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Fed’s policy calculus and global financial markets

|By Matein Khalid| The April payrolls data demonstrated that US economic growth has hit a soft patch. The US economy only added 160 jobs in April, less than the expected 203,000 average in the first three months of 2016. One disappointing data point does not imply a macroeconomic trend reversal since the US economy added 2.8 million jobs between March 2015 and March 2016. Statistical and measurement errors alone can explain a single month’s job growth slump and the rise in average hourly earnings and wage growth demonstrates that the US labour market is hardly in crisis. Auto sales are 17 million units, a post crisis high. The epic fall in gasoline prices is a de facto “tax cut” for the US consumer, 70% of the American GDP.

While New York Federal Reserve President Bill Dudley said that the softer April payroll data does not rule out any chance of a Fed rate hike in June, the financial markets assign a minimal probability to this scenario. However, since first quarter GDP fell to 0.5%, the Yellen Fed will most probably wait till the late July FOMC to determine if economic growth gained momentum in the second quarter. The June 23 British referendum on the EU is another macro risk that the American central bank will want to do nothing next month and wait for the July FOMC. A July rate hike then needs stronger payroll growth in May and June and no Brexit vote in the referendum.
Goldman Sachs US economist team has postponed its timetable for the next Fed rate hike from June to September FOMC. The Federal Reserve has slashed its projected rate hikes from four to two in 2016. Janet Yellen is risk averse since the December rate hike led to carnage in the global financial markets and US growth data for the past year barely add up to 1.9% GDP growth and inflation well below the central bank’s 2% target. However, the Federal Reserve now runs the risk of raising rates just as the US Presidential election reaches its endgame. Donald Trump has already suggested to replace Janet Yellen, a clear threat to the political independence of the Fed. The Chicago interest rate futures markets suggest only 6% odds of a Fed rate hike in June but 52% by December 2016. It is even possible that if the US economy just “muddles through”, the Yellen Fed will not raise interest rates until after the November election. The two year US Treasury note has fallen to 0.7% from 1.05% year to date, a clear signal that the Uncle Sam security most sensitive to changes in the Fed’s monetary policy outlook, does not expect any imminent interest rate rise.
The US Dollar Index has fallen 6% in 2016 as investors have priced in deferred Fed interest rate hikes by the first half of 2016. The Japanese yen has risen 10% against the US dollar in 2016 to 106 as the Bank of Japan has not delivered another “shock and awe” policy easing. The Euro has risen to 1.14 despite negative ECB deposit rates and macro political risks (the migrant crisis, Russia sanctions, UK referendum and Spain). A lower US dollar, delayed Fed tightening and stronger commodities prices have led to bull markets in emerging currencies, led by the Brazilian Real and the Russian Rouble. Yet the resignation of Turkish Prime Minister Ahmet Davutoglu after losing a power struggle with President Erdogan shows that political risk can devastate emerging markets. The fall in the US dollar has not had a bullish impact on the GCC property markets, as bear markets due to high supply, credit market stresses and job losses continue.
After Brent and West Texas crude benchmark rose 60% from their late January lows, the oil markets had their first losing week. Oil bulls focus on the fall in US shale output from 9.6 to 9.1 MBD and the collapse in capex/exploration in non-OPEC states as well as a Saudi-Russian output freeze but the global oil markets still suffer from a glut in black gold. This is the reason Brent crude fell 5.8% last week, despite the wildfire crisis in Alberta. Canada, after all, is the largest supplier of crude to the US, at 3.6 MBD. If global growth declines, Brent crude could well fall to 38-40 this autumn.
Macro Ideas – Value, risk and strategy in Singapore equities
As Southeast Asia’s most trade (China!) and property centric city-state, it is no coincidence that Singapore’s economic growth rate has fallen to its lowest level since 2009 at only 2%. In fact, the Monetary Authority of Singapore (MAS) forecast is even lower at 1.9%, the reason the MAS cut the slope of its appreciation path for the Singapore dollar. Even the oil price crash has hit Singapore since it is a regional hub for oil rig construction and energy storage, with major companies Sembcorp Marine and Keppel are major exporters in the sector. Singapore is also the victim of mild deflation, as the consumer price inflation falls to -0.2%. Yet some of the highest rents in Southeast Asia mean core inflation still remains at 0.8%.
Even though the Singapore dollar has risen from 1.44 to 1.35 now, the MAS shocked the financial markets with a clear preference for a lower Sing dollar, which I would not be surprised to see ease to 1.38 – 1.40 if capital flows exit Asia ahead of potential FOMC rate hikes. The Straits Times Index, though it bottomed at 2540 in February, trades at a modest 12 times earnings, an entire one standard deviation below its historic range, a testament to poor Asian export and earnings growth fundamentals. Yet there is no credible argument for a valuation rerating in Singapore, as the cyclical growth picture is so awful, with Chinese real GDP growth now having fallen to 25 year lows.
Singapore is one of the world’s great economic success stories. Expelled by Malaysia from its Federation, traumatized by its fall to a brutal Imperial Japanese army in 1942, vulnerable to threats from Sukarno’s Indonesia, Singapore emerged as an Asian tiger with one of the world’s highest GDP per capita despite no oil wealth and four decades of 7% plus GDP growth rate. Yet Singapore’s growth rate has dropped to only 2.5% since the failure of Lehman Brothers in 2008 and the ruling People’s Action Party has been forced to confront the social cost of unrestricted immigration and one of the most overvalued property markets in Asia.
Yet Singapore’s government elite, the ultimate technocratic legacy of the late statesman Lee Kwan Yew and father of the current Prime Minister, will unquestionably reinvent its business model to sustain growth in the new digital, networked global economy. The Budget, however, did not inject fiscal stimulus on a scale sufficient for an economy where manufacturing, exports and services have all contracted sharply in 2011, thanks to the trade chill from China and the fall in commodities prices. It is entirely possible Singapore goes into technical recession this summer. A services growth contraction is scary because Singapore is Southeast Asia’s banking, insurance, aviation, retail and container shipping hub. This shock probably triggered the MAS neutral policy on the exchange rate since the Sing dollar NEER is its sole monetary policy lodestar.
I used to buy Temasek crown jewels DBS and City Development to profit from the Singapore miracle in banking and property. Yet I cannot recommend Singapore banks due to their alarming exposure to China, energy and commodities. The property market is in a downcycle and office REIT’s will be hit hard as banks like Stan Chart/RBS shrink space usage and renegotiate leases even while Khazanah and Temasek add more than 2 million square feet of fresh office space to a glutted CBD market. The next Singapore double/triple baggers are in Southeast Asia’s exciting E-commerce revolution as smartphones and online shopping converge with a vengeance. The obvious E-commerce proxy on the SGX is Singapore Post, given its new Alibaba platform, though the valuation is expensive at 22 times earnings. A far better option is another Temasek originated logistics/warehouse operator Mapletree Logistics Trust. Cambridge Industrial Trust has also fallen from SGD 0.72 to 0.52 now, cheap at 0.84 times NAV and offering a 8.5% dividend yield with a diversified tenant base and seven year maturity leases, low refinancing risk and stable cash flows. In short, property investing nirvana, la!
Currencies – What next for the Russian rouble and the Indian rupee?
My strategy recommendation to buy the Russian rouble against the US dollar at 78 was vindicated as it surged to 65 last week. However, I believe the Russian rouble is now overvalued at 65 relative to both fundamentals and macro risks. Brent has fallen 8% from its 48 high. The US dollar bears short covered their positions after the Atlanta and San Francisco Fed presidents called for June FOMC rate hikes. The Bank Rossiya, Russian central bank, needs to sell rouble to replenish the $90 billion in foreign exchange reserves it hemorrhaged in the 2014-15 oil crash. The Syrian ceasefire brokered by Washington and the Kremlin threatens to fall apart. Russia is still in recession and the economy contracted 1.6% in first quarter 2016. Western sanctions on Russia to punish the Kremlin for the Ukraine intervention and annexation of Crimea will continue until July. Corporate profits, manufacturing PMI and business investment are all awful.
Though the sovereign credit risk on Russian Eurobonds has contracted by 450 basis points on long duration debt, I believe the “risk on” trade in Russia will at least pause, though not reverse. The Russian Market Vectors index fund (symbol RSX), has risen a stellar 35% from its bottom in February, the reason for my successive bullish strategy columns on Russia in 2016. Russia is the cheapest major global emerging market – but will remain so as long as its index is dominated by oil/gas/metals while Kremlin risks in geopolitics are so unpredictable. Even Putins own Ministry of Labour expects 600,000 more Russians to lose their jobs in 2016 as the Rodina’s industrial rust belt has not adjusted to the grim realities of the commodities crash. Yet inflation has now fallen from 13% last autumn to 8% now, an argument for cuts in the 11% central bank policy rate.
The Russian rouble was the best performing currency in the emerging market in 2016, rising from 85 to 65 for a stellar 24% rise against the US dollar. Yet this money making feast is now over. Oil, capital flows, sovereign risk, central bank policy easing (monetary divergence with the Fed), recession and capital flight all suggest the optimum macro trade is now to sell the rouble at 65 for a six month target of 72.
It is ironic that despite two years of Modinomics, an oil price crash, massive capital inflows into Dalal Street, the disappearance of the current account deficit, the Indian rupee trades at 66.5 to the US dollar. India is on a roll but the foreign exchange market has still not priced in the fact that the Finance Ministry’s negotiations with the global rating agencies could culminate in a sovereign credit rating upgrade in the next four weeks. So I would use any risk aversion mood swings in due to “hawkish” Fed rhetoric to buy the Indian rupee, ideally against low yielding but overvalued Euro and the Singapore dollar.
The “Bharat Mata” (Mother India) carry trade is a money maker in the current macro zeitgeist even if the Indian rupee does squat against the greenback. The Rajan RBI has been successful not just in reducing the repo rate to 6.50% but also boosting the monetary policy transmission process and kick starting the debate on banking reform. The Rajan RBI has also achieved its policy goal of bringing down the consumer price inflation rate below 5%. India could well deliver GDP growth of 7.5%, the highest in the emerging markets, at a time the Lok Sabha (hopefully) enacts the bankruptcy code, banking reforms and the GST tax bill. This means the depreciation of the Indian rupee in the next two years will be nowhere as draconian as it was in 2011-13, when the Subbarao’s RBI mismanaged money supply growth and spawned a credit Frankenstein that culminated in a 40% currency collapse. It was profitable for Dubai investors to own Indian government debt in 2015 as the RBI implemented successive repo rate cuts. There is still serious money owning long duration G-Sec debt even if the rupee falls to 67 against the US dollar this autumn.
Rodrigo Duterte, the front runner in the Philippines Presidential election, could well be the next occupant of Malacanang Palace. This prospect is the main reason the Philippine peso has depreciated to 47.2 while the stock market index in Manila lost 7% in April, the worst performance in Southeast Asia after Kuala Lumpur. The Manila business elite fears the election of the Filipino Trump. After all, the Makati Business Club once helped to oust both Marcos and Estrada!
Written by

Mr. Matein Khalid serves as Head of Capital Markets and Advisor to the Chairman at Bin Zayed Group LLC. Mr. Khalid serves as the Chief Investment Officer of Salama. He manages Bin Zayed's global equities portfolios in the US, Russia, Latin America, Europe and the Far East. He is responsible for the Bin Zayed's hedge funds / private equities portfolios and external fund manager selection. He also advises the Chairman and board on investment banking relationships, financing and new issues in the international debt markets and merger/acquisition deal flow. Mr. Khalid has 20 years experience in the international capital markets and has worked with investment banks, private banks and securities firms in New York, London, Chicago, Geneva, Abu Dhabi and Dubai. He is an adjunct professor of banking and finance at the American College of Dubai, where he is also a member of the Board of Directors. Mr. Khalid writes on global financial markets and Middle East studies for newspapers and magazines in the UAE, Bahrain, Oman, Qatar and the United States. He has also taught courses on capital markets at J.P. Morgan Chase, (New York), SP Jain and Emirates Institute of Banking (Dubai). He has also taught at capital market seminars at Morgan Stanley (London), Chase Manhattan Bank (Geneva) and Barclays Capital (Hong Kong). Mr. Khalid has briefed ASEAN finance ministers and ultra high net worth investors in Hong Kong at the invitation of the chairman of Barclays Capital. He holds an MBA in finance and BS in Economics from the Wharton Business School and a BA/MA in international relations from the University of Pennsylvania in the US.