I recently had a conversation with Professor Jeremy Siegel and Marc Chandler, Global Head of Currency Strategy at Brown Brothers Harriman, on the outlook for Federal Reserve (Fed) policy following the Jackson Hole Fed conference speeches. Professor Siegel reiterated his view that the Fed is likely to defer a September increase in its target rate and set the stage for a December hike. Marc Chandler disagrees and thinks September has a much greater chance than the market gives credit to. I highlight Marc’s views on the Fed and currency markets below.
Marc, what was your takeaway from Fed chair Janet Yellen’s comments?
In following the U.S. Federal Reserve, I put emphasis on three people and only three people: Janet Yellen, Stan Fischer and Bill Dudley. Their messages have been consistent: The U.S. economy is doing better in the second half of the year (the gross domestic product [GDP] trackers are looking above 3%), the U.S. labor market continues to improve, and scares from poor employment reports in June, Brexit
, the Chinese volatility
—all those things have passed. The Fed has been telling us they are more confident in their ability to raise interest rates
But the market has been doubtful about the Fed hiking. The Fed has overpromised and underdelivered, in my view. I think the only way to reverse that is to underpromise and overdeliver. I thus think there is a reasonable chance of a September move. The Fed has given the market ample warning on conditions for a hike, and it needs to re-establish its credibility. It needs to demonstrate its resolve that when it says conditions warrant a hike, it backs it up with action.
What are the implications for the markets?
For equity investors, does a 25 basis point (bps)
move in September or December make a difference? I don’t think so. I think what is lifting the markets is liquidity
driven from the European Central Bank (ECB) and the Bank of Japan (BOJ)—both of which may announce extensions of their programs in September. The BOJ is already buying all the Japanese government bonds (JGBs)
the government is issuing, and it may expand that further. The ECB, after reviewing its policy in September, is likely to extend the duration of its purchases for another six months beyond March of next year. Of course, the Bank of England also resumed its quantitative easing
program. Long-term investors have been chased out of the bond market with no yields
and chased into higher-risk income or equities.
Marc, on the currency markets, in the past you have discussed a long-term target on the euro of 85 cents to the dollar. Is that still true?
I still believe before this cycle ends, the euro will sell off further, and I do still target the old lows of 82–85 cents back in 2000. The euro had a 35-cent move, from $1.40 to $1.05, and since then has been consolidating between $1.08 and $1.16 and in a band that is still wide enough for traders to lose a lot of money. With this type of broad sideways trading, investors should be asking whether this is a base (for a move higher) or a top (for a move lower). And I think this will prove more likely to be a top for the euro. The ECB is still easing while the Fed is tightening. Before the ECB is done easing, the Fed will tighten a few more times. Combining the health of the European banking system with the political environment and uncertainty from elections in Italy, France and Germany all point to a weaker euro.
The yen has been one of the strongest currencies this year. What is happening there?
Only in the last couple of months have I started putting a few explanations together for the counterintuitive yen strength. I have two big points: Thinking back to yen weakness, I now think that was driven more by diversification of Japanese pension funds into global assets than by Japan’s monetary policies. Japanese pension funds sold JGBs and bought foreign bonds and stocks. Japanese companies kept more money offshore to get better yields. This all turned this year, and Japanese institutional investors were unhedged
. They were taking “naked” U.S. dollar currency exposures, and when the yen strengthened, they were forced to raise their dollar hedge ratios, sending the yen higher.
Note from Jeremy Schwartz: A few days later, I traveled to Tokyo, and one of the largest Japanese insurance companies independently confirmed that it had been unhedged in U.S. Treasuries with U.S. dollar exposure in the past but earlier this year had turned to hedge more of its U.S. dollar risk (effectively buying more yen through hedge instruments). Interestingly, this group was also turning to European bonds—because after factoring in the cost to hedge the euro, yields were better than U.S. yields (when factoring in the cost to hedge the U.S. dollar). The more Yellen hikes short-term rates, the more hedging costs rise and the less hedged these institutions will likely become, which could reverse some of the yen strength we’ve seen.