The world's illustrious central planners are converging on the small ski town of Jackson Hole, Wyoming for the Kansas City Fed's yearly monetary policy symposium on Thursday. Below are some financial market insights from our Macro team...
On the U.S. Dollar, Euro & Other G4 Currencies
Heading into Jackson Hole, each of the G4 major currencies have transitioned to a neutral reading on Hedgeye CEO Keith McCullough’s intermediate-term TREND signal (in our quantitative-based Daily Trading Ranges).
This consolidation rhymes with our proprietary, 10-factor G4 Monetary Policy Model, which suggests each of these four major developed market economies – e.g. the U.S., Eurozone, Japan and the U.K. – should keep policy on hold in the short-to-intermediate term. Positioning, sentiment and fundamentals continue to be skewed in the dollar’s favor from here with U.S. growth accelerating heading into the back half of 2017.
On that last point, Wall Street consensus is still long Euros and other developed-market currencies and short Dollars from a net futures & options contract positioning standpoint (see chart below). Over the last month, currency volatility expectations have picked up considerably. Currency and commodity volatility expectations are most divergent to the upside against equity volatility on the other side. Why? Because the past is projected into the future.
In our macro themes presentation, we outlined the fundamental case for Euro weakness with some added market sentiment color suggesting long euro is becoming increasingly consensus (click here for a brief primer on our short euro call). Long Euro and European growth from here remains a crowded position - we remain on the other side.
What's Next for Emerging Markets
A net $1.6 billion left Emerging Market equities in the week-ended August 16th, the largest of the year. High-yield bond funds saw a $2.3B exodus. Analysts estimate Emerging Market ETFs have almost $250B under management, comprised of $196B in equities and $48B in fixed income. That represents almost 20% of total EM mutual fund assets under management, compared to just above 12% two years ago.
While the risk to EM assets from a near-term reversal in Fed policy seem rather subdued, we continue to see long-term TAIL risk brewing in this asset class as a result of the liquidity mismatch implied by said passive ownership interest.
Simply put, at near two-year highs in EM asset prices and the U.S. dollar off -8.5% year-to-date, do you think the bear case on Emerging Markets is stronger or weaker? Reflation globally has been broadly peaking here in the Spring. Our Growth, Inflation, Policy (GIP) forecasts for the U.S., Eurozone and Japan should perpetuate a further divergence in policy in favor of the USD and U.S. interest rates over the intermediate term.
(Note: This set-up would be bearish for Emerging Markets broadly, but particularly those most tethered to further commodity price deflation.)