The year started with the Swiss National Bank’s shock announcement on January 15th of the removal of the fixed exchange rate peg between the Swiss Franc and the Euro. Then, on January 22nd, global financial markets saw a bigger than expected quantitative easing (QE) programme from the European Central Bank (ECB) when they rolled out a total QE package of €1.1trillion. This move stands out in sharp contrast to the much anticipated interest rate hike by the US Federal Reserve and underscores the increasing clout of central banks and diverging monetary policies on global financial markets. Higher volatility, especially in foreign exchange markets, is in store and a review of investment strategies that were in vogue at the turn of the year is beneficial.
At the start of 2015, the three most popular investments ideas were:
- Long US equities
- Two-tier growth scenario with the US having relatively higher growth prospects on the first tier and the rest of the world on low or no growth on the second tier
- Long US Dollar
- Divergence of monetary policies in the developed economies
- US to raise interest rates while Europe and Japan to ease.
- Long European and Japanese exporters
- Beneficiaries of weak euro and yen and continued demand from the higher-growth American consumers
In the first quarter of 2015, these investment ideas have by and large, borne fruit. However, these “long” investment themes are getting too crowded. Also, looking ahead, we see more macro headwinds than upside triggers for the global economy and financial markets. A key concern revolves around when the US Federal Reserve will raise interest rates. The consensus expectation is for the first rate hike to be in September 2015. Our belief is the US Federal Reserve will postpone and not raise interest rates this year.
We see two key reasons stopping the US Federal Reserve from hiking interest rates:
- Little or no inflationary pressures;
- Slowdown in domestic economic activity.
The much-discussed dual impact of a strong US dollar (cheaper imports) and lower oil (and gasoline) prices translating into little or no inflationary pressures removes the justification for an interest rate hike any time soon.
However, we are more concerned with the second more perilous reason – an unanticipated slowdown in US growth. Such a slowdown will trigger a sharp and potentially very disorderly unwinding of both the “Long US equities” and “Long European and Japanese exporters” trades. The “Long US Dollar” trade will probably also take a step back as investors exit US equities. However, we believe that the impact will be muted given the continued demand for US Dollars from borrowers of US Dollar-denominated debt. Investors in these trades should watch these potential developments very closely and remain nimble in making necessary adjustments.