We all get it wrong ..... it's how quickly you react that counts

Friday 12th February 2016

We all get it wrong ..... it's how quickly you react that counts

ref :- "Dollar Confounds Strategists Ripping Up Forecasts on Market Rout" , Bloomberg online

A couple of days ago and just six weeks into the New Year, no less an entity than Goldman Sachs announced that it was withdrawing from 5 of its top 6 recommended trades for 2016. An embarrassing series of about-turns for one of the industry's stellar names ? Well, we'd all like to be right every time and NOBODY ever is ..... when things start to go pear-shaped, it's all about acting promptly and decisively to limit losses and reassess the situation. Remember the old maxim : "The first cut is the cheapest" ? Actually, it's an affectionate and slightly contradictory modification of the 1967 P.P. Arnold hit "The first cut is the deepest", but for the markets it's the former version that has become a basic trading mantra. Viewed in that light, Goldman's quick decision to pull the plug could even be seen in a positive light (if you were feeling charitable). What's not in doubt however is that they are a very long way from being the only ones to be comprehensively wrong-footed by 2016 so far.

For all the panic about China, oil markets and now banking sector equities, perhaps the most high-profile examples of this are to be found in the fortunes of the US dollar. The last two years have told a tale of dollar strength, and most bought into the idea that 2016 would see further gains with the greenback continuing to be boosted by the "Divergence Trade". It all seemed pretty straightforward ..... a comparatively robust US economy would induce a little wage-led inflation and allow the Fed to push interest rates higher, whilst stuttering performances elsewhere (Japan, Eurozone, for example) would mean that their central banks would adopt a policy of further monetary easing. The diverging paths of interest rates would ensure capital flows heading Stateside and a strong dollar. A no-brainer, right?

Except it hasn't panned out that way, not by a long chalk. Examine the numbers : At year end, USD / JPY was trading at 120.60 yen to the dollar ..... it now trades at about 112.50 (having been below 111.00 yesterday). USD / Euro was 1.0850 dollars per euro and is now scratching around 112.80. The Japanese Yen has actually strengthened by 8% in the two weeks since the Bank of Japan embraced negative rates, the biggest 2-week move in its favour since 1998 and at first glance a pretty counter-intuitive one. So what's going on?

On the one side, both the Euro and JY have been boosted by safe-haven buying at a time of market turmoil (again) that has overridden short-term interest rate considerations. Japan's large current account surplus makes the Yen particularly attractive on this score. On the other, the global economic outlook is sapping confidence that US GDP can continue to press ahead regardless and that has a pretty fundamental effect on the forecast for US rates. The Fed's consensus view that there would be four 25bp rate hikes this year always looked toppy, and as we said yesterday futures markets now suggest there may not be any. There is even talk of the Fed reversing its December rise. Fed Chairwoman Yellen admitted to Congress yesterday that the Fed had been re-examining the practicalities and ramifications of negative interest rates. Frankly the Fed would have been irresponsible not to, but that won't stop flighty markets leaping to some wild assumptions.

All this is not good news for the Eurozone and particularly for Japan. Both need WEAKER currencies that might foster a bit of inflation through dearer imports. There has been talk that the Bank of Japan may be contemplating direct intervention in foreign exchange markets to weaken the Yen. Perhaps so, but on that subject we can only say this : UNILATERAL FX intervention only has fleeting effects, and ultimately will be undone (probably at great expense to the central bank involved). It's possible that the BoJ may seek an agreement for coordinated intervention at the next G20 get-together, but unlikely that they'll get it.

Anyway, as a measure of how things have changed, Barclays have adjusted their forecast of USD / JPY at the end of 2016 from 120 yen per dollar to just 95. Julius Baer & Co, who have a pretty good record with the Jap Yen, have moved their forecast from 118 to 110. Whatever your view, the moral of the story is don't be afraid to change it, and change it quickly, if circumstances change.