LONDON Nov 30 "Buy dollars, wear diamonds" goes
the decades-old foreign exchange market maxim.
But not everyone feels the reflective glow when the sun is
shining on the world's most important currency. Across the world
certain countries, assets and corporate sectors will feel the
A stronger greenback and rising U.S. bond yields squeezes
dollar borrowers, diverts capital from countries that need it
most towards the United States, and hits companies whose cost
base is in dollars. Even within the United States, holders of
riskier high yield corporate bonds will be nervous.
The dollar and Treasury yields have soared since Donald
Trump's presidential election win as investors have bet that his
proposed $1 trillion fiscal package of spending and tax cuts
will give a huge boost to the U.S. economy.
The dollar has hit a 14-year high on an index basis,
and the benchmark U.S. 10-year yield its highest in
over a year. The 10-year yield had its second biggest weekly
rise in almost 30 years.
Below is a look at some measures of how far the dollar and
U.S. yields have come, and some of the potential losers from
continued appreciation in the value of the pre-eminent currency
for global trade, banking, finance and business.
Dollar's 7-year cycles: tmsnrt.rs/2g7ph8E
U.S. 'eurodollar' rate futures: reut.rs/2gEwhJM
Dollar vs G10 FX spec positions: reut.rs/2gDWVCq
All EM assets - stocks, bonds and FX - are vulnerable to a
certain extent. These countries are sitting on $3.3 trillion of
non-bank borrowing in dollars - a figure which has doubled since
2007 - and many depend on overseas capital to balance their
books. Those with large current account deficits.
Turkey and South Africa are among the most dependent on
foreign capital to balance their national books, as this chart
of the so-called 'Fragile 5' current account gaps shows:
Morgan Stanley is "cautious" on EM equities. Its estimate of
aggregate earnings per share for stocks on the MSCI Emerging
Markets index at the end of 2018 is $77,
"significantly" below the consensus $82. The most vulnerable
regions are Latin America, South Africa, Turkey, Indonesia and
possibly India, it says. Relief could come if the dollar rally
JP Morgan turned further underweight EM currencies,
sovereign and corporate credit and local currency bonds. "LatAm
and EMEA EM currencies are no longer cheap, with Asia FX still
expensive due to rate cuts," JP Morgan said, adding that EM bond
fund inflows will likely slump next year to $20 billion. So far
this year, inflows have totalled $49 billion.
The Turkish lira hit a record low last week even though the
central bank jacked up interest rates. The lira is down 15
percent this year and the country's main stock market is lagging
most of its EM peers, up only 4 percent year-to-date.
As issuing bonds in dollars becomes more expensive, some EM
borrowers could be tempted to raise more cash in their own
currencies. JP Morgan forecasts EM local bond issuance to rise
by $42.5 billion, or 9 percent on average, in 2017 versus 2016
to $517 billion. More than 80 percent of that will be in Asia.
Emerging market debt issuance: reut.rs/2gE2qRR
"The property bubble is the most important macro issue in
China." So says Deutsche Bank, adding that it is spreading to
more and more cities across the country. This will force Beijing
to put further pressure on property developers in the coming
months by tightening broad credit growth. As the sector weakens
and heaps the pressure on Beijing to keep policy loose, the
yuan's losses against the dollar will accelerate.
Deutsche has one of the most bearish calls of all on the
yuan, and expects the dollar to rise to 8.10 yuan by the end of
2018 from around 6.90 currently. That's a yuan depreciation of
17 percent. A lower yuan makes interest payments more expensive
for Chinese property firms, already in the crosshairs of a
government trying to cool the overheating real estate market.
Chinese land valuation growth: tmsnrt.rs/2fQgKsC
U.S. High Yield
As the Fed raises rates, so the return on so-called safer
assets increases and narrows the premium offered by riskier
bonds. In this environment, all bonds come under pressure, but
high yield or "junk" bonds are particularly exposed.
Morgan Stanley favours U.S. investment grade (IG) bonds over
high yield (HY), forecasting a -0.9 percent excess return for IG
and a -2.4 percent excess return for HY next year. "As election
euphoria fades and late-cycle risks become more apparent, we
expect spreads to again widen."
U.S. high yield graphic: tmsnrt.rs/2gDVkg7
Unlike EM assets, developed market equities are negatively
correlated to their currencies. This could be most visible next
year in Britain, where sterling has been clobbered by the Brexit
uncertainty and the runaway dollar. Analysts at Societe Generale
reckon Brexit isn't fully priced in yet, but will have to be
Sterling will remain weak, boosting the large-cap FTSE 100
index, where around two thirds of earnings come from abroad. But
the mid-cap FTSE 250 more driven more by domestic factors won't
be so lucky. Long FTSE 100/short FTSE 250 is one of the bank's
top equity market trades for 2017.
UK large cap vs mid cap stocks: tmsnrt.rs/2gwc21D
(Reporting and graphics by Jamie McGeever and Vikram Subhedar;
Editing by Robin Pomeroy)