Yield inversion may not lead to recession and I expect dollar index to move up, says Floyd
What is your view on the dollar index currently, given the Fed's impending rate cut and the inverted yield curve?
Since the beginning of the year, the dollar index has been rather choppy. It is within an uptrend and I expect that trend to continue. Right now, there is just a lot of back and forth price action with the change in the central bank policy in the US last week. That has obviously caught a lot of traders off guard and has not done much for the dollar index. But oddly enough, I still suspect the dollar index will move higher because in the game of the currency market, it is always who is the least ugly relative to another currency. Right now, the dollar is the least ugly currency in the major market.
So, I will be looking for the dollar index to move higher in the weeks and certainly into the end of the year. My favoured weighted play that is obviously through dollar Canada is one way to look at it. The euro at present is also a bit choppy but it would be lower by the end of the year and dollar Canada would be higher.
What is the broader trend that you are tracking when it comes to S&P? Do you expect it to move higher from these levels?
I could easily see the S&P over the next week or two head down towards 2,760 or even 2,700. We are 2,800 right now. So, I would not be a buyer if you are not positioned in the S&Ps right now. I would buy a pullback in here. Overall, I remain bullish on the S&Ps but I am not a raging bull. But the fact remains that the Fed is now even more accommodative, based on what they said last week at the policy meeting and we have other central banks lowering rates. Bank of New Zealand did that last night. The ECB is also indicating its softer policies. These are all historically speaking bullish to equities.
I am not saying that the policies themselves are not flawed but the fact of the matter is easier monetary policy keeps money in stocks. I would be bullish on the S&Ps on a pullback. I would not be overly bearish on the S&Ps at all.
Some analysts are saying that positive signals are overdone and we are headed for an implosion. What do you think of some of these widely negative calls?
I cannot understand why there is a lot of widely negative reports. For the last five to ten years, many times the market has defied logic. We have had a very long period of economic expansion, in fact, the longest in history. It just continues and that is a great thing. But for someone who has been in the markets for many years and I have been in the markets for 20 plus years, this is very unusual. It sometimes can be hard to get your head around.
But the fact of the matter is the Fed is the number one game in town right now unlike any other time in history. As long as you have a Fed that is very accommodating and willing to keep policy rates low as a way to prevent any financial catastrophes, that is going to keep an underlying bid in the S&P. I get it that some people may look at this and say this is going to end badly. Maybe it will tread uncharted waters here in terms of monetary policy. But right now, every time I see a dip, everybody is buying it and it seems that the overall trend is looking up.
I am not agreeing with the policy. I understand the logic but trying to pick a top here has been a sucker bet for many years and right now, while the economy is starting to slow down domestically and on a global basis, it is not at a level that would indicate a recession any time soon.
Even the inversion in the US yield curve has been a little bit overblown. There are some valid reasons why we have seen an inversion in the yield curve and it may not be indicative of a forthcoming recession which, of course, would then not mean that the S&Ps will be significantly lower anytime soon.
So you do not see the inversion in yield curve following past patterns and predicting a recession?
Well yes and no. We are in a very different phase from an economic perspective than we have at any other time. You have factored that in. The Fed is a major player in this town but not as much as they were 20, 30, 40 years ago. I am not saying that the inversion in the three month 10-year is not valid. I mean it is a minor one — about 5 to 10 bps at present. The rest of the curve is not inverted.
In fact, if you look at the 5 and the 30 spread, it is actually rather steep at about 67 bps and if you look at my notes here quick, the two 10 spread is at 15 bps in terms of the steepness. It is not inverted. Historically, when we had a recession, about 75% of the curve was inverted, but that is not the case right now.
One of the things that could really give a good indication as to why we see the inversion on the three month 10-year curve is because last week's announcement by Jerome Powell caught a lot of people off guard. More than two months ago, he was saying we are a long way from normalising. We are getting to that neutral Fed funds rate and last week they came out with no more rate hikes for the rest of the year! That was not at all what the market was expecting but the one likely reason we saw yields drop so low and that three month 10-year spread invert is that we probably saw a flight to a lot of hedging in the interest rate swaps market.
If you are a mortgage trader or just a bond manager with a lot of exposure, you get blindsided with that. You are not factoring that in, you are trying to hedge your existing positions and that is just going to add fuel to the fire to drive rates lower. Again, I am not just looking for counter arguments because everybody now seems to be looking at the curve inversion and saying we are going to have a recession. I am just looking a little a few steps beyond that and trying to be a little bit more objective. I am paying attention to the inversion but I am looking at other parts of the curve where I am not seeing inversion.
Investors are always asking how can we time the markets? They are worried about missing out now that they are seeing rally building up. So what is the advice for them?
One likely reason why we saw yields drop so low and that three month 10-year spread inverted is that we probably saw a flight to a lot of hedging in the interest rate swaps market. Again think about it as a mortgage trader or a bond manager with a lot of exposure.
What is your view on emerging markets? Even if you do not track them very closely, if you have to take a call, would it be fairly positive on emerging markets and specifically for India?
The direct impact or the direct correlation to emerging markets is going to be a weaker US dollar and as I said at the beginning of the interview, I am not looking for a weaker US dollar by year-end. I happen to look at the ETF EEM. That is a good barometer for how emerging markets are performing. Yes, it rallied this year and it has done okay and it still is not a downtrend. I would say if we see EEM fall below $41.80 cents, that would be indicative that the trend is resuming to the downside. The dollar index would be moving higher.
For me, it is really hard to be bullish on emerging markets given my forecast on the dollar index. If the dollar index starts to tank for whatever reason, then of course emerging markets are back into a bullish mode or at least modestly bullish mode. I personally would not be long emerging markets in here until we get some sort of indication that the dollar wants to move lower and I just do not see that at least in 2019.
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This is not the time to be bullish on EMs: Dave Floyd, Aspen Trading have 1769 words, post on economictimes.indiatimes.com at March 29, 2019. This is cached page on Asean News. If you want remove this page, please contact us.