How can traders weather the upcoming summer storms?
US interest rate hikes, weakness in Chinese equities, uncertainty in Greece and the broader implications of an Iran nuclear deal are weighing heavily on the minds of investors. But with a clear-headed assessment of the factors underpinning market volatility, there are still many trading opportunities to be found.
An annus horribilis for investors
Economics professors might call 2015 an annus horribilis for the investment community. With so much geopolitical turmoil and economic uncertainty there may well be merit in this type of sentiment. Lots of tumult is brewing, with the Greek saga gaining traction as the most significant European story.
The anti-austerity Syriza Party is locked in ongoing high-level negotiations with the European Commission (EC), the International Monetary Fund (IMF), the European Central Bank (ECB) and the European Stability Mechanism (ESM). Among others, creditors want to be assured of Greece’s ability to implement the agreed-upon measures, including repayment deadlines.
By August 20, Greece is slated to repay the European Central Bank an amount of €3.2 billion. However, the head of the IMF, Christine Lagarde, remains unconvinced that Greece can service its debt obligations. She is of the opinion that a complete restructuring of debt obligations needs to be implemented. This does not bode well for investor sentiment regarding eurozone stability. Should the IMF decide not to approve a third bailout loan for Greece, the recently agreed package may not come to pass. Failing a deal before the ECB repayment is due, bridge financing will need to be sought.
Factors driving currency volatility
Investors have clearly taken a short-term bullish approach to the European situation, but caution is the order of the day over the long term. The bulls and bears are being taunted by Germany’s refusal to entertain a write-down of Greek debt. Further, if the IMF refuses to partner with creditors, Germany may fail to get the parliamentary support it needs to push the deal through. It is this very uncertainty that is driving the bears out of their caves and into the markets. The EUR/USD currency pair has been hovering at record lows, but the Greek saga is but one component of this complex issue.
Across the Atlantic, the US economy is fundamentally sound and on track for further progress, with strong gains in the labour market coupled with falling unemployment. US interest rates have stayed at historically low levels since 2006 between 0% and 0.25%, and the FOMC opted against a rate hike last week. Members of the Committee were confident however that at least one rate hike would be implemented before the end of 2015. This drove dollar-demand on the US Dollar Index and applied pressure on the euro and other currencies.
Emerging markets were particularly hard hit by speculators after the Fed announcement. According to the JP Morgan Index of EM currencies, current levels are at 16-year lows. This is being fuelled by dollar strength and unusually low commodity prices. Since many emerging market economies rely heavily on mining and agricultural exports, the low prices have sent industries into a tailspin.
For instance, South African gold mines are operating at sub-optimal capacity with falling revenue streams pushing the country from first place in terms of gold production to sixth place today. With copper, oil and natural gas prices tumbling due to oversupply and the recent collapse of the Chinese stock market, producers are hurting.
The Chinese stock market saga
When the Chinese stock market rout began several weeks ago, nobody expected the scale of devastation that ensued on global markets. Commodities were particularly hard hit as China remains the ranking consumer of commodities like copper, agricultural produce and crude oil among others.
With perceptions of slowing Chinese growth and demand, coupled with an oversupply of crude oil, downward pressure has been brought to bear on commodities. The Chinese government intervened by bolstering the stock markets, but they have now moved away from extensive intervention. A figure of 7% GDP growth is still being touted by the government, but analysts are concerned that the real figure may be lower.
Back in the US, analysts have pencilled in the rate hike for September 2015, and that will likely drive dollar-demand and accelerate capital outflows from emerging markets. During the 1998 global crisis and back in 2013, the Fed was hawkish but soon turned dovish to calm global markets.
US domestic consumption expenditure is being fuelled by historically low crude oil prices. With prices trading around $50 to $55 per barrel of late, US industry is able to drive up profits and consumers are saving a lot more at the pump. Higher savings translate into more disposable income and an improved GDP.
The Chinese have hinted at making their currency a global reserve currency, but the bigger story in China is the shift towards a consumer-centric economy. For years China has fuelled its economic engine with export-driven sentiment. Now the Chinese are focusing on their domestic consumption as the driver of Chinese economic strength.
US equities dominated by a few overvalued stocks
From Europe to Russia, China and beyond, central banks are using accommodative monetary policies to spur economic growth. By accelerating the velocity of money flow, countries are hoping to raise the inflation rate, combat deflation and jolt economic activity. The downside is that expansionary monetary policies encourage currency weakness, which invariably strengthens the US dollar.
While the S&P 500 index is only marginally up for the year, healthcare stocks are performing strongly. However, a small number of companies are dominating the index and many analysts believe that a long overdue correction may soon take place. The volatility of the market will naturally increase with any changes in Fed policy. An interest rate hike will shift money from stocks to interest-bearing investments such as bonds and Treasury notes.
So here are the facts to keep in mind when trading over the months ahead:
- The long-term outlook for the US dollar is bullish as fundamentals are sound and an interest rate hike is likely to come before the end of the year
- US equities are buoyant now, but share prices may be impacted by rate hikes later in the year
- Commodities prices are low, which presents opportunities for buyers to go long on futures
- The Chinese economy is in a state of flux, presenting short-term bears with plenty of opportunity
- Emerging market economies will have to soak up increased pressure and currencies like the South African rand, Russian ruble, Brazilian real and Turkish lira will come under further strain
- The euro bulls are out short-term, but long-term accommodative policies, US interest rate hikes and fears of a Greek default remain a concern
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The content of this article is the personal opinion of the author and not Intertrader.com. The information and comments provided herein under no circumstances are to be considered an offer or solicitation to invest. Nothing herein should be construed as investment advice. The information provided is believed to be accurate at the date the information is produced.