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What next for G-10 currencies and crude oil?

The Macro View

Blurred photograph of crowds walking through London

The euro, the French stock market, OAT-German debt interest rates spreads, the Volatility Index (VIX) and the ghosts of Vichy, Oradour and Algérie française convince me that Emmanuel Macron will be the next President of France on Sunday. So I see no reason to abandon my euro bullish strategy even though the single currency has traded as high as 1.0985 on the eve of the second round French vote. It is significant that the euro has risen to these levels despite the strong US April payrolls, the bankruptcy of Alitalia and ECB President Mario Draghi’s denial of an imminent taper. For now, the trend is my friend until the trend comes to an end, possibly when the financial markets focus on a June FOMC rate hike.

‘Sell in May and go away’? Not for my tribe of global currency market junkies. Even though a 100 MP Tory majority in Westminster in June has boosted sterling, Mrs May and the European Union are now embroiled in a bitter conflict over the UK’s Brexit divorce settlement. Sterling is still the best performing G-10 currency against the US dollar since early April, when Mrs May’s decision to call a snap election triggered the move from 1.24 to 1.2950. The dilution of the power of Little England, anti-EU Tory backbenchers and extension of the parliamentary term to three years lowers the Brexit risk premium and justifies cable in the 1.34–1.36 range. The EU’s demand for a $100 billion Brexit bill is a non-starter for Downing Street – I found it significant that Junker’s demand did not trigger a sterling sell off. This shows the resilience of the sterling bulls, as does implied vols and risk reversal skews in the FX options market. It also did not hurt that UK manufacturing data is at its strongest since 2014. As hedge funds slash short cable positions, not even nasty Brexit rhetoric can avert a sterling move to my 1.36 target!

The Japanese yen at 112 reflects not just US Treasury-JGB interest rate differentials but also the foreign exchange market’s complacency about the risk events de jour – North Korea, FOMC, the French second round elections and US data. Implied volatility in yen options has drifted lower and I see no urgent demand for protection against safe haven flows and as stronger yen. The 50 day moving average at 111.70 was no deterrent to yen weakness. Momentum and positioning suggests the yen can slip to 113. The ideal level to buy dollar/yen would be at the 111.60 chart point.

The Canadian dollar has now tanked to 1.3740 as interest rate spreads between Uncle Sam debt and Canadian government debt continue to widen, as West Texas crude oil falls below $50 a barrel and the Trump White House slaps tariffs on softwood lumber from the kingdom of the maple leaf. The loonie was last at these levels in January 2016, when crude oil was $30 and Chinese markets in free fall. If the CFTC positioning data is reliable guide, macro hedge funds are accumulating short loonie exposures.

The Bank of Canada’s policy statements have amplified the bearish pressure on the loonie, as the rise in implied volatility and risk reversal downside protection premia suggest. Planet Forex loves an ambush and Trump’s tariffs have ambushed the loonie. As the father of a Lord Sebastian Flyte wannabe undergrad at McGill in Montreal, the loonie free fall is a bonanza. Momentum/trend signal suggest the Canadian dollar can well fall to 1.3850 as the next strategy target.

While the Reserve Bank of Australia kept policy unchanged, the foreign exchange markets expects the Canberra central bank to ease rates this autumn. The plunge in iron ore prices and the weakness in Dr Copper shows that China risk cannot be discounted. I was stunned that the Aussie dollar stabilised after the RBA decision near $0.7550, not coincidentally the 38.2% Fibs retracement of the decline from its late March 0.7760 high.

Crude oil prices have sunk to their lowest level since November as Brent slid below the psychologically critical $50 a barrel level. The latest spasm of selling was triggered by reports of Libya’s return to the oil export market and Kremlin spokesman Dimitri Pashov’s denial that Russia has decided to extend the Saudi brokered pact to extend last December’s output cut deal. IEA data shows US output is now 9.29 million barrels per day and the Baker Hughes land rig count (a proxy for shale drilling) has doubled since last year. Saudi Arabia and OPEC face a strategic dilemma at their next conference in Vienna. Either extend the output cut pact with Russia as part of the deal or Saudi Arabia abandons the role of swing producer. This means an oil crash once again, as Euro/Norwegian kroner (at 9.48) suggests.

Macro Ideas – Modinomics and Indian financial markets

It has now been three years since Narendra Modi swept the BJP into power in the 2014 general election with the highest majority since Rajiv Gandhi’s election on a sympathy vote just after his mother’s assassination three decades earlier. Modi’s reputation – as a pro-business reformer as chief minister of Gujarat – preceded him while a succession of sordid corruption scandals eroded the last vestiges of political legitimacy for Congress under the ostensible rule of ‘Mr Clan’ Dr Manmohan Singh. Modi’s rule has proved to be a game changer for the Indian economy. The Goods and Services Act (GST) has the potential to add a full percentage point to India’s GDP growth rate, now a stellar 7%. Modi also deregulated diesel and natural gas prices and moved to end retrospective taxation of foreign investments. Modi reformed the coal mining sector and instituted transparent auction regime on telecom spectrum.

The rupee redenomination last November had major execution flaws but will add $265 billion in new deposits into the Indian banking system and penalize ‘black money’ hoarding. The bankruptcy law is mission critical to defuse the non-performing loan time bomb at the heart of India’s predominantly state owned banking system.

Political metrics and financial markets have both vindicated Modinomics. In 2017, the Indian rupee has appreciated 4% against the US dollar to 64 as I write. The Sensex index of India equities scaled 30,000 and India now trades at the highest valuation metrics in Asia, up 18% in the past twelve months. Above all, Modi’s BJP win in the state elections in Uttar Pradesh, India’s most populous state and set the stage for BJP dominance Rajya Sabha (upper house) and a victory in the 2019 general election. To add insult to injury, BJP even beat Aaam Aadmi Party (AAP) leader Arvind Kejrival, an anti-corruption zealot, on his home turf in New Delhi local elections.

However, the ancient Greeks believed in the concept of hubris (the idea so brilliantly presented in Sophocles plays), that excessive pride precedes a great fall. Modi has taken political and economic decisions that could prove disastrous for India’s future as a liberal, secular parliamentary democracy. Modi selected a communal demagogue like Yogi Adityanath as the chief minister of Uttar Pradesh. He has not repudiated his own support base in the fanatical RSS, whose activists assassinated Mahatma Gandhi in January 1948. Modi has imposed price controls on airline tickets, medical devices and pharmaceuticals. He also sacked Dr Raghuram Rajan, arguably the finest Indian monetary economist alive, as Governor of the Reserve Bank of India.

The strong US April jobs data ensures two more Fed rate hikes in 2017. The UK snap election will mean Mrs May will be reelected with a large Conservative party majority in the Commons. These factors, coupled with BJP economic advisor Arvind Subramanian’s aversion to a strong rupee since it hits Indian export growth, leads me to position for a fall to 65. However, despite the $15 billion in offshore money attracted to Dalal Street in 2017, I doubt the RBI will cut interest rates as local banks are flush with deposits due to last November’s banknote reforms. The monsoons will also boost food price inflation and GDP growth has been robust. This means the RBI will be on hold in the next four months while the Federal Reserve increases rates by at least another 50 basis points. The Indian rupee could well slip to 65.40 before the bullish uptrend resumes.

The Macro View

About Matein Khalid

Matein Khalid

Matein Khalid is Chief Investment Officer of Asas Capital in the DIFC; he is responsible for global investment strategy and the development of the multi family office platform. He has worked in Wall Street money centre banks, securities firms and hedge funds in New York, London, Chicago and Geneva. In addition, he has been an advisor for royal investment offices in the Gulf for 8 years. Mr Khalid has four degrees in finance, economics, banking and international relations from the Wharton School, University of Pennsylvania. He is a director at the American College of Dubai and has taught MBA level courses in commercial/investment banking at the American University of Sharjah and British University of Dubai. He writes the Global Investing columns for Khaleej Times, Gulf Business and Oman Economic Review.

Articles by Matein Khalid

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