Investor’s Insights 12/06/2023–18/06/2023

8 min readJun 18, 2023

This newsletter is intended for educational purposes only. The author is not liable for any potential losses, realised or unrealised, of the reader should the reader decide to invest, speculate, hedge or engage in any financial activities based upon the information here. The reader shall do his or her own research and bear the risks should he or she intend to invest.

Welcome to this week’s issue of Investor’s Insights. Many events have happened in this exhilarating week: the release of CPI data in the US, sustained inflation in the Eurozone due to the ongoing war in Ukraine and the decision by the PBOC to cut rates due to the underperformance of the Chinese economy in the latest quarter. Now, let us dig deeper into each geographical sector.

Geographical breakdown

USA

Within an hour after the release of the CPI print in the USA at 8.30am local time, the USD depreciated, most equity indices rose and commodity prices generally increased. This, perhaps, could be due to the fact that the expected inflation is generally similar to forecasted inflation, with the CPI increasing by 4%, meaning the the rate of increase in prices have decreased compared to previous months. The FOMC meeting later on also confirmed that the Fed will skip rate hikes in June (but may have two more hikes later this year).

The actual inflation rates for the previous 2 months were lower than forecasts by TradingEconomics: 5.3% (Actual) vs 5.4% (TE Forecast) and 5.5% (Actual) vs 5.6% (TE Forecast). Based on the chart above, inflation has been steadily decreasing, which is a good thing as the economy is recovering from higher than normal inflation. As a result, we have entered a phase of ‘risk-on’.

What are ‘risk-on’ and ‘risk-off’?

“Risk-on risk-off is an investment setting in which price behaviour responds to and is driven by changes in investor risk tolerance. Risk-on risk-off refers to changes in investment activity in response to global economic patterns.” ~Investopedia

In simpler terms, it is kind of like a ‘switch’ that investors can activate/deactivate to adjust their risk appetite in response to global macroeconomic trends. Generally, ‘risk-on’ is a period of high optimism due to market expansion, lower interest rates etc, leading to indices rising, important commodities (namely oil and copper which are key drivers of economic growth) rising and commodity currency rising (for example, Canada’s largest export if crude petroleum, so if the price of crude petroleum increases, we can expect CAD (Canadian Dollar) to appreciate as well, all other things equal), so investors are willing to take up more risk. ‘Risk-off’, on the other hand, is characterised by weaker than expected growth, pessimistic outlook, perhaps due to unexpected rate hikes by the Fed, resulting in equity indices falling, commodity prices dropping and commodity currencies depreciating.

Now, back to the topic of USA. In the few days following the release of the CPI, the USD rebounded and appreciated against some currencies (perhaps there is a link to the strong growth to the S&P500 index as non-US investors want to invest in USA in a risk-on environment). In the short-run of around 1–2 months, depreciative pressure on the USD is still quite high because the terminal rate is now lower than previously thought to be (due to the Fed skipping a hike), so more investors are now looking elsewhere for higher interest rates to conduct carry trades (perhaps EU or UK are possible places to look at as their inflation is still quite rampant and it is likely the ECB and BOE will continue to hike rates, resulting in interest differential which provides opportunities for carry trades, more on EU and UK later).

What is a carry trade?

A carry trade is a trading strategy that involves borrowing at a low-interest rate and investing in an asset that provides a higher rate of return. A carry trade is typically based on borrowing in a low-interest rate currency and converting the borrowed amount into another currency. Generally, the proceeds would be deposited in the second currency if it offers a higher interest rate. The proceeds also could be deployed into assets such as stocks, commodities, bonds, or real estate that are denominated in the second currency. ~Investopedia

Now, assume we have 100SGD in the beginning (which could be borrowed, or if you are a Singapore citizen, you probably already have it). Let’s say if we put the 100SGD in a 1Y Singapore Treasury Bill at 4%, we will get back 104SGD.

Conversely, if we take the 100SGD and convert them to USD, we will get 74.627USD (at the current rate USD/SGD = 1.34). Next, we can put the 74.627USD into 1Y US Treasury Bill at 5%, we will get 78.358USD in a year.

Now, assuming the interest rate parity from economics holds true, we should get back the same amount of SGD in a year, regardless of whether we put them in a Singapore Tbill or US Tbill, meaning we expect the future exchange rate of USD/SGD = 1.327 in a year. This means that investors expect the USD to depreciate against the SGD due to the interest rate differential.

Potential trade ideas in the above hypothetical scenario:

Long USD/SGD if current USD/SGD is below 1.327
Short USD/SGD if current USD/SGD is above 1.327

Note that in my hypothetical example, there is no commission charged in the purchase of Treasury Bills and there is no commission charged when exchanging currencies at a broker which are unlikely to be true in the real world. There are also many other factors such as relative inflation, relative GDP growth and balance of trade which are driving factors of FX.

Back to the US. While there is depreciative pressures on the USD in the short run, it is likely that the USD will still appreciate later on in the year if the Fed continues to hike later on.

Even if the Fed does not hike, the labour market is still strong as unemployment rates in the US have pretty much reached pre-covid levels of less than 4%.

The S&P500 has also increased steadily, suggesting optimism in the US markets which definitely will be a strong driving factor for ths USD to appreciate in the long run.

EU / UK

While inflation in the Eurozone has been decreasing, the inflation is still slightly higher than in the US, likely due to the ongoing Ukraine-Russia war.

Now, while inflation is still higher in the Eurozone than in the US, interest rate hikes are still lagging behind in the EU than US, as can be seen by tracking the SOFR in the US and ESTR in the EU above. Tentatively, a potential trade idea would be to short USD/EUR due to the lagging interest rate hikes in the EU and relatively higher inflation in the EU than US. However, I will conduct more in-depth research on the EU first before deciding if I will actually make the trade.

China

The PBOC has recently cut interest rates by 10 bps, from 2.75% to 2.65% (Source: Bloomberg, Reuters). This indicates that the Chinese economy is doing poorer than expected, or that the CCP has decided that inflation is now fully under control so it will start to spur economic growth by lowering interest rates.

As such, I think it will be a good idea to monitor China ETFs such as FXI or MCHI.

However, risks of investing in China remain high due to the opaque nature and lack of information. This has been further worsened in the recent 2023 regulatory crackdowns.

This has made it harder for investment analysts to conduct research and derive quantitative information from China. The lack of information and uncertainty regarding China’s regulatory policies present a huge risk.

Investment products tracker

Note that I have reviewed and changed some of the products I am tracking since last week. Apologies for the inconvenience caused. I have also included a new ‘Rates / Fixed Income’ section to track overnight rates and treasury rates.