Strategists and speculators at odds over dollar outlook
Consensus among banks is for declines but market positioning tells a different story
Eva Szalay
Wall Street’s foreign-exchange strategists are at odds with speculators over the outlook for the dollar, underlining the uncertainty over the direction the world’s reserve currency will take next year.
The consensus among banks is that the dollar will decline in 2019, with much of the weakness expected in the second half of the year as shifts in monetary policy begin to favour other currencies, including the euro. However, that prediction comes as speculative bets on an appreciation in the dollar stand near the highest levels of the year, according to data from the Commodity Futures Trading Commission.
“Most banks and FX strategists think that the dollar is going to go weaker next year, but — interestingly — positioning tells a very different story,” said Andreas Koenig, head of global forex at Amundi Asset Management. “At the moment the market is very long dollar so it’s either the prediction for a weaker greenback that’s wrong or the markets’ positioning. It doesn’t add up.”
The past 12 months have offered a reminder of the dangers in being too confident in forecasting currencies. At the start of this year, the consensus among most investors was that the dollar would continue to weaken — a prediction that came unstuck in April as the clear outperformance of the US economy saw the dollar index, a broad measure of the currency, jump 8 per cent in a matter of months. Its strength hit emerging market economies with current account deficits and lots of dollar-denominated debt, but also offered the European economy some relief via a weaker euro.
As the Federal Reserve persisted in tightening monetary policy, investors rediscovered the appeal of dollar-denominated assets as the attraction of riskier bets, such as in emerging markets, eroded.
Mr Koenig said that being long the dollar and US assets had been “a very popular trade this year” because it was a low-risk asset that also had an attractive yield.
The consensus view for a weaker dollar in 2019 is built on the assumption that weaker growth in the US prompts the Fed to stop raising interest rates, while the European Central Bank continues to withdraw stimulus. Analysts at UBS argue that “we think the dollar is likely to depreciate over time as policy normalisation gets under way in Europe and Japan”.
STRATEGISTS AND SPECULATORS AT ODDS OVER DOLLAR OUTLOOK / THE FINANCIAL TIMES
WHAT HAS HAPPENED TO US / GEOPOLITICAL FUTURES
What Has Happened to Us
The global system that many fear is dying is already dead. The new one has yet to emerge.
By George Friedman
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THINK LOCAL WHEN IT COMES TO CHINA´S DEBT / THE WALL STREET JOURNAL
Think Local When It Comes to China’s Debt
One of the biggest areas of vulnerability in China’s huge debt pile is bonds issued by investment vehicles linked to local governments.
By Andrew Peaple
A woman walks at the construction site of a 'red tourism' attraction featuring Chinese Communism, in Shazhou village located in Hunan province, China on Dec. 3. Photo: shu zhang/Reuters
All politics is local, runs the old saw. In China, local governments lie at the root of the country’s debt problem—a problem likely only to grow in 2019.
Most analysts see the Chinese government’s relatively low debt—equivalent to around 16% of GDP at the end of 2017, according to Moody’s—as a strength. But add in both official local government debt, and debt issued by off-balance sheet financing vehicles backed by local governments—known as LGFVs—and that ratio climbs to 60% of GDP.
These LGFVs, which started sprouting up after the global financial crisis, have become an area of huge vulnerability. Back then, Chinese local governments were restricted from issuing their own debt, but still needed to stoke the economy. The solution: set up off-balance sheet vehicles which could issue debt, often collateralized with local government-owned land, and spend the money raised on big investment projects.
In recent years, local governments have become freer to sell their own official debt, but they still face centrally-imposed limits on how much they can issue. With tax revenues declining as Chinese growth slows, and another of local governments’ big income sources—land sales—highly volatile, they face an annual funding gap equivalent to around 10% of China’s GDP, Moody’s reckons.
This persistent revenue shortage has left local governments still reliant on LGFVs to keep issuing debt to fund investment. LGFV bond issuance has grown rapidly this decade; and despite a dip last year, it reaccelerated in the first half of 2018.
Cracks in this system are starting to show. A big concern is that many of the investments LGFVs have made over the years can’t and won’t generate adequate returns. Beijing’s crackdown on shadow banking has put the squeeze on investing entities that have been big buyers of LGFV debt. In turn, funding costs have been rising, particularly for lower-rated LGFVs, meaning interest payments are becoming an ever greater proportion of local government spending, particularly in poorer areas of China.
A big question now is who will bear the fallout if—as many analysts expect—LGFVs start defaulting on bond payments in big numbers. Investors have long assumed these financing vehicles have implicit backing from local governments and, ultimately the central government. Beijing, though, has been trying to dispel that impression, with a series of measures imposed to cut the potential support from local governments to the LGFVs.
If Chinese regulators allow a spate of defaults on debt long believed to be quasi-government, confidence in China’s bond market—vast swaths of which are priced as if they have Beijing’s ultimate backing—could plummet. Conversely, heavy government bailouts would lead to a reassessment of Chinese central government debt levels, and hence a potential repricing of government bonds.
Either way, the hangover from China’s local government debt binge is about to get very interesting.
CHINA QUIETLY DUMPS BONDS / SEEKING ALPHA
China Quietly Dumps Bonds
- Over the past year, both countries have reduced their U.S. bond holdings with no discernible impact on yields.
- Despite the expected rate hikes by the Fed in 2019, it will continue to be hard for fixed income investors to beat inflation after taxes.
Bienvenida
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Friedrich Nietzsche
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Lao Tse
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Warren Buffett
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J.P. Morgan
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Proverbio Chino
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Helenio Herrera
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Karl Marx
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Sun Tzu
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