The Daily Prophet: Currencies Captivate

Robert Burgess is editor of Bloomberg Prophets.
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The story of the year so far in markets has been the wild gyrations in currencies, from the free fall of Turkey's lira, to the continued weakness in Mexico's peso, to the big rebound in Russia's ruble. One could even add the huge jump in bitcoin prices to the list. Although the spotlight in the $5 trillion-per-day foreign-exchange market has largely been on developing-nation currencies, today the majors took center stage.

In the biggest surprise, the British pound soared the most since June against a basket of major-market currencies as Prime Minister Theresa May said U.K. lawmakers would get to vote on the final deal for an exit from the European Union even as she promised a “global Britain.” The greenback went in the opposite direction. It fell the most since July after President-elect Donald Trump said the U.S. currency is too strong. The comments left traders wondering whether Trump would break with the strong dollar mantra of past administrations. After all, foreign investors might be less inclined to buy the Treasuries that finance big U.S. budget deficits if they knew lawmakers desire a weaker currency, making their holdings less valuable over time.


The other big story was the nascent rebound in the bond market. After all, the painful slump in the final quarter of 2016 was thought to be just a prelude to a bear market in 2017 as the global economy finally broke free from the disinflationary forces that suppressed interest rates and supported fixed-income assets. Well, it hasn't gone the way the bears expected. The Bloomberg Barclays Global Aggregate Index is having its best month since June, and benchmark 10-year U.S. Treasury yields have fallen back to November levels. According to Global Sachs Group Inc., what's getting lost in the "reflation trade'' mania is that spare capacity in Europe "is still very large'' and expectations for low inflation are "entrenched'' in Japan.

Looking at the stock market, U.S. equities are leading the MSCI All-Country World Index to within sight of a record high, making it hard to see why the mood at the World Economic Forum in Davos would be "a bit too gloomy,'' as UBS Group AG Chairman Axel Weber put it Tuesday. Yet the rebound in bonds and the surge in gold -- two classic haven investments -- confirm the unease just three days before the inauguration of Donald Trump as the next U.S. president. Bullion has risen every day except one in 2017, culminating in its biggest one-day gain since September. To be sure, the start of the year is usually a positive time for gold. In the past decade, the metal has risen every January in all but three years.


The derivatives market is also signaling some unease. Two-year interest rate swap spreads, which measure the cost to swap fixed for floating interest rate payments, have been on the rise. Usually, the wider the gap, the bigger the general level of anxiety in markets. Today, the spread reached 31.4 basis points, up from a post-election low of 17.35 basis points on Nov. 25. The last time the spread reached such levels was in the first half of 2012, a time when Greece's debt crisis led to worries that the euro zone would fall apart.     


Now, attention will turn to the consumer price index report that will be released Wednesday by the Labor Department. It  will go a long way toward showing whether Goldman Sachs was right when it said the "reflation trade'' is overdone and the nascent rally in bonds can last. The consensus is for a mild increase of 0.3 percent for December in the headline number and an 0.2 percent gain, excluding food and energy -- the same as November. A few hours after the release, Fed Chair Janet Yellen will take part in a discussion at the Commonwealth Club in San Francisco.  

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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