US stocks finished lower overnight despite a strong rise in the oil price, which buoyed energy stocks. The NASDAQ led the declines, falling 1.55% on uncertainty over how the Trump administration will ‘protect’ US technology from Chinese theft.
With the market uncertain about the White House’s plans, and the White House uncertain about those plans too, it’s hard to see how this trade war concern abates anytime soon.
While equity markets might reflect ‘uncertainty’ (don’t they always?) the real action is in the currency markets. The US dollar is cutting a swathe through many of the world’s currencies.
The Financial Times reports:
‘There were few winners against the dollar today, with emerging markets names particularly hard hit. South Africa’s rand was the worst of the EMs, down 2.9 per cent, followed by Brazil’s real, down 1.8 per cent. The Hungarian forint and Mexican peso also saw 1.4 per cent drops. Argentina’s peso is also hurting, down 1.3 per cent.
‘The biggest decliner among G10 currencies today was the New Zealand dollar, down 1.2 per cent, followed by a 1 per cent drop for Sweden’s krona and a 0.9 per cent decline for the euro. Japan’s yen was best off, with a 0.2 per cent slide.’
The Aussie dollar wasn’t spared either. It declined 0.7% to 73.42 US cents in the overnight trading session.
In short, global capital is flowing out of global currency markets and heading back to where it came from — the US.
What does all this mean for global currencies?
The US dollar is the world’s primary ‘funding’ currency. Investors or speculators borrow — or obtain funding — in US dollars, and use these dollars to buy other currencies. Whether that is for investing in foreign equity markets, buying a property, building a bridge, or just speculating in currency markets, the result is the same.
While funding costs are low, and the returns from the chosen investment are high, the going is good. But that’s not the case now. Emerging markets especially are under the pump.
From US investors’ perspective, falling emerging market currencies and stock prices are a double whammy. It makes no sense to invest here right now with borrowed money.
Which is why the US dollar is strong and EM currencies are weak. Hot money is exiting, and liquidity is drying up.
In yesterday’s Money Morning, I showed you the performance of the Chinese and Hong Kong stock markets. They didn’t look good. Capital continued to pull out in yesterday’s trading session. Chinese stocks fell 1.1% while Hong Kong was down 1.8%.
The combination of a tightening US Federal Reserve and a US administration belligerent towards China on trade is a nasty combination.
The result is a tightening of global liquidity. Even the heavily managed Chinese yuan is about 3% weaker versus the dollar over the past few weeks.
What is the outlook for Australia?
The impact of all this is showing up in Australia too. The Financial Review reports that:
‘The Reserve Bank of Australia is at risk of being increasingly sidelined in its fight to shield debt-loaded households against rising borrowing costs as tightening money markets threaten to force the big four banks into hiking mortgage rates.
‘While the funding pressures have so far only forced smaller lenders — who have access to fewer pools of potential funding — to raise their home loan rates, analysts believe it is a matter of time before the majors are forced to follow suit.
‘In a sign of the growing pressures, key benchmark rates at which banks lend to each other have spiked sharply over recent weeks to the equivalent of as much as almost two official Reserve Bank rate hikes, experts said.
‘The rate on the three-month BBSW has surged to 2.11 per cent on Wednesday from 1.70 per cent just three months ago.’
My guess is that some of this has to do with end of financial year need for cash. Gotta get those 30 June balance sheets looking solid!
But it also reflects that the cost of money is increasing globally. Australian banks source a lot of their borrowing needs in offshore markets. As the US dollar is the world’s ‘funding’ currency, if it costs more to borrow, so does everything else.
While this might all sound worrying, keep in mind that the banks have rallied strong lately. Check out the chart below, which shows the ASX 200 Financials index.
Source: Big Charts
[Click to open new window]
The powerful rally in the financials is behind the overall index’s rise to 10-year highs. Whether it’s a short covering rally (and therefore destined to fade) or a reflection of the fact that the RBA is now on hold for years to come (and therefore bullish) remains to be seen.
Regardless, the overall message is that global liquidity is tightening. That’s always a sign to be cautious.
Editor, Crisis & Opportunity