Voima Markets Newsletter—October 2022

Currency market table

The weakest currency of the month in September was the Australian dollar (AUD)

Top news in the markets recently

EUR/USD falls to new 20-year low (FXStreet)
British pound falls to its lowest level against the dollar since 1985 (CNBC)
Bank of England goes into full crisis management mode (Financial Times)
Japanese Yen Tumbles to Lowest Level Since 1998 (Wall Street Journal)

Trader's comment 7 October 2022

Central bank rate hikes have been the hot topic of this year. The rising of interest rates has caused bonds across the globe to have their worst year ever—and 'ever' is a long time. At the same time, stocks have been falling because the raising of interest rates—while the rate of change of economic growth and inflation are both slowing—is a monetary policy mistake and will continue to wreck the economy. Smart money knows this and it shows on all the major stock indices this year.

The Fed has been both signalling and raising its benchmark interest rate more aggressively than other Western central banks, which coupled with globally high inflation has caused investors to pile into the US dollar over other currencies. This has caused the US dollar to quickly appreciate against all other currencies, adding to the losses seen in other than USD-denominated investments like European stocks.

Rising interest rates accompanied by the decline in both stocks and bonds has pulled liquidity from a lot of markets. As a result, gold for example has been declining against the US dollar over the past 6 months in tandem with the US stock market. Apart from the US dollar however, gold prices are up year-to-date in almost all other currencies, including the euro, British pound, Swiss franc, and Japanese yen (on 7 October 2022). This makes gold one of the only asset classes in many countries to post positive returns this year.

Situation now & Q4 2022

Central banks are trying to appear strong by raising rates aggressively in their fight against inflation. However, by being committed to their monetary policy mistakes, central banks will cause (by all definitions) a recession both in the US and across Europe. Another consequence of the aggressive rate hikes is that some markets are starting to break down.

In the last week of September, the Bank of England (BoE) was forced to save the UK government bond market and help avoid a meltdown in the UK pension fund industry by launching a temporary UK bond buying program (quantitative easing or QE)—less than a week before the BoE was supposed to start selling bonds (quantitative tightening or QT). So a temporary 180-degree turn to save some poorly managed money at the cost of people's purchasing power, which is already distressed. “By the people, for the people” or how does the saying go?

Given that all central banks seem to be making the same mistakes at the same time, it seems unlikely to me that the BoE's emergency move would be the only central bank intervention we are going to see during this rate hiking cycle, which is expected to last well into 2023.

The rate of change of economic growth and inflation continues to decline, which coupled with central banks' raising of interest rates is likely to cause further drawdowns in stocks and bonds in Q4 of 2022. That being said, right now stocks, bonds and currencies are due for a short-term correction, as everything is oversold/-bought and bouncing. The same macroeconomic environment seems to extend at least into H1 2023, and so it is likely that both stocks and bonds will see further losses over the next 9 months if central banks do not reverse course a full 180 degrees for good.

In the short term, further losses in stocks and bonds could continue to draw gold lower when measured in US dollars, but from previous drawdowns in gold—e.g. in 2008, 2015–⁠2016 and during the 2020 covid scare—we see that 1) gold tends to bottom before stocks and 2) gold is quicker to recover new highs than stocks. This has been the case for gold measured in US dollars, and the situation in euros seems to be even better for gold.

Gold prices in euros over the next 18 months

From a statistical point of view, gold has appreciated against the euro on an average of 8% per year during low inflation. We have not had high inflation in the eurozone before, but looking at the returns of gold during high inflation which we have seen in other currencies, high inflation tends to lead to higher annual returns in gold. Over the past 12 months, gold priced in euros has risen 11.3%, which is a modest increase compared to the long-term average. From this point of view, I think that it is reasonable to expect gold prices in euros to be 10–⁠30% higher than now by the end of 2023. With this in mind, further drawdowns in gold should be viewed as buying opportunities.

The situation for other currencies like GBP, CHF and JPY is likely to be even worse.

Other news

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