While the Federal Reserve did not raise the overnight borrowing rate at the August FOMC last week, I was chilled to read the US central bank explicitly describe the economic growth as “strong”. The last time this happened was May 2006 at the height of the Wall Street credit bubble that culminated in financial Armageddon two years later.
What is the significance of the Fed’s new Powell Fed language on economic growth? One, the FOMC conclave believes that we are on the precipice of a late cycle peak, the point when wage inflation risk begins to rise. Two, “strong” economic growth means the Fed will keep raising interest rates until the liquidity cycle is choked to prevent economic overheating. Three, this means King Dollar goes ballistic and devastates emerging market currencies. Four, excess liquidity turns into a credit shock as the world’s cost of capital surges higher. Five, companies, countries and industries that borrowed recklessly in the easy money post-Lehman era will go belly up as LIBOR and Treasury bond yields spike higher. Six, the biggest risk in life and markets are the risks you never even knew exist. These risks emerge with a vengeance when the Fed embraces tight money.
Chicago Eurodollar futures tell me the Fed Funds rate will rise 50 basis point with 25 basis point hikes in both the September and the December FOMC. Unlike 2007-8, there is no housing bubble and banking/subprime mania on Wall Street, the bubble now is in global commercial real estate and emerging markets finance and property markets. Emerging market debt is $11 trillion now, up from $5 trillion a decade ago. This will be the mother of all credit and property market busts in the emerging markets. Unlike Ben Bernanke or Alan Greenspan, Jerome Powell will not moderate his monetary timetable to avert an emerging market meltdown. After all, the US economy grew at a 4.1% in 2Q 2018, a bad omen at a time of full employment. Inflation is at 2%, the Fed’s target range. Leveraged borrowers face a dismal prospect of rising rates and significantly lower asset/property prices. The US economy has gone white hot and the Fed will be forced to pop history’s biggest easy money bubble. As I remind my traders at Asas Capital every night, “liquidity is like a cab on a rainy night. It disappears when you need it the most”, J.P. Morgan’s key insight.
US threats to increase tariffs from 10% to 25% on $200 billion Chinese imports means Beijing will be forced to defend its economic model with asymmetric retaliation. Nehru threatened China with his “forward policy” and lost a chunk of Arunachal Pradesh to Chairman Mao. Brezhnev threatened China and faced the wrath of the People’s Liberation Army on the banks of the Ussuri River. Wilbur Ross is talking nonsense if he thinks China will capitulate to Trump’s threats. Surely the ignoramus luminaries who define the Trumpian Era read Sun Tzu? “Behaviour modification” via threats of tariffs does not apply to an ancient, proud 5000 year old civilization that was the world’s dominant economy for 1800 years. Yet a US-Chinese trade war is disastrous for emerging market currencies.
I had predicted the Turkish lira would plunge below 5 to the US dollar a year ago. Trump’s sanctions threat has terrified investors in Turkish assets. Ankara faces a debt crisis, a banking crisis, a current account deficit crisis and a political credibility crisis for both President Erdogan and his impotent central bank governor. With 12% inflation, Ankara faces a global crisis of confidence as the hot money exodus accelerates. The Turkish lira has now fallen 25% in 2018 and I see no bottom for now.
The Reserve Bank of India (RBI) has gained credibility in Planet Forex with its latest 0.25% rise in the policy rate. India will face crucial state elections and a general election next year. The 6.5% repo rate makes rupee bonds a value buy in India. While King Dollar slams Dalal Street with portfolio outflows, political risk and relative inflation spreads mean a 70 – 71 year-end target for the Indian rupee. I expect a 67 -71 rupee range in the last four months of 2018.
Imran Khan will regret his threat to shoot down US drones and disrupt NATO supply lines to help the Taliban in Afghanistan now that Pakistan faces a currency crisis and desperately needs an IMF loan. Foreign exchange reserves are $10 billion or two months import cover and external debt is $97 billion. The state will default without an IMF loan.
