A year in the life of forex
Donald Trump's election victory 12 months ago set off a dollar rally and protectionism fears, and heightened political risk in Europe. Roger Blitz asks Eoin Murray of Hermes Investment Management whether markets are more immune to shock, if benign forex conditions will last and what to watch out for in 2018.
Presented by Roger Blitz
Welcome to Hard Currency, the Financial Times podcast on the foreign exchange market. I'm Roger Blitz. And this was the week that marked the anniversary of Donald Trump's election victory.
It's worth recalling where the markets were 12 months ago. The dollar was propelling higher, the prospect of trade wars and protectionism were on investors' minds, and worries about political risk in Europe were also dominating. So as the fag end of 2017 is upon us, how are investors feeling about a year of Trump disappointment, dollar decline, global growth policy normalisation, and the equity bull run? And what does this year's experience tell us about investors' plans for 2018?
Our guest this week is Owen Murray, who's head of investment at Hermes Investment Management. Owen, just give us, first of all, our listeners a view of how Hermes sees the world and how it plans strategy.
Certainly. We take a very long term view to markets and asset classes in general. We are one of the world's leading responsible investment managers. And so everything we do is with a sustainable view. So for that reason, quite naturally, we have this very long term view and we tend not to react to short term market ruptions.
Because turmoil with Brexit in 2016 and Trump was clearly what everybody had to worry about. But you try and look through all that?
To the extent we can. I would go as far as encouraging our portfolio managers to switch off their screens at such a pivotal moments. I'm not sure that it helps in the slightest for us to attempt to take a short term directional view from information of that kind.
And you look at how investors did play the whole of 2017. I talked about the equity bull run, you know, the economy shifting towards policy normalisation. Does that tell us that the world is becoming a bit more shock resistant? Are all these shocks coming, we're numbing ourselves from them?
I think it might to. I mean, we've observed two particular characteristics of volatility that historically we have seen jumps in the past, and we still can continue to see them today, albeit just from a much lower level. But what's missing is the second characteristic, which is long term memory. So when we look at volatility, historically, we see that when you do have a jump volatility takes a lot longer to digest-- the markets take a lot longer to digest information and volatility remains elevated for a considerable period of time. But in the last couple of years, whether it's been Brexit, Italian referendum, Trump, or any of these shocks, the market has simply been able to digest that information in a matter of days, if not hours.
Yes, and that's kept volatility low. So the question is, can you see when volatility is going to return? Or how?
Yes, I mean to some extent there must be a link between low levels of volatility and the amount of central bank liquidity that we've had pumped into the system. So I think it's a perfectly reasonable assumption to question whether, as we move towards quantitative tightening and a reduction of balance sheets, we won't see some of the volatility come back into markets, including currencies.
Yes, currencies have been pretty benign this year, haven't they? I mean, you look at currencies for indicators for gauges of how the market is feeling do you?
We do. So we look at currencies as part of our overall macro picture. The way that we're structured, we have individual investment desks that have their own philosophies and will come up with their own decisions. And then we take a house macro view, which we offer to them as an additional element.
So you'll look at the currency world this year and you'll probably see only, what, sterling as being the key things to keep looking out for on a regular basis?
I think it's really been the main story this year. We have seen some dollar weakness, but in relative terms I'd have to say that's not huge. If you were just to take a post Trump election view, we've gone from massive longs to massive shorts, and we appear to be moving back towards the middle and in terms of dollar positioning. So yes, sterling has been for a large part of the year, the main show.
And you presumably have portfolios with the UK very much in mind. Does it simply boil down to a binary story regarding Brexit and sterling? Is it simply we are right in the middle of that and we just are in a period of uncertainty? Is that the best we can say at this stage?
Sadly, I think it might well be. I think you're absolutely right, Roger. Uncertainty dominates. And I guess we'll know a little bit more in the next couple of weeks as to whether a deal on cost and on the rights of European citizens etc. is possible before Christmas. And it does appear to us that Europe and the politicians are setting a great amount a store by having something concrete for phase 1 to show by the end of this year, but it's not at all clear to us that we'll get there.
You have a very long term outlook. Do you look at sterling's relative, I mean, historical value and say well, it's pretty cheap at the moment. There's opportunities there.
It's very cheap looking at any sort of reasonable investment horizon as far as we can see. That being said, if it's true that we are now in a new era, one in which it's very difficult to imagine what the world will look like in two to three years time for the UK, I think it's difficult to take a big view on sterling.
OK. That's more problematic. What is a better judgement for 2018? What makes you feel a bit more confident? Let me ask you about emerging markets. I mean, yes, they have had some difficulty over recent weeks, but in the long term are your people more confident about them?
Yes they are. So for us, the view has been that the emerging markets have been an exciting story for this year. In valuation terms, there's a degree of catch up relative to the developed markets, and that has been to the benefit of investors. I suppose equally on the other side of the equation, one is looking at US rate rises, the potential impact of US tax reform, and strengthening dollar. And what does that then mean for emerging markets and emerging market currencies?
Yes. And China has always been a bellwether for how generally emerging markets-- well, actually a bellwether for the rest of us as well. But I mean, does China-- does the benign story about China in 2017 carry on into next year?
I think it could well do. Our views are somewhat polarised. On the one hand there would be a strong group within the firm who have a very positive view on China, their adoption of new technologies, their productivity, and their capacity for continued growth. And even if things do go wrong, I think there's a strong sense that the problems are largely domestic in nature. And that they still have plenty of tools in their toolbox that they could use to correct any problems.
On the other hand, you know, I remain concerned about the level of debt, the amount of credit that's gone into the system. When we've seen that historically in other assets, other markets, that has been a problem and ended badly. And we can't even be exactly sure about the amount of non-performing loans in the market.
So there is the potential for risk to materialise there in 2018.
We parked that problem at the beginning of 2017, we're going into 2018 with the same problem.
Yeah. Well, I think to some extent if one was local domestic Chinese I think there was a need to get through the National Congress just a couple of weeks ago. And that's happened now. Perhaps we'll see a sort of different turn of events now that that's behind us.
The broader story in 2018 about policy normalisation. This looks like it could go, it will carry on but in a desperately slow way, which was probably linked to global growth. Does global growth excite you into 2018?
I think global growth remains incredibly unloved, despite the fact that it does appear to be sort of fairly synchronised around the world. It strikes us that in any normal times we'd be saying, this feels sort of, it's got a very light cycle feel to it. And all the news is coming at the back end of that late cycle, which is a little unusual.
Are there things on the horizon that give us concern? Yes, some. Clearly the unwinding of balance sheet. If that becomes a global phenomenon for central banks then that must, you know, we'd have to ask whether that will have an impact.
Just finally, 12 months ago we didn't know what to make of Donald Trump. At the beginning of the year, we were thinking there's going to be lots of problems on the horizon. Maybe 12 months old we're, you know, a bit more phlegmatic about it all. What do you think should we still be wary of regarding the US president?
I think-- I think that partly hinges on the extent to which the current tax reforms which are in discussion go through. And I think we've seen the Ways and Means Committee, now we're waiting for the Senate Finance Committee to produce their version. I would worry that if we don't manage to get some more serious tax reforms pushed through, if it's even just tinkering and tax cutting, that there will be big questions about the success of Trump in the first half of his term. That in itself could encourage him perhaps to make use of the powers, the executive powers, that he has in his own hands. And I think that particularly for me he focuses on trade and protectionism.
That problem may be coming back to us.
My thanks to Owen Murray of Hermes. Join us again next week for Hard Currency. Until then, it's goodbye.