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China’s bid against the greenback

Last week the IMF invited the Chinese yuan into the basket of foreign currencies it uses to as its unit of account known as Special Drawing Rights (SDR), joining the dollar, euro, pound and yen. This marks a significant step towards what some commentators see as an eventual bid against the dollar to become the global reserve currency, and certainly a growing commitment to let market forces play a greater role in setting its exchange rate.

Prior to extending its invitation, the IMF demanded the People’s Bank of China (PBOC) make some changes to their currency regime, most notably to tie the day’s opening exchange rate to the prior day’s close. This may seem somewhat elementary to a free floating exchange rate, but previously the day’s opening rate was in effect set at the whim of the PBOC, often creating a meaningful gap against the prior day’s close. This is the technical story behind the 2% devaluation in August, the spark that wobbled global markets, particularly in the emerging world.

Since then the Chinese have been forced to use more traditional methods to maintain the yuan’s effective tie to the dollar, namely selling dollars to buy yuan, which has seen their global reserves fall from a peak last year of $4 trillion down to $3.5 trillion today, a meaningful decrease of some 12%, fighting to keep pace with an appreciating dollar.

So where does that leave things today? It is unlikely that China will embrace a full-throttle free-float exchange rate anytime soon, and there is certainly a lot left in the tank to maintain its de facto peg against the dollar. But against that backdrop, now that the yuan is a signed up member of the IMF’s SDR, the Chinese by extension have pledged to reduce the intervention that has been propping up the yuan for so long. In short this means a weaker yuan may be on the horizon, particularly given the Fed has finally started its much discussed commitment to increase interest rates, which in turn could see further upward pressure on the dollar.

There is a long road ahead before the yuan could pose any realistic threat to the greenback’s exalted position of global reserve currency, but the prize at the end may be worth the fight; and if it means a less controlled yuan, that has got to be a long-term boost for global trade.

Be Brave, and Go Bargain Shopping

I had no idea how useful my psychology degree would be when I began working in finance. The study of behavioural finance has a growing audience as more and more economists, advisors, and investors realize that despite best intentions, emotions impact financial decision making, often in a detrimental manner. Most savvy investors accept that markets are efficient and that having a well-diversified strategy is a key to long-term success; those concepts are straightforward. However, sticking to one’s strategy in the face of plummeting stock prices and negative portfolio performance requires resilience and discipline.

It is tempting to consider dialling down risk or holding off on deploying surplus cash. After all, markets could fall further and you could be in a worse position six months or even a year down the road. That’s true, but unless you have a very short time horizon, such short-term volatility should not be a cause for concern. In fact, it is completely normal and expected. When market corrections occur, remind yourself that stocks are “on sale” and there are bargains to be had. By ignoring your emotional propensity to cash in and shove your money under the mattress, you can significantly improve your long-term performance potential. By buying into the market as it approaches a trough, you are helping to lower your average cost and giving yourself significantly more upside potential than if you wait until recovery is underway. But be wary of trying to time the bottom; market timing doesn’t work, and it will just leave you frustrated and anxious.

There will always be a new crisis, but it will not be the undoing of the global economy. We have survived the Great Depression, world wars, oil embargoes, terrorism and bubbles too numerous to count. Markets react quickly, and in the long run, you are far better off participating than sitting on the sidelines. Your portfolio strategy is your blueprint for success. Stick to it to give yourself the best chance for long-term positive performance. Block out the “noise” from the media (remember, they get paid to sell stories not provide financial advice). Rebalance and be patient. This, too, shall pass.

Michael Hasenstab’s Global Macro View

Last week, myself and a few others attended the Franklin Templeton Investment Conference and had a chance to hear from Michael Hasenstab, Ph. D., about his global macro view of the world.  You may or may not know that Michael manages both the Templeton Global Bond Fund and the Templeton Global Total Return Fund. He currently manages more than $175 billion in bonds1 and is the Chief Investment Officer of Templeton Global Macro Group.  His flagship fund (Templeton Global Bond fund) is in the top 1% of its category and has more than doubled the benchmark2, outperforming it by 4.9% annually over the past 10 years3.

Active Approach in Global Fixed Income
Michael began by saying that there are broad macroeconomic themes that have set the scene for an inflection point in bonds and that he believes passive investing in bond indices may no longer be such a good strategy.  The government bonds that dominate global bond indices typically pay very little interest, often have deteriorating credit quality and are susceptible to higher interest rates in the future.

Safe as houses

When I was young the standard dinner party line was… son… whatever you do…. get onto the property ladder.  The old adage was if you stretch yourself over time (but still only within what you can afford) inflation should eat away at the debt, coupled with house price appreciation will mean your loan to value is reduced and you will probably be able to remortgage at better, possibly lower rates.  This framework may have worked for a time when we saw positive inflation and interest rates that were coming down from double digit levels.  It seemed like a one way bet and we all experienced it and believed that as such it was true.  For quite a while house prices only moved in one direction.  Consider the position we are in now.  Interest rates at rock bottom levels and asset prices arguably at elevated levels.  What could happen now if you follow that old advice and stretch yourself when buying a property?  In the UK at the moment most mortgages are fixed for a short period of time, so it is hard to budget long term.

Imagine a situation where house prices drop by 5% over the next two years and interest rates increase.  Those home ‘owners’ that stretched themselves previously are likely to see their loan to value reduce as well as their mortgage payment increase.  This would be acutely felt in the monthly cash flows and in a rising interest rate environment where house price appreciation doesn’t materialise the notion of stretching oneself seems frankly unwise with hindsight.  They could also be in a position where they cannot remortgage because the loan to value is too high.  Maybe one should have considered more about what one needs than what one wants when buying the forever home.

Double-Dip? Maybe…

The Item Club’s latest forecast is that the UK may already have slipped back into recession. The think tank has said that the UK’s GDP shrank in the final quarter of last year and is very likely to contract again during the first three months of this year.

Double-Dip? Maybe Not…

A survey carried out by The British Chambers of Commerce (BCC) has suggested that the UK economy is likely to remain weak for some time to come, but slipping back into recession is by no means inevitable.

However, the survey of more than 6,000 UK businesses also found that domestic demand is at its lowest level for more than two years. But the BCC said that the results do not indicate a recession and are still better than those seen in the

EURO Falling (at last!)

The euro has dropped to its lowest rate against the dollar and pound in 16 months, as concerns continue over the health of Europe’s banks.

The euro fell as low as $1.2780 against the dollar and was at an 11-year low versus the yen. Against the pound, it fell to

Deal or No Deal?

Last week’s summit was heralded as one of the most important in the history of the European Union. EU leaders were keen to agree to a deal which would help them to avoid a repeat of the 2007-8 debt crisis. The 17 members of the eurozone, along with six other countries have signed up to a eurozone pact – an inter-governmental agreement as

Markets rally despite warnings

George Osborne’s November statement on Tuesday raised a few key concerns with regard to the UK economy, but none came as a surprise to markets. The GDP growth forecasts have been revised down to 0,9% for 2011 and 0.7% for 2012 (from 1.7% and 2.5% respectively). Future growth forecasts from the Office for Budget Responsibility (OBR) are 2.1% for 2013, 2.7% in 2015 and 3% in both 2015 and 2016. The Chancellor also said that the