The specific detail around last week’s currency intervention became a little more clear over the weekend. It was apparent that the US coordinated with Japan to assist their efforts to combat a weakening Yen. The reality is that interventions almost always fail to achieve their intended goal of changing the inertia of currency devaluation and instead act only to signal intent. If Japan really wants to strengthen the Yen, it simply must increase interest rates.
This dynamic was reflected in the subsequent move in the currency this week, whereby it appreciated much further on Monday but has since given up half of the short-term strength brought about by these actions.
To help bolster its currency Japan sells foreign reserves, typically US treasuries, and buys domestic assets which helps balance the supply and demand of its own currency. We believe there is a propensity for Japan, as significant holders of US treasuries, to continue to sell these assets while the dollar remains strong relative to its own currency before taking alternate action to more permanently strengthen the Yen.
Until that point, there will likely be many more of these interventions and each one provides a nice opportunity for those utilising the carry trade to add a lower risk leveraging up of their portfolio. It is maybe therefore no surprise to see equity markets moving higher.
There were two interesting factors about the American assistance which are worth highlighting. First, the US has correctly responded to the increasing likelihood that Japan will sell down a large portion of US government debt by offering a facility with which to do so – the Foreign and International Monetary Authorities Repo Facility.
When utilising this mechanism, treasuries are not actually sold; instead, the Federal Reserve exchanges them for dollars. This helps to stop the market from getting spooked by such fire sales and alleviates the upward pressure on government debt borrowing costs. The liquidity is instead provided by dollar currency markets which are in the region of eight times larger and are thus less reactive in the short-term.
However, this dynamic provides another reason to be cautious about the US dollar, and this is where the second nuance comes into play. The Fed in this instance sold euros instead of dollars to execute this currency intervention. Is this an indication that the US is losing its faith in the European experiment? Is this an indication that the US is actively having to enact policy to mitigate anti-US dollar dynamics?
I can’t yet answer either of those with confidence – Maybe the only takeaway is that the selling of US Treasuries by the Japanese will be well managed by America and thus it is a factor in the anti-US dollar narrative that begins to fall away.
Leverage alone is not the sole explanation for a strong week for global equities. Anticipation has grown over the possibility of an Oman brokered deal to reopen the Strait of Hormuz. Oman and Iran drafted an interim proposal under which inbound traffic to the Persian Gulf uses an Iranian-controlled lane and outbound traffic uses an Omani route, but the proposal includes an Iranian transit fee levy of 5-7% of cargo value.
Washington maintains that no transit tolls should be charged under international maritime law but President Trump has confirmed US involvement in the negotiations and points to a resolution soon – of course, with the mid-terms rapidly approaching the view is that Trump needs this to come to a resolution very soon, such that market commentators are beginning to think he may even concede to the Iranians on the tolls. It comes at a time when the US is widely reported to be running out of missiles, which could force Trump’s hand.
Domestically, the US manufacturing sector is rip-roaring; the ISM Manufacturing Purchasing Managers Index surged to 55.6 in July (50 is neutral), marking the seventh consecutive month of expansion while manufacturing payrolls expanded for the first time in 18 months.
Corporate results have shown that almost all sectors are experiencing strong earnings growth as the economic success story broadens out. Palantir was a shining example of technological success this week as its commercial revenue rose 149% over the past twelve months, proving that there are examples of AI demand accelerating.
Markets are craving signs that AI investment is starting to bear fruit, punishing AI hardware where momentum had pushed expectations well into hard-to-beat territory and rewarding any glimmer of revenue expansion in software.
This bout of positivity around AI appears to be feeding into copper prices which turned higher this week. Gold also jumped, and while cooling interest rate expectations can partly explain this move, it’s possible that yet-to-be-confirmed central bank purchases or an undercurrent of stealth institutional accumulation is also to blame, which could put a floor under the precious metal in the short-term and create a renewed period of upward momentum.
Where are markets up to?
The rolling 12 month % cumulative returns in local currency from various indices is shown in the following chart:
Where are the portfolios up to?
The portfolio performance, net of fees, to close of business on Thursday is as follows:
As ever, if you would like to discuss any aspect of your portfolio, please do not hesitate to contact us on service@blythefinancial.com.