Bilal’s Top Picks: Carry Unwind / Dark Side Of Nordics / Machine Learning To Hurt Passive

(total reading time: 6 mins)

We have an eclectic mix of articles this week. Theory appears to be catching up to FX carry trades, but with a twist. Machine learning could harm passive investment strategies. And the EU is forging a path to be a global leader in green bonds.

On the policy front, former Chief Economist of Citi, Willem Buiter, argues that central banks should pick financial stability, rather than inflation, as their primary objective. This comes as surveys show that trust in the ECB is falling. Ever thought how come the Nordics are so perfect? Well, now we learn that they are terrible polluters.

Finally, we feature an article on UK elections, which shows it was as much about Labour losing as Conservatives winning. And why urban unrest will continue into 2020.

Enjoy!

Bilal

Some investment strategies that contradicted theory are now starting to conform though with an unexpected twist. We all know equities deliver solid returns in the long-run, but that’s not always the case. And watch the rise of green investing, especially from Europe.

The Fama Puzzle at 40 (Econbrowser, 4 min read) Traditionally, FX carry trades have performed well, despite violating theory – uncovered interest rate parity (UIP) and rational expectations. The currency with higher interest rates should depreciate to wipe out the carry, but in reality that doesn’t happen. However, since the financial crisis, the theoretical relationship is correctly predicting the real-life direction of currencies. The trouble is that they are now too sensitive to interest rates. (Bearish FX carry trades)

Charting the World’s Major Stock Markets on the Same Scale (1990-2019) (Visual Capitalist, 3 min read) If you invested $100 in the U.S. market in November 1990, you would have over $1,000 today (+980%). However, if invested in Japanese stocks in 1990, you would have made $10 return (or 1%).

The Green Deal Will Make or Break Europe (Project Syndicate, 4 min read) The proposed “European Green Deal” by new EC president Ursula von der Leyen could lead the EU to dominate the issuance of “safe assets” and green bonds. This could help the euro become the top reserve currency. However, the path to this is fraught with politics. (Bullish green bonds and Euro)

There’s a big debate around what objectives a central bank should have – most are thinking of refining the inflation target, yet some are calling for something more radical. Meanwhile, trust in the ECB is declining.

Public Support for the Euro and Trust in the ECB: The First Two Decades (Vox EU, 8 min read) Insights from surveys in member countries of whether the public still supports the ECB and single currency (monetary union). The main findings include: support for the euro is consistently higher than both trust in the ECB and trust in national governments. After the crisis of 2008-2013 public trust in the ECB had deteriorated and the rate of unemployment is the key factor explaining changes in support for the euro and trust in the ECB. [Bearish ECB]

Financial Stability Should Be Central Banking’s Prime Objective (Project Syndicate, 4 min read) Former Chief Economist of Citi, Willem Buiter, argues that financial stability rather than stable prices should be primary objective of central banks. Argues for higher rates and also counter-cyclical macroprudential policy. [Bearish bonds]

Inequality is here to stay, especially in big cities. This could see continued protests in 2020.

2019 Was a Year of Global Unrest, Spurred by Anger at Rising Inequality – and 2020 is Likely to be Worse (The Conversation, 7 min read) Conditions that spawned global unrest on every continent in 2019, are likely to worsen in the face of a slowing global economy and little sign of causes of disaffection being addressed. In 1950, there were only two mega-cities with populations of 10 million or more – the New York metropolitan area and Tokyo. Today, there are 25. The megacities overcrowding phenomena contributes to the anger of the masses that feel left out [Bearish EM]

This week we look at longer-term forces. In the UK, it appears that more people are topping up their state pensions with private pensions. Also, the impossibly perfect Nordic countries may have a dark side – their environmental impact.

Pension Wealth in Great Britain: April 2016 to March 2018 (ONS, 31 min read) The last decade saw an increase of around 10 percentage points (from 43% to 53%) in the number of adults below State Pension age who actively contribute to a private pension, which is very likely the result of automatic enrolment introduction that happened between 2012 and 2018. Median pension wealth for pensions in payment for men is double that for women. [Bullish private pension funds]

The Dark Side of the Nordic Model (Al-Jazeera, 4 min read) Scandinavian countries may top every ranking on human development, but their ecological impact on the planet is outsized. They have some of the highest levels of resource use and CO2 emissions in the world with sustainable level of resource consumption at 32 tons per year compared to the average of 7 tons per year. If everyone in the world consumed like Scandinavians, we would need nearly five Earths to sustain us. [Bullish ESG]

UK election results were a surprise to most. Under the hood, it was as much as Labour loss as Conservative win. Elsewhere in Europe, it appears that lack of employment opportunities is a better guide to discontent than age or wealth.

Election Analysis in The Maps and Charts (BBC News, 3 min read) Prime Minister Boris Johnson’s Conservatives have a majority of 80 seats. A series of interactive maps and charts displaying the regions and categories of gains of losses made by each party. Notably, Labour lost more votes in remain areas than the Conservatives. Labor have had their worst return of seats in any general election since 1935; losing votes in every region in the UK.

The Geography of Discontent (Vox EU, 8 min read) Rather than age, wealth, or education, this new research finds that anti-EU sentiment stems from a combination of long-term industrial decline, lower employment and less educated workforce. Importantly, while education remains important, the lack of employment opportunities ranks as high [Bearish euro]

Market structure is changing. Some like the advent of machine learning could enhance investor returns, while others like fragmented clearing are adding an additional cost.

What Machine Learning Will Mean for Asset Managers (Harvard Business Review, 7 min read) Harvard asserts that machine learning (ML) will actually reverse the trend towards passive investment. ML can make more accurate forecasts by using alternative data (eg images and sound), employ non-linear modelling, reduce human biases and be quickly implemented without regulatory approvals (unlike say the auto industry). [Bullish ML quant managers, bearish traditional passive]

The Cost of Clearing Fragmentation (BIS, 30 min read) Latest BIS research shows that an architecture based on multiple but fragmented central counterparties (CCPs) lead to daily opportunity costs of $80 million for end users. This happens mainly because global liquidity dealers cannot net trades cleared in different CCPs. [Bearish banks]

China continues to assert itself around the world, but providing many forms of support to poorer nations. Meanwhile, it is playing Macau off against HK.

Yes, Virginia, China Is Exporting Its Model (CFR, 5 min read) Xi Jinping has reiterated his belief that “[China] offers a new option for other countries and nations who want to speed up their development while preserving their independence.” From Cambodia to Tanzania, China aims to provide institutional frameworks to enhance state control or providing technology to support development. This shows China’s global reach [Bullish China]

Exclusive: Protest-free Macau to Win Financial Policy Rewards From China (Reuters, 4 min read) Chinese officials are helping Macau to establish its yuan-based stock exchange. It will start by handling the local bond trading business, as well as investments in start-ups from Portuguese-speaking countries, marking the next step of Macau’s integration in China’s Greater Bay Area.Looks like China is starting play Macau off against HK. (Bearish Hong Kong)