my thoughts even informally known – but were I to make a recommendation on HSBC, which of course I am not going to do, I’ll leave it to the individual to liberally second-guess what it might have been.
Have a good week.