Markets were focused on one of their favourite pass-times last week; fed watching. The FOMC underlined that it considers recent softness in core inflation to be transitory, and also defied uncertainty over two hurricanes which battered the U.S. earlier. Mrs. Yellen informed markets that the run-off of the Fed’s balance sheet will begin in October and that the Fed believes the economy is strong enough to warrant a continuation of the so far slow, but steady, hiking cycle. The peanut gallery saw this as a moderately hawkish statement, but this was because markets had been pricing out a December rate hike going into Wednesday’s meeting. Fed funds futures and front-end rates have since corrected to reflect a near certainty that the Federales will raise rates one more time this year, likely in December. In effect, though, the Fed merely confirmed the path that it set out 12-to-18 months ago. Last week’s signal to markets from the Fed led punters to re-evaluate a vexing question; does the market lead the Fed or the other way around? The vibe I am getting from the veterans on FinTwitter is that the Fed laid down the gauntlet, signalling that it intends to push on. If that is true, trades are there for the taking.
Read MoreLast week I warned of a tipping point in financial markets but also contrasted it with potential for a return of the reflation trade. Judging by the price action since, investors have opted to step back from the brink. The dollar finally has found some support—aided by PBoC intervention—bond yields have increased and stocks have rebounded modestly. One week does not make a trend, but the path toward a new reflation trade is simple. The dip in U.S. core inflation is temporary and political uncertainty will fade, prompting investors to focus on the bright side. If so, late-comers to the trend of a weaker dollar and lower yields are in for a rude awakening. By Q1, markets could be looking at a White House pushing through tax cuts; hurricane rebuilding will be underway—perhaps boosted by bipartisan support for infrastructure spending—inflation is rising, and the Fed has re-started its hiking cycle. I am not sure that I believe in this version of the world, but the implications are clear if you do. Bonds should be sold aggressively, the dollar is a buy—in particular against the euro and the yen—and domestic U.S. growth stocks, mainly financials, should be added to global equity portfolios.
Read MoreI am tempted to use one of the most tired clichés to describe the state of play in financial markets. In his famous book with the same title, Malcolm Gladwell describes a tipping point as "the moment of critical mass and threshold" at which point the parameters and rules of the game—in a market or environment—change radically. As I peer across markets and economies, I am starting to wonder whether we are getting close to just that. The eye of the storm is quite literally the U.S. where the layers of economic and political uncertainty are now so thick that I am not even sure where to start. The tinfoil hat scenario goes something like this. The devastation of hurricanes Harvey and Irma is worse than feared and become a stagflationary hit—negative supply shock and plunge in demand—but the call for decisive action in Washington and the Eccles building go unheeded. The debt ceiling bites right when the economy needs the flexibility the most and the Fed is caught between a rock and a hard place as inflation soars. Pyongyang uses the confusion to show that it means business by firing a missile towards Alaska.
Read MoreThe portfolio finished August much in the same fashion as in the previous four months, stumbling to a monthly loss of about 0.7%. The dip extended the decline since May to a total of 1.1%—a far cry from the punchy +6.4% in the first four months of the year—and paltry compared with the MSCI World's +3.7% return in the same period. The numbers get even worse by adding currency effects. In a nutshell, your humble scribe has found himself on the wrong side of the contrarian trade of the year; the greenback's fall from grace. Accounts denominated in DKK and GBP with a lot of USD denominated investments have not been particularly friendly for returns so far in 2017. Speaking of which, traders' arguments about the dollar is reaching a crescendo and bucky has a decision to make. A few weeks ago I mused that if DXY broke 93 to the downside, punters would need to rethink their views. The DXY slipped to 92.5 towards the end of August, and I imagine many FX geeks are doing just that. The chart below shows that the dollar hasn't exactly crashed through support, so it still has time to step back from the brink, but it's getting sporty.
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