Monday, January 27, 2014

Meltdown? | Emerging markets and the Kiwi

Whew. Thursday and Friday of last week were something to behold in the markets. The much anticipated correction just might have started in equities, and the Forex space has not been exempted from the turmoil.

The proximate cause for the sell-off was a purchasing managers’ report from China that came out in the very early hours on Thursday morning (GMT), and which fell short of the average of expectations of a group of economists that had been polled by one of the US news channels. It also fell below the figure of 50, which indicates contraction rather than growth. Now, PMI reports are important but they are, nevertheless, an amalgam of the subjective opinions of individuals. At the start of the week, on Monday, official Gross Domestic Product (GDP) figures for China also showed a contraction, but because this particular contraction was smaller than the “consensus” of a group of economists, the markets actually rose further on the news.

This illustrates, if illustration were needed, the fickle and capricious nature of the trading community. Commentators late last week had it that the evidence on Thursday morning of the reduction in activity in the second largest economy on the planet, when combined with the expected turning off of the cheap money that has emanated from Quantitative Easing in the US, is enough to threaten equities to the extent that the stock markets have to go into meltdown and emerging market currencies must be devalued in a precipitate manner.

Except for one thing - all of this was already in the public domain. It is well known that China is in the process of adjusting its economy from one that relied on the export of manufactured goods and government sponsored infrastructural projects to one that can be supported, to a much greater extent, by domestic consumption, with a corresponding reduction in growth rates. The announcement of the end of QE by the Federal Reserve in the USA was made before the Christmas and New Year holidays.

And be sure of one thing: None of this will impact in the slightest on the resolve of the Federal Reserve to carry out tapering and, eventually, to increase interest rates in line with steady improvement in the US real economy which will be measured, in the first instance, by rises in employment.

Emerging markets and the Kiwi

While the New Zealand dollar is heading in the right direction against the Aussie for our trading strategy (Kiwi is strengthening), it is not doing so with anything like the speed we would have expected. Remarks made by pundits late last week variously suggested that it was being tarred with the “emerging market” currency brush, or that it was suffering because it is a commodity currency.

Our Kiwi friends will not be happy about the emerging market allusion and, while New Zealand exports a lot of its produce to China, this is in the form of dairy products and other soft commodities, purchases of which can be expected to actually rise both in the context of the Chinese transition to internal consumption (see above) and the relaxation of the one-child policy, which was announced by the Chinese government late last year. This last can be expected to increase even further the demand for baby formula and other dry milk powder products.

All in all, the turmoil in the markets in the final two days of last week meant that our risk control and money management procedures were employed to the fullest possible extent.

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