Macro Battleship with Christopher Wood

There has been a lack of currency volatility for most of 2019. But of late that has begun to change. The U.S. dollar has begun to sell-off. The U.S. Dollar Index has declined by 1.6% from its recent high reached in late May, though it is now 1% above its recent low reached in late June (see following chart). It is also the case that gold has risen above the perceived critical US$1,360/oz level (see following chart).

U.S. Dollar Index

US Dollar Index - July 2019

Source: Bloomberg

Gold Bullion Price

Gold bullion price

Source: Bloomberg

I will assume for now that the soft dollar trend persists at least through to the FOMC meeting on July 30-31. With the consensus expecting a 25bp cut, the action on the U.S. dollar will probably depend on whether this is just a single 25bp “insurance” cut or the beginning of a monetary easing cycle.


A Weak Dollar Bodes Well for Asia

A weaker dollar, if sustained, would be good for Asia and emerging markets given the longstanding negative correction. The correlation between the U.S. Dollar Index and the MSCI Emerging Markets Index has been a negative 0.89 since October 2016 (see following chart). Since the U.S. Dollar Index peaked in late May, the MSCI Emerging Markets Index has risen by 6.7% over the same period.

U.S. Dollar Index and MSCI Emerging Markets Index

US Dollar Index and MSCI Emerging Markets Index

Source: Bloomberg

Bank Indonesia policy rate and CPI inflation

Bank Indonesia policy rate and CPI inflation

Source: Bank Indonesia, CEIC Data

A weaker U.S. dollar will also make it easier to do what most Asian central banks want to do anyways. That is to cut interest rates. Indonesia is a good example. Bank Indonesia could easily cut its policy 7-day reverse repo rate by 100bp in the next 12 months from 6% to 5% (see previous chart). The same potential for a further 100bp of easing also applies in India where the policy repo rate is currently 5.75% and where, unlike Indonesia, monetary easing has already begun, with the new RBI Governor Shaktikanta Das having already cut the rate by 75bp since he was appointed in December (see following chart).

The reason there has been so much room to cut rates is because the previous RBI Governor got the inflation forecast badly wrong, so the Indian economy was facing unnecessarily high real interest rates for an extended period. The real repo rate, deflated by CPI inflation, rose from 0.4% in July 2017 to 4.4% in January 2019 and is now 2.5%.

RBI Policy Repo Rate and CPI Inflation

RBI policy repo rate and CPI inflation

Source: CEIC Data, RBI

Korea is an example of slowing export growth in Asia with exports declining for seven straight months, with shipments to China declining for eight consecutive months.

In both India and Indonesia in recent years the main driver of the sharp decline in inflation has been falling food inflation, helped by increased productivity and improved distribution connectivity. CPI inflation in India has slowed from 11.5% in November 2013 to 2% in January and was 3.2% in June, while food inflation fell from 17.9% in November 2013 to a negative 2.6% in December 2018 and was 2.2% in June. Similarly, CPI inflation in Indonesia has slowed from 8.4% in December 2014 to 3.3% in June, while food inflation fell from 10.6% to 4.9% over the same period.

If a weak U.S. dollar is a following wind for Asia and emerging markets, these markets must also contend with the negative growth environment caused by trade wars and the like. On this point, Asian exports continue to decline. Asia ex-China exports declined by 5.2%YoY in May and were down 4.1%YoY in the first five months of 2019.

Korea is as good an example as any of slowing export growth in Asia, at least part of which must be trade war and tech war connected. Korean exports have now declined for seven straight months, with shipments to China declining for eight consecutive months. Korean total exports declined by 13.5%YoY in June after a 9.7%YoY decline in May, while exports of semiconductors and exports to China collapsed by 25.5%YoY and 24.1%YoY respectively in June (see following chart).

The continuing weak trend remains in the context of an interesting divergence between the DRAM price and DRAM stocks, which have continued to move in opposite directions since the start of the year. Samsung Electronics and SK Hynix are up 20% and 23% respectively year-to-date. By contrast, DRAM spot prices have collapsed by 49% so far in 2019 (see following chart).

Korea Export Growth

Korea export growth

Source: CEIC Data

DRAM Price and Korean DRAM Stocks

DRAM price and Korean DRAM stocks

Source: Bloomberg

The Rise of Bitcoin and the Distrust of the Fiat Paper System

Returning to the subject of gold’s breakout and a weaker U.S. dollar, I have also already made reference to the phenomenal rebound in Bitcoin, which remains above US$10,000 after having made a low of US$3,100 late last year, down 84% from the peak of US$19,500 reached in December 2017. It is now US$11,907. The long-term chart of Bitcoin continues to look extremely positive again (see following chart).

Bitcoin Spot Price

Bitcoin spot price

Source: Bloomberg

One of the many interesting aspects of Bitcoin is that it reflects distrust of the current fiat paper system. In this sense, Bitcoin and physical gold share similar characteristics. While the grounds for distrusting the fiat paper system have become ever clearer as it has become only too evident from central bankers’ recent chatter that the G7 economies cannot tolerate any level of positive real interest rates whatsoever.

Thus, markets began to show stress last year when U.S. interest rates went slightly positive in real terms. The real 3-month T-bill yield, deflated by core CPI, turned positive in September 2018 while the S&P500 peaked in the same month and subsequently declined by 20% to a low reached in late December (see following chart). The real 3-month T-bill yield has since risen from 0.03% in September 2018 to 0.34% in February and is now 0.14%.

The emerging markets are a different matter, of course, as discussed above with reference to India and Indonesia. This is why emerging market sovereign credit ratings should long since have been upgraded and G7 sovereign credit ratings downgraded in the post-2008 era because the former still run orthodox monetary and fiscal policies. But that has not happened for obvious reasons. 

US Real 3-month T-bill Yield and S&P500

US real 3-month T-bill yield and S&P500

Source: Bloomberg

The views expressed in Chris Wood’s column on Grizzle reflect Chris Wood’s personal opinion only, and they have not been reviewed or endorsed by Jefferies. The information in the column has not been reviewed or verified by Jefferies. None of Jefferies, its affiliates or employees, directors or officers shall have any liability whatsoever in connection with the content published on this website.

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