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Vaccine arrival expected to trigger dollar slump in 2021



Wall Street analysts expect the arrival of a vaccine against coronavirus to send the dollar sinking next year as confidence returns to the global economy.

Big banks with already negative views on the dollar for 2021 cut their forecasts further this month after clinical trials bolstered hopes that vaccines could become widely available next year, sparking an economic rebound that encourages a hunt for riskier bets.

The dollar is typically in demand in times of stress, reflecting its traditional role as a haven for investors and savers, as seen in a startling rally at the height of the coronavirus outbreak in March. Now some currency watchers believe a vaccine changes everything.

“Vaccine distribution we believe will check off all of our bear market signposts, allowing the dollar to follow a similar path to that it experienced from the early to mid-2000s,” Citi analyst Calvin Tse said in a research note. “Can the dollar decline 20 per cent next year alone? We think yes,” the bank added.

That would be a big move in currency terms. According to consensus forecasts compiled by Bloomberg, investors anticipate the dollar index will slip roughly 3 per cent from its current level by the end of next year. The median forecast is for the euro to reach $1.21 over that time period, from about $1.18 now.

Line chart of US Dollar index showing Dollar has fallen sharply this year

A fall of 20 per cent for the dollar, on a trade-weighted basis, would be the biggest since the slide that started in 2001. But that 33 per cent drop took several years, when other currencies — particularly in emerging markets — pushed higher as investors sought out countries with higher interest rates and rapid growth. It lasted until the 2008 financial crisis.

Citi expects the US Federal Reserve to continue providing stimulus to the economy and to “err on the side of caution” before considering interest rate increases even as the global economic recovery speeds up. That could encourage investors to find a home for their money elsewhere, as rising inflation expectations in the US reduce the dollar’s relative attractiveness and investors target faster-growing countries that may tighten monetary policy sooner.

The dollar index — a measure of the currency against six peers — has already declined this year, falling more than 4 per cent since the start of 2020, after the Fed wiped out some of the yield advantage US assets had enjoyed over their peers. The euro has gained nearly 6 per cent against the buck since January, while the Australian dollar has marched more than 4 per cent higher.

But this year’s drop in the dollar index is minor compared with its gains in previous years: it rose almost 13 per cent in 2014 and 9 per cent in 2015. Buying into US markets has been “almost unavoidable” over the past decade, according to analysts at Goldman Sachs, as corporate profits boomed and the Fed raised rates while many other central banks stayed closer to zero. This has made the currency expensive, setting it up for large falls ahead, said Zach Pandl, co-head of the bank’s global foreign exchange research. Goldman Sachs expects the dollar to slide 6 per cent on a trade-weighted basis over the next 12 months.

Bar chart of % gain/loss against the US dollar showing Most G10 currencies have risen against the buck in 2020

Mr Pandl said the currency should weaken even if the US economy gathers pace because of its role as a “barometer” of the health of the global economy, falling when growth is buoyant and rising at times of slowdowns.

“Even if the US economy performs quite well, we think the dollar can weaken substantially as investors look for higher returns outside of the US and exit the safe havens that they have been in throughout the Covid period,” he added.

Andrew Sheets, a cross-asset strategist at Morgan Stanley has pencilled in a 4 per cent drop in the dollar index and expects the Norwegian, Swedish, New Zealand and Australian currencies to outperform once the vaccine is widely available. The euro and emerging markets peers such as the Brazilian real, the South African rand and the Russian rouble also have room to appreciate against the buck, he said. Mr Sheets sees the euro trading at $1.25 by the end of next year.

“We are in the perfect environment for a rally in risky assets, a weaker dollar and stronger growth-sensitive currencies through the end of the year,” said George Saravelos, global head of currency research at Deutsche Bank.

But some strategists are decidedly more cautious, in light of the surge in coronavirus cases worldwide and the economic damage of renewed lockdown measures.

“We are just very bullish on the dollar as we go into year-end,” said Mark McCormick, global head of FX strategy at TD Securities. “Every single piece of good news has been emphasised and every single bad reality has been shoved aside.”

Analysts at Barclays have also flagged concerns that too small or too delayed a fiscal package from US policymakers could take the shine off risky assets and shore up demand for havens.

“Markets at some point have to respect the present tense rather than just look ahead,” added Mr McCormick.

Goldman’s Mr Pandl argues, however, that the positive vaccine trials significantly reduce investors’ hunger for safety. “The vaccine developments are sufficiently positive that most investors should be positioning for dollar weakness today,” he said.

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Pimco’s Ivascyn warns of inflationary pressure from rising rents




US Inflation updates

A leading US bond manager has warned of inflationary pressure from housing rental costs that could push interest rates higher and overturn a sense of complacency among investors.

The comments by Dan Ivascyn, chief investment officer at Pimco, which has $2.2tn under management, comes after US 10-year interest rates eased in recent months to about 1.25 per cent. Fears of an inflation surge sparked alarm among bond investors at the start of the year and pushed the important benchmark to a peak of 1.75 per cent by the end of March.

“There is a lot of uncertainty on inflation and while our base case is that it proves transitory, we are watching the relationship between home prices and rents,” Ivascyn told the Financial Times. “There may be more sustained inflation pressure from the rental side.”

Owners’ equivalent rent is a key input used for calculating the US consumer price index. As rents become more expensive, investors could become increasingly concerned about “sticky inflation”, pushing the 10-year Treasury yield back towards 1.75 per cent, said Ivascyn. 

Line chart of US 10-year expected rate of inflation showing long-term bond market inflation expectations loiter near decade peaks

The Federal Reserve said in its latest policy statement last week that it had made “progress” towards its goals of full employment and 2 per cent average inflation. Jay Powell, the Fed’s chair, said there was more “upside risk” to the inflation outlook, although he expressed confidence in transitory price pressure over time.

The latest measure of core consumer prices, which is followed by the central bank, ran at 3.5 per cent over the 12 months to June, the fastest pace since July 1991.

“There is a lot of noise and uncertainty in the data” and “the Fed has a difficult job deciphering the economic information coming in”, said Ivascyn.

The fund manager said the potential for much higher bond yields is probably capped by the prospect of the central bank tightening policy in the event of inflation expectations breaking higher.

Bar chart of assets under management ($bn) showing Pimco Income ranks as the largest actively managed bond fund

“We do believe if the Fed sees inflation expectations rise out of their comfort zone, that they will probably act,” said Ivascyn. “That has been the message from Powell’s last two press conferences.”

Pimco expects the central bank will announce a tapering of its current $120bn monthly bond purchases later this year, with a view to starting the process in January. While the policy shift is being “well telegraphed” and data dependent, Ivascyn said higher bond yields and more market volatility were likely.

“This is a tough market environment and it is a time when you want to be careful,” he said, adding that Pimco had been reducing its exposure to interest rate risk as the bond market had pulled borrowing costs lower. 

“Valuations are stretched and it makes sense to adjust our portfolios.”

Ivascyn oversees the world’s largest actively managed bond fund, according to Morningstar. The $140bn Pimco Income Fund co-managed with Alfred Murata, has a total return of 2 per cent this year, versus a slight decline in the Bloomberg Barclays US Aggregate index. Over the past year, the fund has extended its long record of beating its benchmark, according to Morningstar.

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Wall Street stocks follow European and Asian bourses lower




Equities updates

Wall Street stocks followed European and Asian bourses lower on Friday after markets were buffeted this week by jitters over slowing global growth and Beijing’s regulatory crackdown on tech businesses.

The S&P 500 closed down 0.5 per cent, although the blue-chip index still notched its sixth consecutive month of gains, boosted by strong corporate earnings and record-low interest rates.

The tech-focused Nasdaq Composite slid 0.7 per cent, after the quarterly results of online bellwether Amazon missed analysts’ forecasts. The tech conglomerate’s stock finished the day 7.6 per cent lower, its biggest one-day drop since May 2020.

According to Scott Ruesterholz, portfolio manager at Insight Investment, companies which saw significant growth during the pandemic may see shifts in revenue as consumers move away from online to in-person services.

“[Consumers are] going to start spending more on services, and so those businesses and industries which have benefited in the last year, companies like Amazon, will be talking about decelerating sales growth for several quarters,” Ruesterholz said.

The sell-off on Wall Street comes after the continent-wide Stoxx Europe 600 index ended the session 0.5 per cent lower, having hit a high a day earlier, lifted by a bumper crop of upbeat earnings results.

For the second quarter, companies on the Stoxx 600 have reported earnings per share growth of 159 per cent year on year, according to Citigroup. Those on the S&P 500 have increased profits by 97 per cent.

But “this is likely the top”, said Arun Sai, senior multi-asset strategist at Pictet, referring to the pace of earnings increases after economic activity rebounded from the pandemic-triggered contractions last year. Financial markets, he said, “have formed a narrative of peak economic growth and peak momentum”.

Column chart of S&P 500 index, monthly % change showing Wall Street stocks rise for six consecutive months

Data released on Thursday showed the US economy grew at a weaker than expected annualised rate of 6.5 per cent in the three months to June, as labour shortages and supply chain disruptions caused by coronavirus persisted.

Meanwhile, China’s regulatory assault on large tech businesses has sparked fears of a broader crackdown on privately owned companies.

“It underlines the leadership’s ambivalence towards markets,” said Julian Evans-Pritchard of Capital Economics. “We think this will take a toll on economic growth over the medium term.”

Hong Kong’s Hang Seng index closed 1.4 per cent down on Friday, while mainland China’s CSI 300 dropped 0.8 per cent, after precipitous slides earlier in the week moderated.

Japan’s Topix closed 1.4 per cent lower, after the daily tally of Covid cases in Tokyo surpassed 3,000 for three consecutive days. South Korea’s Kospi 200 dropped 1.2 per cent.

The more cautious investor mood on Friday spurred a modest rally in safe haven assets such as US government debt, which took the yield on the 10-year Treasury, which moves inversely to its price, down 0.04 percentage points to 1.23 per cent.

The Federal Reserve, which has bought about $120bn of bonds each month throughout the pandemic to pin down borrowing costs for households and businesses, said this week that the economy was making “progress” but it remained too early to tighten monetary policy.

“Tapering [of the bond purchases] could be delayed, which in many ways is not bad news for the market,” said Anthony Collard, head of investments for the UK and Ireland at JPMorgan Private Bank.

The dollar, also considered a haven in times of stress, climbed 0.3 per cent against a basket of leading currencies.

Brent crude, the global oil benchmark, rose 0.4 per cent to $76.33 a barrel.

Unhedged — Markets, finance and strong opinion

Robert Armstrong dissects the most important market trends and discusses how Wall Street’s best minds respond to them. Sign up here to get the newsletter sent straight to your inbox every weekday

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US regulators launch crackdown on Chinese listings




US financial regulation updates

China-based companies will have to disclose more about their structure and contacts with the Chinese government before listing in the US, the Securities and Exchange Commission said on Friday.

Gary Gensler, the chair of the US corporate and markets regulator, has asked staff to ensure greater transparency from Chinese companies following the controversy surrounding the public offering by the Chinese ride-hailing group Didi Chuxing.

“I have asked staff to seek certain disclosures from offshore issuers associated with China-based operating companies before their registration statements will be declared effective,” Gensler said in a statement.

He added: “I believe these changes will enhance the overall quality of disclosure in registration statements of offshore issuers that have affiliations with China-based operating companies.”

The SEC’s new rules were triggered by Beijing’s announcement earlier this month that it would tighten restrictions on overseas listings, including stricter rules on what happens to the data held by those companies.

The Chinese internet regulator specifically accused Didi, which had raised $4bn with a New York flotation just days earlier, of violating personal data laws, and ordered for its app to be removed from the Chinese app store.

Beijing’s crackdown spooked US investors, sending the company’s shares tumbling almost 50 per cent in recent weeks. They have rallied slightly in the past week, however, jumping 15 per cent in the past two days based on reports that the company is considering going private again just weeks after listing.

The controversy has prompted questions over whether Didi had told investors enough either about the regulatory risks it faced in China, and specifically about its frequent contacts with Chinese regulators in the run-up to the New York offering.

Several US law firms have now filed class action lawsuits against the company on behalf of shareholders, while two members of the Senate banking committee have called for the SEC to investigate the company.

The SEC has not said whether it is undertaking an investigation or intends to do so. However, its new rules unveiled on Friday would require companies to be clearer about the way in which their offerings are structured. Many China-based companies, including Didi, avoid Chinese restrictions on foreign listings by selling their shares via an offshore shell company.

Gensler said on Friday such companies should clearly distinguish what the shell company does from what the China-based operating company does, as well as the exact financial relationship between the two.

“I worry that average investors may not realise that they hold stock in a shell company rather than a China-based operating company,” he said.

He added that companies should say whether they had received or were denied permission from Chinese authorities to list in the US, including whether any initial approval had then be rescinded.

And they will also have to spell out that they could be delisted if they do not allow the US Public Companies Accounting Oversight Board to inspect their accountants three years after listing.

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