Dollar threatens the emerging markets party

Hopes for a strong recovery in EM currencies persist — just about

Eva Szalay in London

Nearly all EM currencies have weakened against the dollar since late February © Financial Times

When French investment bank Natixis polled its clients in December about their key expectations for the year ahead, their survey found that 52 per cent of them expected emerging markets to outperform major economies.

The market consensus also held that currencies battered by the impact of coronavirus in 2020 would turn into star performers this year, their rise fuelled by the global economic rebound, a wilting dollar and loose monetary policy in the US.

It’s not shaping up that way. In the first quarter of the year, emerging markets equities rose around 5 per cent, less than half the 9 per cent surge in the S&P 500. 

The currencies of developing economies have also fared less well than anticipated, while the dollar has gained nearly 3 per cent against a basket of its peers in that period.

“Yes, EM currencies faced a more challenging year relative to expectations,” says Aaron Hurd, a senior portfolio manager at State Street. 

He described the performance of these currencies so far this year as “disappointing, but not so bad overall”.

It hasn’t been great either. Nearly all EM currencies have weakened against the dollar since late February, with a slight recovery at the start of April. 

But the dollar is still 9 per cent stronger against the Brazilian real and it’s up 5 per cent against the Russian rouble since the start of the year. 

It’s also advanced against market darlings such as the Mexican peso and the Chinese renminbi.

Rising yields on US government bonds have been the main spoilers of the EM rebound story in the first quarter. 

As investors moved to price in a roaring comeback for the US economy, they have nudged yields on Treasuries sharply higher, increasing the attractiveness of US assets at a time when yields in emerging markets are near historic lows.

Before the pandemic, emerging markets interest rates were higher than those in major economies to compensate investors for taking more risks. 

Currencies in EM economies tend to be more volatile and vulnerable to sudden shocks than the dollar or the euro. 

But in 2020, central banks across the world moved in concert to slash rates to near zero, leaving little to tempt investors.

Now that rising inflation fears are forcing US yields higher as investors price in a less accommodative stance from the US Federal Reserve than before, this is becoming a problem for EM central bankers.

The key question is how they respond and how fast. Ed Al-Husseiny, a senior rates and currencies analyst at Columbia Threadneedle, says South Africa, Brazil and others will have to raise rates much faster than before to keep inflation in check and stop their currencies plummeting. 

But raising key rates too fast can kill off budding economic recoveries.

“The Fed is priced for no hikes this year but the market expects a four percentage point hike in Brazil, that’s how bad it is,” Al-Husseiny says. 

“EM central banks cut rates last year and they’re now paying the price.”

Brazil has already surprised investors with its biggest interest rate rise in a decade that pushed the key Selic rate to 2.75 per cent in March, with the central bank’s chief signalling another equally chunky rate rise at the next meeting.

Analysts at Capital Economics say central banks will choose to keep policy rates at near zero rather than risk derailing economic recoveries, even as yields on long-term US Treasuries rise. 

This will cause emerging markets currencies to lose ground against the dollar.

Domestic stories such as the firing of Turkey’s central bank governor and rising geopolitical tensions in Russia have also added to the burden on EM currencies.

But some investors remain optimistic, believing that US government bond yields will stabilise and the original playbook for 2021 can resume with a strong economic rebound and a weaker dollar buoying emerging markets assets.

State Street’s Hurd expects “a sustained [and] widespread” rally in currencies, with the Russian rouble being a favourite bet. 

The rouble has been the second worst performing currency this year because of heightened geopolitical risks, with the dollar rising nearly 5 per cent this year.

Wim Vandenhoeck, senior portfolio manager at Invesco Fixed Income, adds: “We continue to believe that global macro conditions . . . are setting the stage for a sustained outperformance of EM assets.”

“We believe interest rate and currency valuations [in emerging markets] are now more attractive than they were at the end of last year.”

The Gold Investment Thesis Revisited


Recent Corrective Action Ignores the Fundamentals

Since gold’s intraday August 7, 2020, high of $2,075 per ounce, the metal has retreated 21.49% to $1,708 as of March 31, 2021. 

Precious metals mining equities declined 23.56% over the same period. 

Eight months of corrective action has occurred despite solid and visible strengthening fundamentals for gold, leaving proponents of gold to wonder what they are missing.

Which snowflake triggers an avalanche? 

What you need to know is that the massive buildup of systemic risk since 2008 is largely underappreciated.

Missing, in our opinion, are the yet unseen consequences from extreme financial asset valuations supported by the rapid expansion of new public and private sector debt. 

Economic nirvana, founded on path-dependent monetary and fiscal policy, is impossible. 

The punchbowl cannot be taken away without wrecking the economy and the markets. 

Public servants are unwilling and incapable of doing so. 

Intoxicants will most likely disappear for unforeseen reasons. 

We believe that gold senses adverse outcomes long before they have been articulated.

Four familiar refrains explain gold’s recent correction:


Rising interest rates.

Gold has been battered by the gale of microscopic advancements in U.S. 10-year Treasury yields and the expectation of higher yields to come. 

Rate increases are viewed as a “healthy” sign that all is well with the economic recovery. 

Scant consideration is given to systemic risks stemming from indigestion of the oversupply of new U.S. Treasuries relative to the lack of buying interest from traditional investors.

Little thought seems to be given to the possibility that higher interest rates could short circuit the economic recovery. 

As noted by MacroMavens (3/22/2021), economic sensitivity to “rate increases move alongside the total level of debt. 

If debt levels double, for example, the interest rate required to precipitate a crisis should be around half of what it was previously. 

As it turns out, total non-financial debt in the U.S. today is roughly double what it was at the end of 2006 ($61 trillion vs. $30 trillion when the housing bubble began to deflate). 

It goes without saying that the reason why financial and economic crises have been occurring at successively lower and lower levels of interest rates is that we, as an economy, have been taking on ever-increasing amounts of debt.

“ Rate increases, as minuscule as they may be, may have little room to rise before triggering another financial crisis.


Exposure to gold could dilute strong returns achievable in financial assets.

Secular bull markets in equities and bonds dull investor interest in risk mitigation. 

As noted by Simon Mikhailovich of TBR (The Bullion Reserve, 3/1/2021), “gold is behaving exactly like insurance should behave — rising and falling with confidence and catastrophic risk perceptions.”

The 2020 peak in gold was driven by acute concern over potential damage from the COVID-19 global pandemic. 

News of vaccine efficacy opened the door for projections of robust economic growth in 2021. 

Risk perceptions retreated along with the gold price. 

However, equity and fixed income valuations stand at all-time highs, with many metrics ranking at 100% of historical experience.

As noted by David Rosenberg (Rosenberg Research, 3/29/2021): “proliferation of IPOs [initial public offerings], retail participation, leverage, liquidity and SPACs [special purpose acquisition companies] should be a concern with anyone who has a keen sense of the history of what speculative-driven markets look like.”

At moments of maximum valuation, risk is highest and perception of it is lowest. 

According to the March 18 SentimenTrader (quoted in The Belkin Report, 3/22/2021): 

“By the end of last week, nearly 100% of traders were in a risk-on mode. 

A risk-on mentality has been so strong that the 50-day average of the aggregate indicator has climbed to 90.5%....

Our backtest engine shows that when the 50-day average has been this high, future returns have been poor.” 

As famously noted by Bob Farrell,* markets are mean reverting. 

Upside overshoots in valuation lead to overshoots on the downside. (See Bob Farrell's 10 Rules.)


Bitcoin is the new gold.

Bitcoin has diverted money flows from gold. 

Perhaps the 2020 August peak in gold would have been $200-$300 ounces higher without speculation that Bitcoin will displace gold. 

A persuasive Grant’s Interest Rate Observer essay, "Bitcoin Goes to Wall Street," suggests otherwise: “There will be a crash as Bitcoin is a bubble…Stripped of its monetary pretensions, Bitcoin will revert to its legacy role as a crypto version of a Western Union International wire transfer.”2

Bitcoin is internet dependent. 

If Australia was able to silence Facebook for incurring government displeasure, what are the implications for digital currency payments that escape the tax collector?

Bitcoin price behavior is indicative of epic speculation. 

Little difference can be seen in Figure 1 which overlays the price patterns of Bitcoin and Tesla.

The movement towards digital currencies is inexorable and will tighten the government’s grip on taxpayers. 

Gold is physical property. It stands alone as an off-the-grid store of value with minimal counterparty risk. 

Gold's usefulness in transactions was written out of the script for a century. 

Few proponents would argue that the metal's value depends on utility for routine day-to-day payments. 

On the other hand, blockchain technology holds favorable implications for gold. 

Digitization of almost anything is possible. 

Digital gold tokens for those who wish to transact in the metal already exist and could come into wide use by the end of this decade. 

More important, blockchain will connect lenders and borrowers, allowing owners to earn interest on their physical holdings.

Figure 1. Price Patterns of Bitcoin and Tesla (2018-2021)

     Source: Bloomberg. Data as of 3/31/2021.


Strong economic growth will significantly reduce and possibly negate systemic risk concerns implied by unprecedented public and private sector leverage.

Consensus is united on this — typical is the quote from Cornerstone Macro: “The March U.S. Markit Services PMI added 0.2 percentage points to 60.0%, its highest level since July 2014, with the future output index jumping 5.2 percentage points to 72.7%, its highest-ever level. 

Strength was broad based: employment (+2.0 percentage points), new orders (+0.6 percentage points ). 

Note: services include travel & tourism, the sectors hardest hit by the outbreak. February’s pullback represents a temporary — likely supply-chain driven — pause in the long-term manufacturing rebound. 

Manufacturing will continue to be an important driver of activity this cycle. And it’s not just high-profile auto demand — it’s a healthy U.S. domestic CAPEX cycle and an improving trend in exports, supported by China’s ongoing recovery. 

And tailwinds from the U.S. Manufacturing Renaissance/onshoring theme will continue. 

They have a long way to run.”

Central to this view is faith that monetary and fiscal policy support extends as far as the eye can see. 

Referring back to Farrell, “When all the experts and forecasts agree, something else is going to happen.” 

The time to be bullish was exactly one year ago when fear was pervasive. 

Bullish arguments like the one above are long in the tooth. 

Data that falls short of consensus is brushed aside, for example, harsh weather, a colossal ship aground in the Suez Canal, seasonality or a shortage of semiconductors leading to disappointing car sales. 

Surging economic strength is old news, priced into sky-high valuations and in our opinion likely to prove short lived. 

The Chinese PMI (purchasing managers index) is rolling over, emerging market economies are sputtering, Europe remains in pandemic semi-lockdown and the bloom of the “commodity supercycle” is fading.

The Market Bubble Will End Badly

Our contrarian view is that the market bubble will end badly. 

“Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways (Farrell's Rule #4). 

Well chronicled are the risks implied by record valuations ("Bubble Deniers Abound to Dismiss Valuation Metrics," Bloomberg, March 27, 2021).

In our opinion, a bear market is the single most critical catalyst missing to revive interest in gold. 

The multi-billion Archegos Capital Management margin call exemplifies the reckless use of leverage likely seen only as markets top. 

The episode is most likely not an isolated event. 

There is never just one cockroach. 

Losses to hedge funds and their prime brokers will get little political sympathy, but a wipeout of small investors will attract close scrutiny from Washington D.C.

Bear markets progress in three stages (Farrell's Rule #8) — a sharp drop, an oversold bounce and a protracted grind lower as fundamentals deteriorate. 

The last grinding bear market took place in the 1970s. 

Few active investors today recollect the experience of a decade-long march lower in prices that led to a sea of change in attitudes, expectations and psychology. 

Sharp selloffs since the 1970s have been short circuited by monetary interventions and caused any potential bear market to be still born. 

The “buy the dip” mentality has been programmed into investor reflexes. 

Repeated reliance on easy money to quell market selloffs has neutered public policy. 

The Fed has become “path dependent,” both arsonist and firefighter, as explained from time to time in Grant’s Interest Rate Observer.3 

Faith in central banker omnipotence is the cornerstone of the financial asset super bubble.

For the time being, the Fed tolerates rising rates on Treasuries because it believes the baton has been passed along to fiscal policy. 

The Biden administration obliges. 

Expectations for economic growth based on dramatic increases in government spending seem boundless. 

As noted by Andy Kessler (The Wall Street Journal, 12/6/2020): “Expect more multiplier mumbo jumbo as the Biden administration begins its tax-and-spend fiesta….Multipliers are a canard, a Keynesian conceit.”

The economy is bouncing back from the pandemic-induced recession, as it tends to always bounce back from a downturn. 

But there is good reason to think that this post-recession bounce is sustainable. 

The marginal utility of debt stimulus is subject to the law of diminishing returns. 

Odds are strong that the bounce will fizzle and open the door to even greater debt creation that the market cannot digest at submarket interest rates.

Inflation or Deflation? Gold Performs Well Either Way

Either inflation or deflation seems possible at this moment. 

A strong case can be made for both. 

Gold exposure wins out either way. 

We are quite confident that if central bankers achieve their desired 2% inflation, it will not be transitory or easily dispatched. 

“I can tell you that we have the tools to deal with that risk (inflation) if it materializes,” said Janet Yellen, U.S. Secretary of the Treasury. 

Policymakers are omniscient and all powerful, Yellen would have us believe. 

Credulous markets swallow this nonsense for now.

As noted by Joseph C. Sternberg (The Wall Street Journal, "What Inflation Debates Miss: Inflation," February 11, 2021): “Inflation in the academic and policy jargon has come to mean a specific event: a rapid run-up in consumer prices.” 

In Sternberg’s view, the too narrow CPI (consumer price index) goalposts do not capture the essence of inflation, including deep social, political, and psychological aspects. 

“Malfunctioning price signals (read: inflation) make it impossible for a society to allocate its resources with any rationality or fairness.” 

Tame CPI (consumer price index) readings are blind to the “phenomenal bid-up in prices for financial assets,” which “wreck the value of and income from” the savings of investors. 

The seeds of inflation have already taken root. 

Indices designed and maintained by high IQ government bureaucrats (such as CPI, PCE (personal consumption expenditures), Core PCE, WPI (wholesale price index), etc.) will sound the alarm too late for the Federal Reserve to gently tap the brakes.

The deflation case rests on the idea that overreliance on debt issuance for economic stimulation causes inescapable economic lassitude. 

According to Lacy Hunt of Hoisington Investment Management Company, “public and private debt in the United States rose last year to 405.9% of GDP [gross domestic product], up from 365.9% in 2019.” 

Overuse of debt becomes a “persistent drag” on economic activity because of ever-increasing amounts of resources that must be consumed for debt service. 

Hunt believes that government stimulus has become counterproductive to economic growth. 

That view seems to pass the test of common sense and extensive historical data supports Hunt's view.

Gold and gold mining shares performed well in the inflationary 1970s and the deflationary 1930s. 

Monetary disorder leading to capital destruction was the common thread.

The Deflationary 1930s

The 1930s deflation was characterized by an extended severe economic contraction (The Great Depression). 

The famous market crash was preceded by the rash speculation, unchecked optimism of the 1920s and excessive leverage. 

The Fed tightened monetary policy during the downturn to make matters worse. 

The fall in the general price level does not capture the essence of deflation. 

The essence was a general collapse in confidence leading to cascading credit defaults. 

Loss of confidence in financial conventions led to sweeping political change and monetary debasement in the form of dollar devaluation vs. gold. 

Interest rates crashed while gold appreciated 70% and gold stocks became market favorites.

The Inflationary 1970s

The inflationary 1970s were set off by the Vietnam War and amped up social spending deficits abetted by easy money policies of a politically pressured Federal Reserve. 

Monetary debasement took the form of consumer price inflation which destroyed capital, particularly for debt investors. 

Interest rates soared and gold rose nearly 24 fold4 in nominal terms. 

Capital losses in real terms were disguised by a rise in the general price level. 

Gold stocks became market favorites.

Prolonged austerity forced a rise in savings and was the cure in both historical cases. 

World War II imposed a moratorium on consumer spending resulting in the buildup of savings, pent-up consumer demand and a post-war boom. 

The Volcker prescription of ultra-tight monetary policies triggered a politically unpopular protracted recession during which savings increased and savers were rewarded by high real interest rates. 

A secular bull market followed.

Which Snowflake Triggers an Avalanche?

What will trigger the next financial crisis? 

Which snowflake triggers an avalanche? 

What you need to know is that the massive buildup of systemic risk since 2008 is largely underappreciated. 

From "Fixed-Income Powder Keg" (Grant’s Interest Rate Observer, 3/19/2021)5: 

“When you suppress one market artificially, as they have the rate market, the volatility that is normally expressed there — goes somewhere else.”

The origin of the next financial crisis, whatever it turns out to be, will be sourced in financial dementia. 

As noted by economist John Kenneth Galbraith, “there can be few fields of endeavor where history counts for so little as in the world of finance....The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version. All financial innovation involves, in one form or another, the creation of debt secured in greater or lesser adequacy, by real assets.” (A Short History of Financial Euphoria, 1994).

Gold is the Obvious Answer

Defensive investment strategies are few and far between. 

Fixed income, debased by artificially low rates, no longer passes muster. 

Selling volatility to generate income seems like a form of insanity. 

Gold is the obvious answer. 

Whether in physical form or precious metals mining shares sporting good dividend yields and trading at depressed valuations, we believe this unwanted investment strategy will prove seaworthy for all conditions.

The Unlikelihood of a War With China and Russia

By: George Friedman

Much has been made of China’s seemingly unending potential to invade Taiwan – nearly as much as Russia’s buildup near Ukraine, which many believe is little more than a pretext for a future war. 

Lurking behind this is the age-old fear that Russia and China will team up to undermine the United States, say, by launching simultaneous attacks. This isn’t inconceivable, but neither is it likely.

Let’s begin with China. 

An invasion of Taiwan would obviously be an amphibious operation. 

One of the principles of war is the value of surprise. Surprise is particularly important in an amphibious assault. 

At Normandy, for example, the U.S. and Britain mounted a massive disinformation campaign to convince the Germans they were not going to land where they did. 

If defenses are concentrated on the point of disembarkment, the attack could be a slaughter. 

Even if China had a superior force, the force multiplier of correct deployment and preparation could devastate its soldiers.

There’s also the issue of distance. 

Some 100 miles (160 kilometers) of water lay between China and Taiwan. 

Assuming a direct line of attack, the attack force will be at sea for about five hours. 

Apart from alerting defenders to planned positions, the force would be subject to air and missile attacks and more dangerous submarine attacks. 

The probability of the Chinese reaching the landing zones without enduring heavy losses is high. 

Even if U.S. space-based reconnaissance were completely neutralized – and I doubt it would be – submarines could provide targeting information to U.S. missiles distributed globally.

If Chinese troops successfully land, and if Taiwanese troops are forced to cede ground, supply and reinforcement will pose an enormous problem for the Chinese. 

At this point, the landing point would be known, and the routes needed to resupply Chinese infantry mapped. 

Resupply and reinforcement by aircraft would not be enough. 

So even if the initial landing took the beach, the resupply problem would cripple Chinese operations.

There is also a political problem. 

A Chinese invasion of Taiwan would trigger warning signals among U.S. allies in the area, some of which, such as Japan, could prove dangerous. 

Of course, a stunning and low-cost victory by China might force them to reconsider their alliances, but a drawn-out conflict or an outright defeat would convince U.S. allies of Chinese intentions, and they would prepare accordingly. 

China must win fast if it is to use the attack as a lever to intimidate the region.

This is the ultimate problem for China. 

In any war you can lose. 

A victory would turn China into a genuine, not notional, superpower. 

A defeat would shatter that dream. 

In addition, the U.S. might choose to counter an invasion with simultaneous actions in chokeholds critical to China, such as the Strait of Malacca, or at Chinese ports. 

The Chinese could not control the U.S. response, which might include (or theoretically substitute for a Taiwan strategy) seeking to paralyze China’s maritime trade. 

This coupled with hostile economic actions by Europe would make anything but a stunningly rapid victory, potentially crippling.

China has not had fleet action since 1895 and initiating their unbloodied navy with an amphibious operation against the U.S. Navy could result in defeat or victory. 

China is aware of this, which is why they forfeited surprise. 

They do not intend to invade Taiwan. Alternative islands are somewhat (only somewhat) less risky. 

The Chinese have created a sense of impending war. 

An attacker might try instead to downplay war.

Which brings us to Russia. 

As I have written, Russia is in the process of trying to recreate the strategic depth that it had for centuries and lost when the Soviet Union collapsed. 

So far, it has reached a dominant position in Belarus and managed to emerge from the war in Nagorno-Karabakh with a sound political position as well as peacekeepers deployed. 

This means, respectively, that it has strengthened its position on the western path over the North European Plain, and that the entry point in the Caucasus has been shored up with soft, political moves.

There is a third line of attack into Russia, via the Carpathians or, more precisely, Ukraine. 

Of all the buffers Russia lost in 1990-91, none is more critical to Russia than Ukraine. 

The Russians have attempted soft maneuvers designed to change or shift the alignment of the Ukrainian government, but they have consistently failed, both for passing reasons and because Ukraine has a memory of Soviet brutality. 

Moreover, Kyiv has been bolstered by Western support. 

This support is cautious in the extreme so as not to provoke Russian fears of an attack, but it is there as a potential reality.

The massing of Russian troops along the border of Ukraine has to be read in this sense. 

Are the Russians preparing a military operation to retake Ukraine? 

The problem with such an operation is the vast size of Ukraine. 

Assuming no resistance at all, which is not likely, it would take weeks for Russia to fully occupy Ukraine, and during those weeks it would have to assume that Western weapons and supplies, and perhaps troops, would pour in. 

An extended campaign by Russia would do more than prove costly; it would leave other Russian interests short of defenders. 

The status of Belarus might be challenged, as well as the Russian position in the Caucasus. 

The emergence of Russia against the borders of a range of NATO members, from the Baltics to Slovakia, Hungary, Romania and Bulgaria, would likely revitalize NATO, driving much of Europe from its strategic complacency and toward panic.

There is no question that Ukraine is critical for Russia, and a revitalized NATO might be a small price to pay for it, but Russia faces the same problem as China: It could lose. 

Russia has a vast army, but as with the Soviets, only parts of it are effective. 

And as with the Soviets, Russia’s ability to support a massive armored force logistically is unknown. 

A rapid seizure of the area south of the Pripet Marshes might not strain Russia’s forces, but should the U.S. and NATO rapidly arm Ukrainian forces with anti-tank and anti-air weapons, and support them logistically, a quick win could become a long battle. 

This would particularly prove true if U.S. aircraft, optimized for anti-armor warfare, were thrown into the battle. 

Turkey, seeing an opening, might test Russian forces in the Caucasus, and Poland could move in on Belarus.

None of this is certain, but Russian planners must be taking these possibilities seriously. 

Optimists rarely win wars, and Russia has learned not to be optimistic. 

It could find itself bogged down in Ukraine, hammered with advanced weapons and facing attacks on its flanks. 

In other words, it could lose. 

What’s more, starting a war in Ukraine would mean sacrificing economic possibilities in Europe.

Now, a war is possible. 

Russia has used military exercises as cover for war before, namely, with Georgia. 

But Georgia is small and Russia didn’t take all of it. Ukraine is startlingly big, and I suspect its forces will have training on U.S. weapons that have not been distributed out of concern for Russian fears – but they could be rapidly distributed in the event of war.

There is, then, the possibility of coordination between Russia and China. On the surface this is reasonable. 

In practice it would have little effect. 

A war with China would be a naval war. 

A war with Russia would be a ground war. 

There would be no contest for troops between regions, only for supplies, and only if both wars were extensive, which is doubtful. 

The two at war with the U.S. at the center would not achieve a dilution of forces, nor could Russia or China support the other. 

Russia cannot supply meaningful naval support, and China cannot sustain meaningful ground forces at that distance. 

An alliance to launch a war together would of course panic the U.S., but the U.S. has been good at using panic to mobilize the public.

So in my view the likelihood of war, let alone a coordinated war, is low. 

Neither China nor Russia is so desperate as to risk defeat or a long, bleeding war. 

And each is acting as if it is not serious about war; instead, they are advertising the threat. 

Of course, all things are possible, but this seems farfetched.