Cut Italy some slack

In the last few days the market has been getting worked up about the new Italian government and its deficit plans. Italy is well known to have the largest debt burden in the EU, and the largest as a % of GDP after Greece, and after all the problems Greece caused it is not surprising that expansion of Italy’s budget deficit is view with concern. But a bit of perspective is necessary. First of all, the proposed rise in the deficit is only to 2.4% of GDP – below the EU guideline limit of 3%. The Italian deficit has only been lower than this in three years since 2000, so this is hardly an unprecedented blowout. But the EU will not be criticising Italy for exceeding deficit guidelines, but for failing to do enough reduce their debt – which is currently at 130% of GDP, well above the EU guideline of 60%. To that extent, EU concern is understandable, but looking a little more closely it is hard to argue that this debt should be a major concern.

The debt level is a concern if it is rising year on year and starts to spiral out of control. But this is currently not the case in Italy, where the debt level has been stable since 2014, partly because Italy is running a primary budget surplus, as it has for many years, partly because the yield on Italy’s debt, and consequently Italian debt interest payments, have been falling steadily. So much so, that even though the debt level is close to its highs at 130% of GDP, net debt interest payments are at the lowest level since 2000 (and long before that) at 3.5% of GDP.

To determine the level of the deficit that is needed to reduce the debt level we need to do a little maths. Leaving aside some technicalities, the primary surplus needs to be greater than the debt level multiplied by the difference between the nominal growth rate and the nominal interest rate. Or:-

p > D(g-i) where p is the primary surplus, D is the debt level, g is the growth rate and i is the average debt yield.

In Italy’s case, D=130, and i=2.7%. g is the biggest problem, as this is averaging only around 2% in the last few years. Still, on that basis we need p> 130(0.02-0.027) = 0.91.

If Italy runs a deficit of 2.4% of GDP, with debt interest payments of 3.5% of GDP, it is running a primary surplus of 1.1% of GDP. This is lower than we have seen in recent years, but still greater than 0.91% and enough to keep the debt level stable, albeit barely reduce it.

Now, this is all very well for now while yields are low, but, you may ask, what happens if yields go up in the coming years as they seem likely to do when the ECB stops its QE and starts raising rates? This is a fair question, but Italy has protected itself to some extent by extending the average maturity of its debt to 7 years, so that any rise in yields will take some time to have a major effect.

But the bigger picture is this. The best way for Italy to exit the debt trap is to boost its (nominal) growth rate. While we can argue about the best way to do that, a modest fiscal boost won’t do any harm, while the impression that they are subject to an EU strait-jacket will not help. There are some minor signs of improvement in the Italian economy. The long term unemployment rate has started to fall, the growth rate has picked up modestly, and the current account is in increasing surplus. This, by the way, suggests that the Italian private sector is saving too much and holding back growth. A little more government spending and some boost to consumer confidence could be what is needed to keep growth accelerating.

While Italy’s debt does need to be dealt with in the longer run, the EU should see that attempting to impose austerity is not going to work either economically or politically. Trying to slap the new government into line will only foment more disaffection with the EU and likely create an even more anti-EU political movement. In any case, there isn’t much the EU can do to stop Italy’s government doing what it plans in the short-term. Things like the excessive deficit procedure take a long time to kick in and are pretty ineffective anyway. The biggest discipline on Italy will be the markets, and the best way for the EU to help Italy is to encourage the markets to cut Italy a little slack.




GBPSEK selling opportunity

The Turkish crisis and Brexit muddle create an opportunity to sell GBP/SEK


Turkish crisis dominates the action

This month global markets are mostly concerned with Turkey, with the sharp fall in the currency the main driver of concerns about deteriorating credit quality due to large net external liabilities. The degree to which foreign currency debt of Turkish entities is currency hedged is unclear, but is key for determining their solvency. Other than the weakness of the currency, the economic situation is in any case vulnerable, but has been for some time. But from a baseline of vulnerable, conditions have deteriorated steadily in the last year or two, with inflation rising and the current account deficit widening, in part because the central bank has not been allowed to make the rate rises required to stem these trends. This political aspect of the problem makes it much more intractable, especially when you throw in the pastor and the aggressive tariff response from Trump.

It is hard to see the endgame at this stage. Funding the current account deficit will remain very difficult as long as there is no action. Even significant interest rate rises may not help much at this stage. Capital controls may come in, and there are risks of default on external debt. However, most of the risk is not government debt, as in previous crises, but corporate debt. This makes a bailout unlikely and difficult, but also probably reduces contagion risks. While there is significant exposure to Turkish debt among European banks, it is not game changing – even the most exposed banks would survive the worst case scenario as long as the problems remain isolated to Turkey.

Which leads to the main question, which is one of contagion. Most commentators argue that this is the primary risk, citing parallels with previous EM crises, notably Asia 97. And they are right, because markets are never entirely predictable, and if appetite for risk disappears what currently appears a perfectly solid investment can quickly become vulnerable. (Almost) everyone needs to raise money, and in such circumstances even perfectly solvent entities can struggle to refinance if markets suddenly become unprepared to fund. As Hamlet says “there is nothing good or bad but thinking makes it so”, and shocks like Turkey can lead to some pretty muddled thinking.

Nevertheless, we doubt that the Turkish situation will lead to a big global meltdown in EM, or a renewal of the Eurozone crisis. Even worst case scenarios should remain contained.  While we may have a period of pressure on some EM currencies and higher EM yields, in the end the global economy is starting from a position of reasonable health driven by good US growth and improving Eurozone growth, combined with a generally more solid global banking system. There are savings looking to be deployed towards higher yielding assets in a world of still very low yields. There are no certainties, but this episode looks likely to present an opportunity to buy risky assets. Of course, care is required, as especially in August things can go a lot further than we would expect before turning. Things that look cheap may yet get a lot cheaper, so technical signals that the market has completed its rout need to be awaited.

Opportunities created by Turkish crisis

The obvious opportunities are the emerging markets that have suffered in sympathy with the Turkish Lira. The ZAR, BRL, and even MXN have all weakened, and there may well be value there. But getting these right requires good timing and a clarity that the crisis is over. In these situations it is often better from a risk/reward standpoint to consider the less obvious collateral damage. In the G10 space the two currencies that have suffered the most since early August are the NZD and SEK. The NZD is understandable as it can be considered the closest thing to an emerging market in the G10 space. But the SEK? Sweden has a current account surplus, very low interest rates and inflation, the strongest growth in Europe and a very secure budget and banking system. It is no-one’s idea of an emerging market. Nevertheless, the SEK does tend to exhibit characteristics of a risk positive currency. This is in part a historic issue harking back to the days when Ericsson made up 30% of the value of the Swedish equity market and it was strongly identified with the tech boom and bubble. But nowadays, while still showing one of the strongest growth rates in the EU, there is no particular dependence on tech. Both EUR/SEK and USD/SEK have risen to levels that have to be considered excellent longer term value regardless of which way the Turkish crisis is resolved, but GBP/SEK may represent the best trade, given the risks involved in the run up to the Conservative Party conference and the October EU Summit.

With the UK parliament on holiday, there have been no significant developments in the last couple of weeks, but there has been more and more noise suggesting that the risk of a “no deal” Brexit is increasing. The main upcoming events are the UK Conservative Party conference from September 30 to October 3 and the EU Summit on October 18/19. Neither looks likely to provide any real progress on Brexit, and the prospect of “no deal” will consequently become even more probable, at least as far markets are concerned.

There are several reasons for the lack of progress, but the two main ones are the lack of any majority in the UK parliament for ANY Brexit plan, and the perception on both sides that the threat of “no deal” – and the brinkmanship involved in that – is necessary in order to get the “best” deal for their side. It may be that an apparent increase in the probability of “no deal” is actually a necessary condition for a deal to be done, but the process will nevertheless have continued market impact.

For what it’s worth, we believe that a free trade deal of some sort is the most likely eventual outcome in the Brexit process. Probably the best reason for this is Ireland. “No deal” would require a hard border, and that is anathema to both sides as well as effectively contravening the Good Friday agreement. But even though a free trade deal is likely eventually, that doesn’t matter right now because it isn’t the most likely next step. More stress is required to produce that outcome.

From a trading perspective, the battleground is GBP. We look to play this from the short side not only because the next events look likely to be GBP negative, but because GBP is starting from a position which we regard as barely below fair value. The current price does not adequately reflect the risks of Brexit.

GBP/SEK looks an attractive vehicle to express GBP weakness here.

Time to buy European equities




france 10 year



Eurostoxx and S&amp;P




GBPJPY hitting selling area







gbpjpy and ppp

Source: OECD, FX Economics



Source: OECD, FX Economics








USDMXN way out of line with fundamentals






Source: OECD

Mexico current account

Source: World Bank, OECD


Rate hike won’t sustain GBP strength




Real UK base rate

uk real rates

Source: Bank of England



Riksbank policy – dangerous, myopic and unsustainable.









Source: Riksbank, BIS

EUR/USD – Echoes of 2002



eurusd and ppp

Source:OECD, FX Economics


eurusd and tnotebund

Source: Bloomberg, FX Economics



Germany’s trade surplus is down to Germany not the ECB


german stuff

Source: OECD


german stuff1

Source: BIS



german stuff2

Source: EU Commission

The UK needs a weak pound



sector balances

Source: ONS


householdbalance and GDP

Source: ONS






UK retail sales – the beginning of a slump?

Unusually I think it’s worth highlighting a monthly release. There is a lot of randomness in most monthly data and UK retail sales is one of the most vulnerable to monthly glitches, often because of seasonality problems. However, if you look at a 3 month average of sales the trend has been quite clear in recent years, until the last couple of months where it looks like everything fell off a cliff.

uk retail

Source: ONS, FX Economics

Now, it’s as well to be cautious in interpreting such sharp moves in retail sales, especially around the turn of the year when Christmas effects can be unpredictable. The plunge we have seen is really based on just a couple of months data. But as can be seen from the series, it is rare for the 3m/3m trend to move so sharply. If we see a similar story in March it would be fair to conclude that there has been a clear weakening in the trend.

Which leads me to the March data due for release tomorrow, Friday April 21. Looking at the screens today, the market median expectation for retail sales is for a m/m decline of 0.2% in the headline number, and a 0.4% decline in the core. Now, this seems to me to be quite a pessimistic forecast. The impact on the 3m/3m growth rate would be minimal, as shown below.

UK retail march

Source: ONS, FX Economics

Retail sales only makes up around 40% of personal consumption, but even so, a 1.2% decline in a quarter is quite a serious slump. Even if we assume the rest of spending carried on as before at the 0.7% q/q rate seen in Q4, then this would still mean negative consumer spending growth in Q1. As I was last month, I am a little sceptical that spending has been quite that weak. Last month we got a rise of 1.4% m/m, which was still far too little to prevent a sharp weakening in the 3m/3m trend, but was nevertheless well above the monthly forecasts. Markets saw this as good news, simply because the outcome was better than expected on the month, but it’s very hard to see how this sharp weakening in the retail sales trend is actually positive news for GBP. This month we may get more of the same. It would take something above a 3% m/m gain to prevent retail sales falling q/q in Q1. But a better than expected outcome of a 1% rise or so seems quite likely, as this would still mean a fall of 0.75% q/q. But surveys don’t suggest any major recovery, with the BRC survey showing the weakest quarter since May 2011 for non-food sales.

So we might get a knee jerk positive reaction because the monthly forecasts once again look quite weak and the m/m rise may be better than forecast. But any positive GBP reaction could prove a selling opportunity for GBP as the strength of the UK economy that Theresa May and the IMF have been telling us about in the last week looks to have come to something of a shuddering halt in Q1. Who knows, this may be another reason that May has called an election now. There are initial signs of a slowdown, and she may want to get an election in now in case they become more obvious in the coming months and years. We are in the sweet spot when it seems consumer confidence is still high, or at least was until Q1, exports are getting some support from a weak pound and there are as yet no negative consequences of Brexit to deal with. Things might not look so rosy in a few months.

UK election – GBP surge may last a while but…










A strange time to worry about the euro




real yieldsSource: FX Economics, OECD, national central banks





GBP isn’t cheap

Over the last few weeks and months I’ve noticed quite a few commentators suggesting that GBP might now be attractive because it is very cheap. For instance “the pound looks increasingly “cheap” in a historical context” (Morgan Stanley March 7). “The pound looks cheap at current levels” (ANZ December 6). “The pound is looking “cheap” from a longer-term point of view” (Scotia Bank March 2). There are plenty of others. The consensus seems to be that the pound is cheap because it is suffering from Brexit woes, and that if those were to fade, or be overtaken by concerns elsewhere in the world, the pound would recover. But I would argue that although the pound is obviously cheaper than it was, it still isn’t really cheap against most of the other major currencies.

If something falls a lot it doesn’t necessarily mean it is now cheap. It’s possible of course. But it is also possible that it is falling in line with long-term equilibrium – i.e. it is no cheaper than it was. Or, more likely, it could be that it has fallen from expensive levels and is now just less expensive, or fair. How to decide? Well, some sort of sensible model of fair value is necessary, otherwise we don’t know where we are starting from, or what affects long term equilibrium.

A lot of people run a mile as soon as they see the word “model”. Models are distrusted. So I’m not going to create anything complicated or use any fancy econometrics. I’m simply going to point out three things.

  1. It is the real value of a currency that matters, not the nominal value. This is just another way of saying that if prices rise in one country or currency area relative to others, then unless the currency falls, things are now more expensive in that country/currency area. In other words, to keep the real value of the currency stable, currencies have to fall if relative inflation is high in their area.
  2. Trade balances and current accounts matter. The bigger your current account deficit the more capital you need to attract to finance it and, other things equal, the lower your currency has to be.
  3. Interest rates make a difference. If you have higher interest rates than others there will be more demand for assets denominated in your currency. This ought to apply to real interest rates (interest rates minus expected inflation) rather than nominal rates, because future inflation would typically lead to currency depreciation (point 1).

I don’t think anyone would argue with these three points. But if these are accepted, I don’t see why people see GBP as cheap.

Point 1 is really the most crucial. While terms of trade and interest rates are clearly important, the impact from changes in export and import prices can take some time to be felt and can be offset by other flows. Similarly, interest rate variations affect short-term demand, but if such variations are cyclical they may not have much impact on long-term value. But where we are starting from in terms of the real value of the currency is critical.

So where does the pound stand in real terms? There is more than one way to measure this, but I will use two main methods. First, let’s looks at the commonly used measure of the real effective exchange rate. The chart below shows the narrow real effective GBP exchange rate, and on the face of it, GBP does look quite weak by historic standards. But looking at it next to the EUR effective exchange rate, it isn’t so clear. Since the financial crisis the EUR has weakened more on a trade weighted basis than GBP. Even more dramatically, the USD is well above the highs seen in the last 20 years


Source: BIS

So what’s going on? Well, a little more light is shed if we look at another measure of value – namely GBP versus purchasing power parity (PPP). Below is a chart of EUR/GBP against EUR/GBP PPP.

eurgbp ppp

As this shows, EUR/GBP remains some way below PPP. This is not unusual – it has only briefly traded above PPP in the past. This is itself a little puzzling, and I would argue that it is hard to justify, of which more later. But even taking that as given, EUR/GBP is only marginally stronger relative to PPP than its average in the last 20 years.

So GBP isn’t really weak against the EUR at all. What we are seeing here is not GBP weakness, but USD strength.

This is all the more obvious if you look at GBP/USD relative to PPP, shown below.


The USD is as strong against the pound (relative to PPP) as it has been since the 80s and the Reagan era. But the USD is strong against (almost) everything. Only the CHF among the majors looks stronger relative to long run fair value.

Now, USD strength is based on the cyclical strength of the US economy, and to that extent is justified in the short to medium term because US interest rates are higher than the UK and Eurozone, and rising. While the UK economy is (arguably) similarly strong to the US, given low levels of UK unemployment, the UK doesn’t have the interest rate advantage. Indeed, real UK rates are the lowest in the G10. Not only that, but the UK also has a massive trade and current account deficit. The chart below illustrates the situation.


Source: OECD. Real rates based on 2018 forecasts of PCE deflator

The further north-east you can get in this diagram, the more attractive your currency should be. A big current account surplus, like Switzerland, will normally allow you to have low real rates while high real rates, like New Zealand, will normally allow you to run a big current account deficit. The UK is currently enjoying the worst of both worlds. It’s also noticeable that real rates in the US aren’t all that attractive, and may not be high enough to justify the very high level of the USD. As far as the EUR is concerned, there are clearly other issues at play, including existential concerns. But without even considering the potential future negative impact of Brexit (though of course some of this is included in the real yield), it would make sense for GBP to be well below fair value. The fact that it still trades well above PPP against the EUR, and close to it against the USD, suggests it is far from cheap.

What will it take for the CHF to weaken?


Source: BIS









Source: SNB

Canada (and CAD longs) should be worried about the US border tax


Trump has talked a lot about Mexico, imposing a border tax  and getting them to pay for the wall. USD/MXN has reacted aggressively, and although it is off its highs in common with the general USD dip in recent weeks, USD/MXN is still 60% higher than it was 2 years ago. But it seems to me the market ha been overly focused on Mexico when it comes to Trump’s trade policies. While he has been very vocal on the possibility of a tariff on Mexican and/or Chinese goods, the actual plan for a border tax adjustment looks much more likely to be along the lines proposed by the House Republicans. This would be part of a general tax reform involving a cut in the corporate tax rate to 20% and a “border adjustment tax” of 20%. Such a tax would likely be charged on all imports (while all exports would be tax-deductible) regardless of where the imports come from. It seems unlikely the new system would be focused on Mexico or any other single country. As such, it seems the reaction seen in USD/MXN is excessive relative to the reaction seen in other currency pairs.

This sort of tax is normally associated with consumption tax based systems like VAT. In that case, a tax is added to imports to level the playing field with domestic goods on which VAT has been charged, while exporters get VAT refunded. Although the US system isn’t a consumption tax based system, the idea is to switch the US system to a territorial system in which companies are only taxed on revenues earned domestically rather than the current worldwide system in which US companies are taxed on all revenues. The argument is then that the system (a destination based cash flow tax or DBCFT) will then be broadly equivalent to a consumption based tax system. There are several technical arguments about deduction for wages and land which mean that this is probably not correct, and the tax my consequently be against WTO rules. This may be a problem for the system in the long run, but establishing whether it breaches WTO rules and generating a response will take some time, and the short to medium term impact of such a policy, if implemented, is likely to be significant.

If such a system is implemented, it will immediately increase import prices and reduce export prices. From a trade perspective, it would effectively be equivalent to a devaluation of the USD by 20%. The academic response from trade economists to such a policy is that the market reaction would be for the USD to appreciate by 20%, leaving everything real effectively unchanged. But in practice this won’t happen. The level of the USD doesn’t only affect trade, but also asset values and capital flows, and changes in such flows in response to moves in the USD are often larger and almost always faster than changes in trade flows. It is also the case that some of the reaction has already happened, notably in the MXN. Even so some currencies are still likely to be affected if such a plan is put into practice, as it may be in time for the 2018 tax year.

While some impact can be expected on many currencies, of the liquid currencies the CAD seems much the most vulnerable. 75% of Canada’s exports go to the US, making up 4% of its GDP, so such a big move in the terms of trade would have a huge impact. Unlike USD/MXN, the CAD doesn’t start from a position of being cheap. The consumption based PPP for USD/CAD is around 1.30. Other major currencies may also be hit, but they are all less exposed to trade with the US. Many also start from a cheaper level (notably the EUR) and are more capital market determined (the EUR and the JPY). From a risk perspective, if such policies are perceived as damaging to US growth, the CAD could also be expected to suffer from the impact on risk appetite and commodity prices. Add to this the fact that the CAD has strongly outperformed rate spreads this year (see chart), so will probably weaken anyway if the market takes a positive view of Trump/Congress tax and spending plans, and the potential upside for USD/CAD looks substantial.

Policy mistakes should not always be reversed


UK inflation is rising

The Bank of England cut rates by 25bp and increased asset purchases in August in anticipation of a loss of confidence after the Brexit vote on June 24. The objective was stated to be to “provide additional support to growth and to achieve a sustainable return of inflation to the target.” Subsequently, growth was substantially stronger than expected through the remainder of 2016, mainly due to strong consumer spending, funded by increased borrowing. Now, many (including myself) thought the cut was a mistake at the time. But we all make mistakes. The Bank’s assessment of the impact on confidence appears to have been incorrect. Of course, some might argue that growth was stronger because the Bank eased policy, and no-one can prove that is wrong, but I think it is far-fetched. The fact is that the majority of the population (or at least half) are in favour of Brexit, so there is no good reason why the vote should have undermined consumer confidence. Business confidence might have been damaged in the longer run, but very few investment decisions are changed in a short time frame, so if there is a negative impact, it is yet to be felt. In practice, the relative resilience of spending may convince businesses to hold their nerve until the new trade arrangements become clearer, which may well take some time, as long as growth doesn’t start to slip back.

So it certainly seems as if the Bank of England made a policy error. While there is still very likely to be a longer term supply side shock from Brexit, that may not happen for quite some time, and the demand side shock the Bank initially expected has not materialised thus far. So what should they do? Should they reverse their easing and admit their error? The latest Inflation Report certainly shows inflation is expected to move above target soon and stay above target for the whole forecast horizon, which would suggest there is a pretty good prima facie case to raise rates or at least halt the increase in asset purchases. But the best way to fix an error is not always to simply reverse policy. Unless the reversal is done very quickly, the environment faced is different from the one faced initially. Things have changed.

In this case, the most notable change has been the decline in the pound. This has been good in some ways, as it has helped sustain manufacturing an export confidence in the face of uncertain future trade relationships, but it will lead to substantially higher inflation going forward, starting quite soon, as higher import prices feed through to CPI. It has also already led to higher inflation expectations. The key question as to whether this is sufficient reason to reverse the policy easing is whether the coming rise in inflation leads to an increase in wages and other factors generating domestically generated inflation. At this stage this is not clear, and is important. If wages don’t respond, we will see a sharp decline in real income growth as inflation rises, and if we also see a rise in rates from the Bank, there is a danger this will lead to a sharp decline in consumer confidence, potentially at the same time as sterling rises in response to a rise in rates. This could make the current optimism about the UK economy evaporate quite quickly.

So at this stage it seems sensible to wait. Inflation is coming, and it would be as well to see how this impacts spending and confidence before acting to reverse the move made in August. There has been a lot of British bravado since the Brexit vote, but high levels of debt and declining real incomes, plus the uncertainty surrounding the trade relationship with the EU and elsewhere, suggest that confidence is likely to be fragile. After making a policy mistake it is important not to compound it. The Bank mustn’t act looking in the rear view mirror.



Corbyn’s cap is a bad idea


This is not just a fashion statement, though the Mao style cap is not likely to endear Corbyn to Middle England or improve his electoral chances. It also refers to his idea of a wage cap at somewhere between his own salary (137k) and 50m. He sensibly backed away from that idea as the day went on yesterday, but unfortunately has tarnished the whole idea of dealing with excessively high pay with his ill thought out plan. Excessive  pay is an important issue, but the key point is that it is excessive, not that it is high.

He gave footballers’ high pay as an example, but footballers’ high pay is a very poor example. Footballers are talented, and are paid a lot because their talent is in demand. Their ability is broadly measurable and certainly observable, even though there may be some disagreements about the contributions that players make, and clubs compete for their services in the open market. In general they are highly trained, have committed their whole lives to honing their specific skills, and are competing in an extremely competitive market. Pay is high, but reflects both high demand for their services and the very low probability of being successful.

Compare this with the chief executive of a large public company. The skills required are more amorphous. Leadership, strategic thinking, man management, and ruthlessness may all be required, but it is very hard to quantify whether CEOs are making a difference. If their companies are outperforming in their sector it may be a partial guide, but that may be because of their workers or company specific factors unrelated to them. Nevertheless, it’s necessary to measure performance in some way, and the company’s performance is a better guide to CEO performance than most, because the CEO’s objective should presumably be to maximise shareholder value (subject to some constraints of acceptable behaviour). Other employees can no doubt have more specific objectives, but for CEOs the bottom line should be the…er….bottom line.

But the argument many give for paying CEOs of large companies big salaries is that the larger the company, the greater the potential for the CEO to add value. If a CEO makes a decision that raises revenue by 1% it makes a difference of 100m for a company with 1obn in annual revenue, but only 10m for a company with 1bn in annual revenue. But this cuts both ways. If the company underperforms by 1% the CEO will be losing the company more money the larger the company is. This suggests that larger companies’ CEO salaries should be more volatile. Potentially larger but more dependent on performance. But you don’t see too many pay deals where the CEO has to pay the company money, so any deal has to accept that the CEO gets a basic salary that can only be increased by the bonus. On this logic, surely the larger the company the lower the CEO’s basic salary should be and the higher the gearing to performance.

Anyway, this is the sort of detail that Mr Corbyn didn’t seem to consider before jumping into the debate with both feet. A salary cap is precisely the wrong way of going about things, as it would just mean a lot of underperforming CEOs earning a lot of money regardless of performance. Admittedly this is not very different from the current situation, but with lower salaries, given the general lack of sensitivity of CEO salaries to performance. In that sense Corbyn is right in recognising there is a problem, but his solution was initially ill thought out, and subsequent attempts at a more sensible presentation of ideas have been tarnished by his initial floundering.


Trade ideas for 2017


  1. Long Euro Stoxx 50 – Entry 3280, target 4000, stop 2870.

European equities are just too cheap. The Euro Stoxx 50 has massively underperformed the S&P 500 since the financial crisis. Part of this is of course because the Eurozone economy has underperformed the US. But the scale of US outperformance is excessive. US nominal GDP has risen 24% since 2008. Eurozone GDP has only risen 10%. But the S&P 500 has risen 45% since the 2008 high, while the Euro Stoxx 50 is still 28% below its 2008 high. Of course, part of the strength of the S&P is due to easy monetary policy – US 10 year yields are, even with the recent rise, around 1.5% below where they were pre-crisis. However, this is even more of a case for Euro Stoxx strength. Bund yields are more than 4% below pre-crisis levels, and while peripheral yields have fallen less than bund yields, most have fallen more than the US 10 year.

With Euro Stoxx down 28% from 2008 highs and long-term yields down around 3% or more, the risk premium has increased enormously. Now, many will point to all sorts of risks to justify this. French, German, Dutch and maybe Italian elections next year. Greece still an issue. Brexit.  But if the US can welcome Trump with higher equities, a European political shift to the right won’t necessarily be bad for stocks. European growth appears to be improving slowly, and European yields are set to stay a lot lower than the US. Plus the above calculations don’t take account of the 35% decline in the Euro since 2008. Currency adjusted, the underperformance of  European equities is even more dramatic.

Of course, it may be that higher US yields lead to a US equity decline, so perhaps some of this should be taken relative to the US. But if US yields rise because of stronger growth and inflation under Trumponomics, it will benefit European growth as well, and will probably not mean a drastic decline in US equities, making European equities all the more attractive.

2. Long USD/CHF – Entry 1.03, target 1.20, stop 0.95.

There is also a case for long EUR/CHF but it makes sense to be long USD on the basis that even after the latest change in the Fed outlook the market is still pricing quite a moderate US rate profile through 2017. An aggressive Trump spending programme could lead to still more spread widening in favour of the USD.

Even so, I find it hard to sell EUR/USD looking for moves below parity. It does look likely to happen, but long-term the EUR will be good value at those levels assuming the Eurozone disaster scenarios don’t play out, so I look for a trade that is better value. The CHF remains the world’s most overvalued currency, and continues benefit from general distrust of the EUR. But if Italian banks don’t go under and growth continues to steadily improve helped by further US fiscal expansion, the case for holding CHF against the EUR looks weak, with the EUR likely to benefit against the CHF from improving equity market confidence (see above). Negative Swiss interest rates will become even more of a disincentive to hold CHF if other assets are becoming more attractive.

In disaster scenarios, the SNB is likely to ensure the CHF benefits less than the USD.

3. Short GBP/SEK – Entry 11. 50, target 9.50,  stop 12.25.

This was to some extent the trade of 2016, but I think it has further to run given that it has had a sharp correction higher since sterling’s “flash crash” on October 7th. The Swedish economy continues to show the strongest growth in Europe, and although the Riksbank remains highly focused on inflation and will consequently not be tightening policy anytime soon, the Riksbank is nevertheless likely to tighten before the ECB and before the Bank of England, as growth in the UK looks likely to be restricted by rising inflation and consequently weak real incomes and consumption.

Brexit is more of a swing factor than a pure negative for GBP, but it seems unlikely that the UK will achieve any real clarity ahead of the major European elections this year, while concerns may build about another Scottish referendum. The risks consequently see to be more on the GBP downside in the short term.

Although the SEK has gained against GBP in 2016, it has been generally weak against other currencies, and despite the UK’s Brexit issues and massive current account deficit, GBP/SEK is only in the middle of its range seen since the financial crisis. Furthermore this doesn’t take into account GBP’s real appreciation due to relatively high UK inflation over the period, which means that in real terms GBP/SEK is nearer the bottom than the top of its post crisis range. Rising UK inflation will be creating more real GBP appreciation going forward, further supporting the case for nominal SEK gains.


Disclaimer: These are my ideas and I believe them to be well founded. However, they could easily go wrong. All trades are taken at your own risk. I take no responsibility for losses (and no claim on profits) made due to following these ideas. 

ECB promises are worthless




