The Asian crisis is caused by over-extended credit to Thailand and other EMs

Outlook: Today the main release is jobless claims and hardly anyone will try to make a mountain out of that molehill. The one important data this week is tomorrow’s CPI, likely an advance on the most recent numbers, 8.3% in April from 8.5% in March but perhaps back up to 8.4-8.5%.

Bloomberg tells us to worry about the yen getting too weak, nearing a 24-year low that “may spark turmoil on the scale of the 1997 Asian Financial Crisis if it declines as far as 150 per dollar, according to veteran economist Jim O’Neill. Speculators are gathering around the beleaguered currency and positioning is by no means extended, suggesting there’s still room for bears to pile in. Some 74% of Japanese business managers say a weak yen is having a negative impact on the nation’s economy.”

No, the Asian crisis was caused by over-extended credit to Thailand and other EMs, then a dawning realization that many emerging markets had borrowed too much, including Argentina and Russia. Those high-yielding bonds crashed on plain, old-fashioned sovereign credit risk. Currencies fell afterwards. While it’s true Japan has the most debt of any of the majors by any measure (per capita, etc.) most of it is owned by the Japanese themselves. Japan is not reliant on foreigners to buy its sovereign paper. So, the comparison is false. One thing is nothing like the other and to bring up the Asian crisis is a just glib showing off.

Elsewhere, we see a somewhat peculiar relationship between currencies whose central banks have already raised rates losing upward momentum (to wit, NZD, AUD) in the “sell the news” manner, while those still in expectations mode are doing better, despite inferior relative returns, nominal and real. Oxford Economics says “The straightforward explanation is that there is little further tightening for the market to price in from here,” especially for currencies already a bit overvalued (NZD again). This implies “early movers are rewarded, but lack of follow through will be penalised. We see GBP and CAD moving into this camp in 2022H2, and the US Dollar in 2023.”

We agree, on the whole, except maybe about the endless hikes expected from the Fed. If it’s expectations of future policy decisions that rules the roost and we can’t see the end for the Fed (if only due to pig-headedness in some quarters), maybe the Fed overshoots. So, does this mean the dollar falls even if and when the US real rate of return is higher than everyone else? Or does it mean the dollar crashes once it’s clear the Fed is done even though by then the US has the highest real return over everyone else?

Rocky’s Rule #1: The only reason to make an investment denominated in another currency is to get a higher real return in your home currency after tax.

The other issue is the institutional factor, in this case confidence in the central bank. It’s pretty high in Europe even as the ECB is obviously behind the curve and distracted by things like divergence in market-driven bond yields that may need some emergency actions. The US has nothing like this. Well, the US has nothing like Italy. Even Italy is not really (classic profligate) Italy anymore, not with Mr. Draghi at the helm. So, if the NZD early-mover saga has a parallel in the eurozone, that means the late-mover, the ECB and the euro, have a lot more breathing room than yields and expected yields would ordinarily dictate. Interesting folks, those Oxford Economists.

The big story looming over us all is what, if anything, the ECB was going to do at the policy meeting today. The consensus was no rate change, however much the hawks squawk for even a little something (let alone the 50 bp they really want), but probably some reassuring noises about “maybe next time,” meaning July. Recall the ECB hasn’t been in the hiking mood since 2011. And this is exactly what we got.

For one thing, the bank wants to end QE before hiking and that doesn’t happen until next month. For another, the core inflation rate is “only” 3.8%, up a measly 0.3% from the month before (vs. 8.1% in May from 7.4% in April). By July the core will be over the 2% target for a full year, which has the ring of justification. It doesn’t but can be made to sound that way.

Econoday opines that a hike will help tamp down wage demands in Germany (8.2%) and France (20%, yowza)–these are precisely the wage-push contributors to inflation most feared in Europe for decades now. This is probably a lost cause–the unions are far too savvy to believe that raising the cost of doing business via interest rates is in any way a benefit to them even if it pushes inflation down sometime in the future–workers have food to buy now.

But as we saw in the first 30 minutes after the ECB announcement, the euro got the benefit of the expected hike, just as Oxford Econ predicts. Does this mean it fades away on sell on the news in July? That depends on what other promises get made. In any event, the dollar is on the backfoot as risk appetite refuses to get squashed. Our biggest worry today is the AUD, our canary in the coal mine for growth. If China is back, the AUD should thrive, recent hikes or not.

Political Tidbit: The US Congressional hearings on the Jan 6 insurrection go public today and promise to be as incendiary as the Watergate hearings. The goalpost is proving the ex-pres Trump knew about the insurrection in any or all of its forms, of which there are at least three (including Pence throwing out the ballots of the states Trump lost). What did he know and when did he know it? And how much of it was devised on his off-hand non-orders? Hard to prove, as his lawyer Cohen has made clear.

It’s going to be ugly and disclose the basic drive for power without morality of Trump and his gang. Nixon’s former counsel John Dean has a TV documentary on CNN now that is well worth the watching. The current crop of crooks is just as crooked but a lot less impressive. Any effect on finance or the dollar? Maybe a little more respect for the US subtracted from the inventory that was left after Trump got through rummaging through it.

This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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