Markets Are Broken and Nothing Is Working
(Bloomberg Opinion) -- For investors, 2018 is poised to go down in the record books ... but not in a good way. With less than three months left in the year, global benchmarks for stocks, bonds, commodities and currencies are all down. It's rare for all four to be down in a year, and it has only happened once before — in 2015 — in data going back to 2004. It would be easy to write off the poor performance as an anomaly that will soon correct until you realize that the factors weighing on global markets aren't likely to go away anytime soon.
The most obvious culprit is the Federal Reserve. The central bank is on track to raise interest rates four times this year, and seems intent on boosting them at least three more times in 2019, according to Bloomberg News's Wes Goodman, who pointed out the poor performance of global financial assets. Those rate increases are having a ripple effect, most notably on short-term bonds and emerging-market assets. But the Fed isn't the only culprit. Other major central banks are joining the Fed in lifting rates from crisis-era lows or are looking for any excuse to do so. They are also starting to withdraw liquidity in other ways. The collective balance-sheet assets of the Fed, European Central Bank, Bank of Japan and Bank of England, which grew steadily to 37.2 percent of their countries’ total GDP at the end of 2017 from less than 20 percent in 2011, have shrunk to 36.6 percent this year, data compiled by Bloomberg show. If the trend holds, 2018 would mark the first such decrease since 2006. And just like you can't put all the blame on the Fed, you also can't pin all the blame the central bank community. Political worries — from Brexit jitters in the U.K. to turbulence in Italy, Turkey and Brazil — as well as trade-war concerns are also playing the villain. The Paris-based Organization for Economic Cooperation and Development said in late August that during the second quarter, international trade in merchandise by the world’s biggest economies contracted for the first time since 2016 against a backdrop of a stronger dollar and rising protectionism.
It's no wonder that the International Monetary Fund last week trimmed its 2018 global economic growth forecast to 3.7 percent from the 3.9 percent it had forecast in July. It was the IMF's first downgrade since July 2016. Of course, there are some winners: U.S. stocks are holding onto a small gain, junk bonds are eking out a positive total return, oil and related energy commodities are rising and the dollar and yen are stronger than they were. But those are increasingly looking like the exception in a global market just wanting to get 2018 over with as fast as possible.
A BULLISH COMMENT ON BONDS
Late Tuesday afternoon, the U.S. Treasury Department released its monthly report on foreign ownership of U.S. Treasuries. The data showed that those outside the U.S. increased their ownership of U.S. government bonds in August by $35.5 billion to $6.29 trillion. That’s welcome news at a time when the Treasury increasingly needs to see demand for its debt as the government steps up borrowing to finance what will soon be a $1 trillion budget deficit. The downside — and what most media reports focused on — was that Japan and China, the two largest foreign owners, decreased their holdings. China's shrunk by $6 billion to $1.17 trillion and Japan's fell by $5.6 billion to $1.03 trillion. But that doesn't tell the full story, according to David Ader, who for 11 years running was ranked as the No. 1 U.S. government bond strategist by Institutional Investor magazine. In a note, Ader points out that much of the declines were due to a reduction in the amount of very short-term Treasury bills held by China and Japan. More importantly, their holdings of longer-term securities actually rose, with China's increasing by $9.4 billion in the largest gain since February and Japan's rising by $4.5 billion. "From a portfolio perspective they've gained duration, which seems like a bullish comment" on the U.S. bond market, Ader wrote in the note.
THE WAIT IS OVER
The Treasury Department stopped short of calling China a currency manipulator in its much-awaited foreign-exchange policy report to Congress. Now, everyone can go back and focus on whether the yuan will weaken beyond 7 per dollar for the first time since 2008 (it was at 6.9275 Wednesday) and whether that will sway the Treasury's views going forward. Still, it's a good time to remind yourself that China takes a more holistic view of its currency. Chinese officials actually look at the yuan versus a basket of 24 currencies. No one knows exactly what weights China assigns each of the currencies in the basket, but the thing to know is that the yuan just dropped to its lowest ever against a Bloomberg replica of the CFETS RMB Index basket, which was started in 2015. The Bloomberg CFETS RMB Index fell 0.09 percent to 92.07 on Wednesday, bringing its drop since mid-June to 6.18 percent. The decline is in line with China’s easing measures to support growth, said Irene Cheung, a currency strategist at Australia & New Zealand Banking Group in Singapore. China may allow the index to dip slightly below 92 as long as the move is gradual and the yuan is stable versus the dollar, according Bloomberg News's Emma Dai, who was citing Cheung.
PARIAH NO MORE
Turkey, which has seen its currency collapse as much as 43 percent this year and its borrowing costs soar, persuaded bond investors to scoop up $2 billion of five-year bonds. If getting the sale done wasn’t surprise enough, investors placed bids for more than three times the amount of bonds that were sold, allowing Turkey to reduce the yield by 25 basis points to 7.5 percent, according to according to Treasury and Finance Minister Berat Albayrak. The issue ends a six-month hiatus for Turkish international debt sales and may set a benchmark for the country’s dollar-starved banks to follow, according to Bloomberg News. It also comes just days after Turkey released U.S. Pastor Andrew Brunosn, settling a conflict that strained ties with the U.S. The Turkish economy relies heavily on foreign-capital inflows to finance its vast funding shortfall, and much of that cash comes in through the nation’s lenders, which need to maintain access to international capital markets in order to keep credit flowing. “If the currency continues to stabilize and there are no negative surprises between now and year-end, the outlook for 2019 will be much more encouraging,” Daniel Moreno, the London-based head of global emerging-market debt at Mirabaud Asset Management Ltd., which oversees $8 billion, told Bloomberg News. Turkey's lira rose to its strongest level since early August amid the bond sale, and its benchmark index of stocks also gained.
SUGAR IS SWEET
Outside of energy, there are few commodities that have sparked any excitement this year. Sugar looks like it wants to change that. Prices have soared 26 percent since late September. That marks a dramatic turnaround to start the fourth quarter, after it recorded the biggest slump among major commodities in the nine months that ended in September, according to Bloomberg News's Fabiana Batista. Sucden Financial Ltd. cited three bullish reasons that emerged during a sugar conference last week in London: the timing of India’s exports, Brazil’s ethanol demand and a shift in strategy by hedge funds. With the rally, “the urgency has perhaps lessened” for India to boost exports as part of a plan to aid mills, Nick Penney, a senior trader at Sucden in London, wrote in a report. In Brazil, the world’s biggest sugar producer, motorists have “become used to filling the tank with ethanol, and the habit should continue” after a change in government policies on gasoline pricing made the cane-based fuel more competitive, according to Penney. Also, speculators have rushed to unwind bearish bets, partly because of the low volume of sugar delivered against the expiration of October futures, Bruno Lima, head of sugar at INTL FCStone in Campinas, told Batista. In the week ended Oct. 9, net-short positions were down 72 percent to 46,213 futures and options contracts from the record in April, government data showed on Oct. 12.
Federal Reserve Bank of St. Louis President James Bullard is scheduled to give a speech at the Economic Club of Memphis on the outlook for the U.S. economy. Bullard isn't a member of the rate-setting Federal Open Market Committee, so his speeches tend to carry little weight in the markets. But that will soon change, as Bullard becomes a voting member of the FOMC next year. Public comments by Bullard put him squarely in the camp of the doves, according to Bloomberg Economics, which is to say he's against tighter monetary policy. More specifically, Bullard has expressed doubts about the need to raise interest rates further. Such views will likely make him one of the staunchest opponents of the FOMC’s baseline forecast of three rate hikes next year, according to Bloomberg Economics. Bullard could even become the first official dissenter of committee action under Fed Chairman Jerome Powell.
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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.
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