Global Macro Outlook September 2017

The Great Reversion: Returning to Economic Reality

  • In this month’s edition of the Global Macro Outlook, we will look at two unique divergences between the economic hard data and general market sentiment. Building on those themes, we will see how we can translate these macro data trends into actionable trade ideas for the private trader or investor.

 

  • The first of these themes is what we might call a broad-based show of strength from the European economies. In Germany, for example, the Federal Statistics Office has noted a “Magic Square” of positive macroeconomic effects: GDP growth of more than 2% YoY, unemployment rate at a multi-decade low (below 4%), export levels are at record highs, in addition to stable inflation. Elsewhere, in the Czech Republic, unemployment rates have plummeted from 5.3% at the beginning of the year to a mere 4.4%. The number of job vacancies are on a steady uptrend, and wage growth is averaging at more than 6% YoY – so much so that the Czech National Bank (CNB) proclaimed that they are “likely to raise interest rates”. Even in Spain, we see that quarterly GDP growth rates are averaging at around 0.9%, returning to the kinds of levels achieved prior to the ’08 Crisis.

 

  • Broad-based strength in the Eurozone of course calls into the question the record-low levels of interest rates that are being maintained by the European Central Bank, and whether the macro data calls for such accommodative policies. This would lead us to expect higher European bond yields moving forward and equally higher expectations for the Euro.
  • On the flip-side of Euro Strength, what we’re also seeing is weaker data coming out of the U.S., with most of the economic data conflicting with initial projections of U.S. strength. Earlier dot-plots made by Federal Reserve had indicated that they expected the Fed Funds Rate in 2017 to be as high as 4%. However, the current Fed Funds Effective Rate is at a mere 1.16%, which is far below the levels that the Fed has projected. This, of course, has serious implications for the momentum for the U.S. Dollar: with expectations for bond yields having to correct downwards and economic expectations for the U.S. market much lower-than-expected, we expect the U.S. Dollar to break further downwards.

 

  • Finally, given these hugely divergent themes that are happening in vastly different environments, in what ways can we express the singular thematic idea? A simple and easily executable expression of the theme would be via the EUR/USD currency pair. As we can see from the medium-term chart on the left, there has been a strong bullish pattern forming in the currency pair, likely as an effect of more and more money realising the over-optimism and pessimism for the U.S. and Eurozone respectively.

 

  • The pair has made a strong breakout to the upside following ECB head Mario Draghi’s comments at the Jackson Hole conference, in addition to Fed Chair Yellen’s more-or-less dovish stance towards monetary policy. Traders and currency investors can use this opportunity to anticipate a reversion to the 1.18000 baseline before taking up a long position.

Nicholas Tan Wei Hong