A random walk down global macro village
Europe to be the Achilles heel of markets in 2017, writes Matein Khalid
2017 will be a historic year for global politics and the world financial markets. After eight years of creeping socialism under Barack Obama, the White House and Senate are controlled by the most pro-market Republican politicians since Ronald Reagan’s supply siders in the early 1980s. Trump’s American First protectionist policies have shaken relations with China and Mexico and his casual indifference to the “strong dollar” policy (“its killing us”) has led to a sharp selloff in the greenback after it hit 103.80 on the US Dollar Index on post-election reflation euphoria. Yet, paradoxically, if the US Dollar Index falls below 100 the risk of proactive Yellen Fed tightening beyond the three FOMC dotplot projected rate hikes for 2017 grows.
The Trans-Pacific Partnership (TPP) is dead without the US and North American Free Trade Agreement (Nafta) is under serious threat. The 35-year bond bull market is over and US dollar interest rates have begun an inexorable rise that will spread carnage across the leveraged dark alleys of the planet. Turkey’s meltdown could well spawn a 1998 Thai baht or 1994 Mexican peso style emerging market contagion. The Saudi brokered Opec oil deal is under threat not just from Iraqi (and Kremlin) non-compliance but from a sharp rise in the Baker Hughes land rig count, an infalliable leading indicator of a shale oil supply tsunami from the Texan Permian Basin and North Dakota’s Bakken. This will be the year of living dangerously for my tribe of global macro traders in Dubai.
So what are the trends that will help me and my principals in the kingdom make money in 2017? Note the Blackstone, HDFC Bank and KKR have been double digit winners in the first three weeks of January though, as usual, I was wrong on gold but right on silver and crude oil.
One, I fear Europe will be the Achilles heel of the global markets in 2017. I just returned from a trip to the Old World and the rise of populism, anti-immigrant, fears, banking woes and political fragmentation is truly frightening. The only possible strategy was to take the Renfe to Seville and wonder the haunted magnificence of the Alhambra in Grenada and the Alcazar in Cordoba, the lost world of Andalusia.
Two, as the 10-year US Treasury note yield fell to 1.40 per cent last July, I remember a Private Bankerji (NRI leveraged bond broker and structured products with five per cent hidden fees peddler, in plain English), tell me that capital gains existed only in the bond, not stock markets. I cracked up with laughter. Now the ten-year US Treasury yield is 2.50 per cent. Three-month Libor is 100 basis points and set to triple in the next two years. I wonder if Private Bankerji’s five times leveraged bond clients are laughing as their portfolios hemorrhage cash? Private Bankerji co-mingles securities to avoid a margin call but as the ten-year US Treasury yield rise to even four per cent or more, a bloodbath is inevitable. The Great Bond Bubble of 2016 will explode once Trumpian fiscal stimulus ignites inflation risk.
Three, Trump is playing with fire with his implied threats to devalue the US dollar at a time of rising interest rates. He should remember the global macro scenario of 1987. Jim Baker’s threats to devalue the US dollar to force West Germany to reflate at a time of rising US Treasuries led to 22 per cent single day fall in the US stock market on October 19, 1987. Black Monday. As Treasury yields continue to surge, as Beijing and Washington sleepwalk into a new trade war and a cold war on Taiwan/South China Sea, investors could well panic. Inflation risk is grossly mispriced on Wall Street. What if the US inflation rate spikes up from two per cent to five per cent? After all, Trump’s fiscal stimulus comes at a time of full employment, rising wage growth and a White House talking down the dollar. Our currency, your problem, as Nixon’s Treasury Secretary John Connolly sneered to the world. Is the Middle East ready for a world where three month Libor is six per cent and crude oil is $40, as the US shale oil surge will derail the Opec output deal and force Saudi Arabia to abandon its role of a “swing producer”. This means 30-50 per cent hit to the GCC property markets, where bank leverage is high octane fuel for speculation.