Bear case for the dollar

What will drive the US currency? Three events will influence the USD faith:

  • Rotation out of Treasuries. Us treasuries are 14 trillion USD market. The single largest owner is the FED with 4.5 trillion. Foreigners own around 65% of the residual paper, with Japanese and Chinese investors leading the rankings.  The trade has been great for them. The US deficit has been shrinking (mainly due to US oil production increases) and therefore treasury issuance has been decreasing. At the same time, FED was buying up most of the new issuance. There were very little treasuries left for investors. All this drove the rates down. Long treasuries was a trade of the past decade. This is now reversing. US tax reform, if approved, will drive the deficit up which will increase the supply of treasuries. At the same time, FED will start to reduce it 4.5 trillion pile of treasuries by 300 bln of treasuries per year. So the treasuries will face a double pressure on rates: due to increasing inflation (driven by imported inflation from EM) and due to an increase of supply of treasuries. Buying treasuries at the time of increasing rates is an unattractive proposition. Foreigners will be most likely selling their Treasuries holdings putting up pressure on USD. As they hold now more than 65% of the treasuries not owned by FED, the wave could be very significant. Both for the yields and for the USD.

 

  • US tax reform. US companies have substantial cash holdings abroad. If the tax reform is enacted, the investors will repatriate their offshore capital holdings back to the US. This will most likely strengthen USD.

 

  • Increase in US interest rates – traditionally, the most important driver for FX is an expectation of interest rates differentials. The most important are 2-year interest rate differentials. If one believes that inflation is starting to emerge, than interest rates will be affected. That would be putting an upward preassure on USD.

The question is which one of the above will prevail. Naturally, it should be the one with the biggest numbers. This means significantly weaker USD due to rotation out of treasuries. I believe that it is already happening. The evidence is in the interest rates. As mentioned it is mainly two years interest rate differentials that drive the rates. The US, two-year rates, are highest levels for the last eight years. Despite that, the USD has been weakening. It might be an indication that the importance of this driving force is lower than the force of the above. Get ready for a rollercoaster ride. 

What could save the USD? Only FED. Hawkish FED. Significant increase in USD interest rates would save the USD. I would not be my money on Hawkish FED.

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Short term play on OMV Petrom

OMV Petrom is more than 10% down in the last two weeks despite the oil price increasing over that period. The reason is the mishandled SPO by second largest shareholder Fondul Proprietatea. The sale of 2.5% at 0275 draw the price down.

This already happened once in October. At that time the announcement of the sale drove the price down and after the SPO the share price rebounded. See http://www.seekingalpha.com/article/4034808-omv-petrom-special-situation-oil-play-due-mishandled-spo-major-shareholder

The current SPO was three times oversubscribed with allocations at 36%. Rebound expected.

Time to get back to Fondul Proprietatea

Fondul Proprietatea, one of the largest closed end funds in the world, is becoming interesting. In the last few days Romanian index and Fondul are down 5%.

The reason for the sell off is Romanian bank shares. The sell off was caused by speculations of new asset tax on banks to be imposed by Romanian government. It may be a buying opportunity to get back/increase exposure in Fondul.
Fondul trades at 31% discount to its NAV. The reason for such steep discount is in high proportion of unlisted assets in its portfolio.
Over the last years FP was selling one non-listed asset per year. This year they may be selling half of unlised NAV:
– sale process for the two electricity distribution companies is under way (19% of NAV)
– Salt mine is in sale process (2% of NAV)
– Fondu appointed advisors for the disposal of Hidroelectrica stake (33% of NAV)
Unlisted assets now represent 69% of total assets. If the disposals would materialize, unlisted assets would decrease to 15% only while cash would represent over 55% of total assets. The price would sky rocket.
For more information on the opportunity pls go to:

Egyptian Pound is the most undervalued currency in EM

Please read my Egyptian Pound published here last week
23 May, 2017 FT.com
 Egyptian pound ‘cheapest in EM’ after central bank hikes rates – RenCap
Better late than never.Analysts at emerging-market specialists Renaissance Capital had practically given up hope of an interest rate rise from the Central Bank of Egypt after predicting one earlier in the year, but now they see some good opportunities after the central bank finally moved overnight. The CBE surprised observers by increasing all its rates by 200 basis points (2 percentage points), taking the overnight deposit rate to a record high of 16.75 per cent in an effort to combat the country’s eye-watering inflation rate.The central bank has been struggling to contain inflation since it devalued the pound and moved to a floating exchange rate regime last November, as the weaker pound has driven up the cost of food imports. Headline inflation hit an annual rate of more than 30 per cent in April, with food prices climbing at least 3 per cent six months in a row. RenCap had predicted a rate hike would be needed in February or March, and chief economist Charlie Robertson admits that by last week “we wondered if the CBE was just trying to ‘wait out’ the inflation cycle, given how weak domestic demand was”.While the move may have come a little later than hoped, Mr Robertson says it is good news for the Egyptian pound:It shows a commitment to getting inflation back down again, after months where it has consistently been running high.Currency stability – which should be supported by the higher interest rate – will help drive down month on month inflation. Currency appreciation should help more.Despite the inflation difficulties, RenCap thinks the Egyptian pound is the cheapest emerging market currency, with current levels of around E£18 per dollar “cheap” compared to a fair value of between E£14 and E£15 per dollar.The pound did briefly approach those levels at the start of the year, rallying more than 14 per cent in just two weeks. However, analysts had suggested the extent of the climb may have been influenced by CBE intervention and it quickly erased the gains.At publication time the currency stood at E£18.10 per dollar, a 0.5 per cent climb for the day.While the central bank’s move is expected to reduce pressure on prices, the CBE admitted that bringing inflation down will take some time. Policymakers said higher inflation will be “temporarily tolerated”, with the bank targeting a decline to around 13 per cent by the end of next year, and “to single-digits thereafter”.

Investment idea: Long Egypt Government bonds

Investment idea: Invest in local currency Egypt Government debt instrument yielding 16% + benefit from the currency comeback after a steep devaluation

Summary:

  • Last year Egypt enacted reforms required by IMF. IMF provided funding to Egypt
  • Further reforms laws are being enacted
  • As a part of the IMF lead reforms Egypt devalued its currency by 100%.
  • To balance its budget Egypt stopped fuel subsidies
  • Interest rates are around 16%
  • The Egyptian economy is benefiting from the reforms and is starting to recover
  • 16% yield represents a downside protection. If the economy improves part of the shock devaluation would reverse. An investor would make the 16% + a gain from currency uplift.

 

 

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