Macro Musings; Dailiy Nibble - Consensus trades – what could go wrong?

The most consensus trade of all is for a stronger USD (despite the USD rip of the last 18 months). First level thinking that supports such a view is; 1) yield differential/growth differential; 2) U$9tn of USD borrowing globally particularly from EM countries, some of which is now being called; and 3) currency wars every way you look (608 interest rate cuts globally since Lehman and counting) Other consensus trades tend to be a derivative of the strong USD; weak EUR, weak gold, weak oil. Generally when consensus is so one-sided it means the majority of the investment case has already played out. The other problem in this case is that USD strength is the biggest problem for the world right now. So is consensus wrong?

First of all about that US growth differential? The latest leg up in the USD was driven by the strong NFP print and was the final nail in the coffin for all those USD doubters. However, a look below the headline number and the NFP should be taken with a pinch of salt. Firstly the 2 month average was much less impressive and brought job numbers back in line as September had been particularly weak. Secondly most of the jobs that had been created were for workers over the age of 55, in fact workers between 26 and 54 were notably weak. Why does that matter, because it is the 25-54 years olds that are going to drive consumption and the recovery. So let’s not get carried away just yet about US economic strength as other data has been far less confirming. Also the higher the USD goes the weaker the US economy is likely to be.

A final point on the USD is that historically the USD has tended to peak around the time of the first interest rate hike. I.e. the market has already priced in the hiking in advance. This may be even more apparent this time round as and tightening cycle is likely to be much shallower than usual.

The main case for a weaker EUR is predicated on further easing by the ECB. While Draghi has strongly hinted this is coming in December lest we not forget that Draghi has a long track record of promising but not delivering. Firstly the available pool of assets to buy with an expanded program continues to shrink as yields go negative across much of Europe. Secondly there remains vocal opposition out of Germany as to the efficacy and (in)stability of further QE. Further QE is certainly not a foregone conclusion.

Gold has been in the doldrums since it peaked in 2011 and shows no sign of reversing. That said physical gold appetite remains very strong, particularly out of Asia. China and Russia continue to accumulate official reserves and retail demand in places such as the US and UK haven’t been this strong in years. However, ‘paper’ gold remains out of favour but an inflection point may not be too far away. On Comex almost everyday we hit a new record for paper claims vs physical holdings registered. This does not appear to be a sign of a healthy and fully functioning market. I do however believe that in the short-term the path of least resistance is down.

Oil, after a brief recovery, is heading south once again. Despite cuts in supply demand has weakened more than expected keeping pressure on prices. However, markets tend to overshoot and as production comes out and demand starts to respond this may also turn. However, it is harder to argue for a strong recovery as supply is ramping up from areas that have not been producing for some time (Iraq, etc).

Consensus trades always make me wary, if everyone believes and is positioned for them who is the marginal new player. And once the tide turns the move can be violent.

Caveat emptor.