'The past two weeks have been a wake-up call for the global economy' - Simon Smith, FxPro

SIMON SMITH
PROFILE:
• Current Job: Chief Economist for FxPro
• Career: Holds an MSc. in Economics from the University of London and a BSc. from Brunel University. He has held economic and strategy positions with Standard & Poor’s.

View profile at FXStreet

Simon Smith has over seventeen years experience of macro forecasting and investment strategy research. Prior to joining FxPro in May 2010, Simon was a consultant with Thomson Reuters, having spent four years as Chief Economist at Weavering Capital. 

Simon has held economic and strategy positions with Standard & Poor’s, together with consultancy firms 4Cast and MMS International. He holds an MSc. in Economics from the University of London and a BSc. from Brunel University.

It’s clearly stemmed from China, because the issues that have been there for a long time now have manifested themselves in a change in exchage rate policy and a sharp fall in the stock market. The impact on Fed expectations has largely resulted from this, together with the ongoing and partially related fall in commodity prices. If you look at the past two years, Chinese stocks have had a near zero correlation with global equties (comparing MSCI Global and Shanghai composite on 2 month rolling correlation) and in turn the Chinese stock market has had no discernable relationship with what is actually going on in the economy. We’ll probably go back to this state of affairs very soon, but I think the past two weeks has been a wake-up call for the global economy in general. China’s intervention kept the global economy afloat back in 2008-10, China conducting expansionary policies when much of the developed world was struggling. What we’re seeing now is partially the fallout from that, in terms of excessive debt levels.

I’m struggling to see a hike before year end, as I’ve done for much of the year. Naturally the recent market turmoil has reduced the odds of a September move, together with the (partially) related fall in commodity and also oil prices. As I’ve said before, the Fed wants to be sure as it can be before instigating the first move higher in rates to minimise the risk of having to unwind it later on and I think the current uncertainties on the inflation outlook don’t put it at that point.

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The move higher on EUR/USD has had two primary drivers. The first is covering of short positions given the euro’s position as a preferred funding currency. As risk has been rapidly removed, then such trades reliant on a short euro leg have been unwound. The second element is the fact that at a time of concerns about capital scarcity, the euro is in a more comfortable position than most, given that the eurozone is running a comfortable current account surplus. This means they are not reliant on overseas capital, in contrast to many emergin market currencies that have been suffering (e.g. Brazil, South Africa & Turkey).

It is, but I guess not as much as some would have liked. It’s largely down to the deflationary impact of events in China which served to accelerate the pace of declines seen in crude prices that were already in place during most of July, which makes it less appealing to go into a non-yielding asset.

There is an element of lower volumes during August, but I think that has played a relatively minor role in the recent volatility. In my opinion, “Currency war” is one of the most badly-used phrases in finance, so I tend not to get drawn into such debates. You have to remember that low volatility (actually and implied) was one of the reasons we saw the global financial crisis (of course, they were many factors). If markets get too complacent, then risk is mis-priced and it tends to get very messy. Ahead of the financial crisis, many policy makers thought we had entered some new paradigm of perpetual steady non-inflationary growth and markets to a large degree believed it. So there is a balance to be had. Markets do over-react and volatility will decline, especially implied volatility as being seen in the VIX, but don’t go wishing for a world of low volatility because that can be just as dangerous as you don’t appreciate what lies beneath.