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March 5, 2018

The Market Sentimentalist: Zero-Sum

by Amareos.

*This article originally  published prior to the March Ist  announcement on tariffs by US President Trump

One of the numerous criticisms directed towards President Trump is that he tends to view everything as a zero-sum game. Almost certainly informed by his years as a corporate deal-maker, every gain made comes at someone else’s expense. Such thinking seems to be behind the administration’s recent greenlighting of tariffs on US steel and aluminium imports. The recently issued reports[1] by Commerce Secretary Ross cited “national security concerns” for supporting the imposition of tariffs. However, Trump’s comments that he expects the measures to “create a lot of jobs”[2] (presumably American) shows he views such steps as living up to his “America First” campaign slogan.

The political merits of following such an approach, one that naturally excludes cooperative “win-win” solutions, are dubious. Trump’s argument that it would not be prudent for the US to be buying steel from a country with which it could be in a military conflict with in the future seems eminently sensible (12 countries were listed in the reports, but, of those, China and Russia seem to be the most plausible candidates). That said, given the geopolitical backdrop is already hardly rosy, if such actions serve to increase the odds of eventual conflict[3], or accelerate its arrival, then perhaps the logic is not as sound as it might appear.

Additionally, the economic merits of such actions are also far from obvious. Ever since the Great Recession, leading economists around the globe have worried that governments, driven by a desire to retain as much domestic demand as possible, would succumb to the siren call of protectionist measures[4] (as happened after the Great Depression), undermining the long wave of globalization. A potentially high price to pay for supporting one sector of the US economy.

Nevertheless, there is one area where Trump’s zero-sum world view is relevant – the foreign exchange markets – and the USD has been weakening of late. What is driving this move and can it continue?

Over recent decades the general view of market participants is that US administrations have supported a “strong dollar” policy. This it is nothing more than a marketing slogan to assuage foreign holders of US debt that the Treasury would not deliberately devalue its currency. In reality, it is a residual. US policy towards its currency’s exchange rate is one of benign neglect – whatever exchange rate is consistent with the best US macroeconomic outcome is the policy. At times this equates to a strong USD, at other times a weaker USD.

Between 2014-2017 it was a strong USD environment. Reflective of the Fed being (or at least perceived as being) the vanguard of monetary policy normalization, the greenback experienced the strongest appreciation of the world’s four leading currencies.

Last year this dominance was challenged by the EUR, as investors began to anticipate a similar shift in the ECB’s monetary policy stance amid a brightening up in the region’s economic outlook and the fading of political risks associated with national elections in France and Germany given the failure of the populist parties to make significant headway.

So far this year, and continuing the performance merry-go-round, the strongest G4 currency has been the JPY. Gains that, in part, reflect the recent stock market turbulence – a positive for a currency widely considered to be a safe haven (a nonsensical proposition in our view, as we have outlined previously[5] and will reiterate later in this note).

The USD has, in contrast, become the laggard with weakness reflective of a resurgence of worries about the implications Trump’s fiscal USD 1.8 tr stimulus package (more “America First”) on the current account – the so-called “twin deficits”.

The link between a country’s fiscal balance and the current account balance flows directly from an identity in the national accounts – the sectoral balances. In simple terms, if a government borrows money and net domestic private sector savings (households plus corporates) are insufficient to fund the borrowing it must come from foreign investors. As this capital account exactly mirrors the current account balance, ergo the US external position worsens.

When we look at the evolution of crowd-sentiment towards the USD, it is little wonder that such “USD bearish” arguments are resonating. As shown in the exhibit below, collectively the tone of mainstream and social media towards the US currency (dark grey line) has been declining sharply from historically elevated readings (positivity was concentrated in social media commentaries – orange line[6]). The crowd is capitulating, and given the strength of the momentum of the sentiment downturn, it suggests the recent bout of USD weakness could persist for a while.

Exhibit 1: Crowd-Sourced Sentiment – USD 


Even though the dynamics of crowd sentiment indicate that the “twin deficit” worries are striking a cord with investors, the above sectoral balance rationale for USD weakness relies on a crucial assumption. Trump’s fiscal stimulus package will only generate a significant worsening in the US external balance to the extent that the behaviour of domestic US savers is unaltered. If, instead, US private sector savings rise, then the spillover effect of fiscal stimulus on the US external balance – and by extension on the USD – will be mitigated.

Critically, this will depend upon the reaction of US interest rate markets. As we outlined in our previous Market Insight, public perceptions of US economic growth and (especially) future inflation have been trending higher over the past several months – see exhibit below.

Exhibit 2: Crowd-Sourced Macroeconomic Sentiment – US 


With additional fiscal stimulus set to reinforce this reflationary backdrop, it seems likely that the Fed will continue to signal its intention to raise interest rates starting with a move at next month’s FOMC meeting – and quite possibly at a faster pace than previously suggested – a scenario that US Treasury market seems to increasingly concur with given the continued uptick in bond yields (with the 10-year now in spitting distance of the psychologically significant 3% handle)[7]Ceteris paribus higher US interest rates should encourage greater domestic saving, something that would mitigate the impact of fiscal stimulus upon the US external imbalance and reduce the downward pressure on the USD.

(NB: It has been suggested by some commentators that the weakness in the USD has been partly responsible for the swift rebound on Wall Street – a rebound we did not envisage[8]. To the extent that the equity market rebound removes concerns held by US central bankers that asset markets cannot withstand higher US interest rates, and hence can pursue a faster normalization pace, then the abatement of USD weakness would be a danger point for equities – we are certainly not out of the woods yet!)

In addition to US domestic factors, there is also an international dimension to consider because, as mentioned at the outset, currencies are a zero-sum game. Continued USD weakness necessarily implies currency strength for the EUR and the JPY (and GBP – leaving aside aperiodic Brexit negotiation rumblings).

Starting with the EUR, when we scan across crowd sentiments in the region all seems well. In keeping with the US macroeconomic backdrop, the public is enjoying the warming heat of the reflation trade, with economic growth and inflation sentiment having risen to their highest levels in years – see exhibit below.

Exhibit 3: Crowd-Sourced Macroeconomic Sentiment – Eurozone


Unlike the US though, crowd perceptions towards the currency are much more ebullient, with the latest reading for the EUR standing at multi-year highs – see exhibit below.

Exhibit 4: Crowd-Sourced Sentiment – EUR


That said, perhaps, things in the region are just a little too good with the high level of sentiment towards the EUR (orange line) hinting at an asymmetrically skewed (downside) risk profile[9].)

In this regard, the other line (dark grey) on the above chart is worth noting. It is our sentiment based political risk indicator for the region and it has been moving consistently lower over recent months. This is rather a surprising result given the uncertainty about the outlook of the upcoming Italian general election, where the party leading the polls is the populist Five Star Movement (M5S). Even though M5S could still be out of government despite winning the largest vote share (thanks to the machinations of Italian politics) one very plausible coalition government contains Berlusconi’s Forza Italia and Salvini’s Lega – formerly the Lega Nord (a cute bit of rebranding to broaden their appeal in the south).

Victory by this right wing alliance would be troublesome for the region’s political establishment (not forgetting Chancellor Merkel is still trying to cobble together a coalition with the SPD, an option being put to their party’s members and which is less than a slam dunk). The Lega’s eurosceptic credentials are impeccable and, more importantly, they have some serious bargaining power as a result of the size of Italy’s public debt burden.

Unlike Greece, whose eurosceptic government was knee-capped by the rest of the EU, financial turmoil in the Italian BTP bond market would be a grave systemic event. In addition, Italy has EUR 439bn of liabilities within the infamous Target 2 system. It is the extent of their liabilities, not the fact that Italy is a net contributor to the EU budget (unlike Greece), that strengthens their bargaining power[10].

Having been worried about last year’s populist uprising and seen them come to naught, the crowd has adopted a more relaxed attitude this time around. This might be the right approach, but it could just as easily be complacency. After all, something is motivating the likes of Ray Dalio’s Bridgewater fund to hold significant short positions in the region[11], including Italy – not an obvious trade if the Eurozone outlook remains as serene as the crowd seems to think. Any surprises on this front, especially given the positivity of public perceptions towards the EUR, could see the currency under some downward pressure to the benefit of the USD.

Finally, the JPY. In our view, the most significant change, or rather none change, for the Japanese currency was the reappointment of Kuroda as BoJ governor and the appointment of Wakatabe, a Professor from Waseda University and proponent of more aggressive monetary easing, to the policy board.

Even though Kuroda’s reappointment was widely expected, investors do not seem to fully appreciate its significance, in large part because of the repeated failure to appreciate the significance of the shift in the BoJ’s operations in September 2016, specifically the adoption of the longer-term nominal JGB yield target.

As we detailed in an Market Insight published at the time[12], this change in policy tool means that the BoJ effectively gave up control of its balance sheet, in pursuit of the yield target in order to generate reflation. All of the chatter about potential BoJ tapering of its asset purchases is therefore entirely misguided. Changes in the rate of BoJ purchases of Japanese government bonds is simply a reflection of underlying demand and supply conditions in the secondary bond market. The only policy change that matters – or should matter – to investors is whether the BoJ changes the numeric value of the yield target.

Admittedly, there have been signs of reflation in Japan as well. As can be seen in the exhibit below, crowd-sourced growth and future inflation sentiment have picked up in Japan.

Exhibit 5: Crowd-Sourced Macroeconomic Sentiment – Japan


However, given the failure of the first waves of Abenomics to fuel a sustained rise in inflation, and given the lack of real progress on the third arrow (structural reform) maintaining a reflationary bias falls on the shoulders of the other two arrows – fiscal policy and monetary policy. Of these, monetary policy has the biggest burden given the sizeable of Japan’s public debt (a post war record high among developed countries).

Moreover, with the BoJ now owing a colossal 40% of outstanding JGB issuance, it’s fate has become intimately intertwined with the government. Its policy independence has gone – this is fiscal dominance. Bearing this in mind, PM Abe’s decision to reappoint Kuroda, and to appoint Wakatabe as his deputy, is a clear sign that BoJ policy will remain super accommodative and, as a result, the long-term trajectory for the currency is downward.

So worry about the US “twin deficits” if you like, but a broader perspective suggests that in the zero-sum world of currencies persistent USD weakness is a far from obvious outcome.

*This article originally  published prior to the March Ist  announcement on tariffs by US President Trump

Amareos crowd-sourced sentiment indicators are based on MarketPsych Indices


[1] See:

[2] See:

[3] See:

[4] See: and

[5] See:

[6] There was considerable divergence in the tones between mainstream and social media towards the US last year as we noted at the time – see:

[7] Short-term US interest rate futures suggest that three 25bp rate hikes for 2018 remains the median expectation. However, the probability of four hikes occurring has rebounded concomitant with the rebound in global equity prices – see: .

[8] See:

[9] This is related to the concept of crowd fail that we outlined in a previous Market Insight – see:

[10] It is a bit like John Paul Getty’s famous quote “If you owe the bank USD 100 that’s your problem, if you owe the bank USD 100mn, that’s the bank’s problem”.

[11] See:

[12] See:


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