Mighty US dollar flexes its muscles ahead of Jackson Hole
China cuts interest rates to deal with unfolding property crisis
Equity markets rediscover gravity, gold loses altitude too
The relentless rally in the US dollar is gathering momentum as market participants seek refuge from the troubles in other major currencies and brace for a more forceful tone from a Federal Reserve trying to wrestle back control of financial conditions.
A deepening energy shortage has torched the euro, with natural gas prices in Europe hitting record high after record high, turning entire industries that used to rely on cheap energy unprofitable or uncompetitive. Complicating matters further, an unprecedented drought has dried up rivers, making it harder to transport cargo.
Meanwhile, the Bank of Japan has left the yen for dead with its refusal to even consider tighter monetary policy, the British pound continues to trade like a mirror reflection of unsteady equity markets, and the meltdown in China’s property sector has ravaged the commodity currencies. There is no real competition around, so investors are gravitating towards the world’s reserve currency.
Speculation that the Fed will strike a more assertive tone at the Jackson Hole economic symposium later this week has probably added fuel to the dollar’s rally. Despite raising rates with incredible force and signaling that more is in the pipeline, US financial conditions have loosened lately, which is counterproductive for a central bank that is still trying to slow the economy and tame inflation.
Chairman Powell could attempt to retake control, either by hyping the prospect of ‘high rates for longer’ or by hinting that active sales of securities are a realistic option in the balance sheet reduction process.
China cuts rates, is it enough?
A seismic shift is underway in China. The crisis in the beleaguered property sector is spiraling and threatening to infect the nation’s enormous banking system, which has an asset footprint multiple times the size of national output and is therefore a systemic risk. Rising interest rates in the rest of the world are adding to the financial stress, while the persistence of zero-covid strategies has exacerbated the economic fallout.
To prevent contagion and shore up confidence, Chinese authorities announced last week they will be offering special loans to troubled property developers and the central bank cut its lending rates by 5-15 basis points today, focusing its firepower on longer-dated lending rates.
The news provided some relief to the Australian and New Zealand dollars - both economies that rely on Chinese demand to absorb their commodity exports. That said, it seems the People’s Bank of China is bringing a knife to a gunfight as the rate cuts are too small to make a real difference, and might simply counteract the impact of rising rates abroad.
Rising yields hit stocks and gold
The euphoria that characterized equity markets over the last couple of months is evaporating. Wall Street lost around 1.3% on Friday and futures suggest the selling will resume today, as market participants trim some risk exposure ahead of the Jackson Hole symposium and after a stunning run overall.
The S&P 500 got rejected exactly at its 200-day average and the catalyst for the reversal was the same that enabled the relief rally in the first place - the bond market. Treasury yields have started to march back higher, inflicting damage on equity valuations that were becoming increasingly unrealistic in an environment where earnings growth is essentially stagnant once inflation has been accounted for.
Gold suffered for similar reasons. Real and nominal Treasury yields are grinding higher while the greenback bulldozes its way through the FX arena, which is a toxic combination for gold that competes with bonds for capital flows and is generally priced in US dollars.