As economies continue to re-open, markets remain buoyed by the prospect of demand returning. Whether this resurgence in demand – which comes on top of huge policy support – will lead to inflation is a key issue. Philip Lane commented today that he sees demand deficiencies as the dominant factor for the Euro area, and we feature his recent speech identifying the factors synchronizing inflation globally. We also feature our recent podcast guest, Martin Wolf, on why he thinks the likelihood of higher inflation has risen but ultimately remains modest. On markets we feature a bullish case for gold and why low bonds returns are not the unusual.
We also feature markets veteran Susan Wegener with her take on Angela Merkel’s legacy following last week’s Franco-German proposal for a €500bn recovery fund. Plus our daily COVID tracker.
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As economies continue to re-open, markets remain buoyed by the prospect of demand returning. Whether this resurgence in demand – which comes on top of huge policy support – will lead to inflation is a key issue. Philip Lane commented today that he sees demand deficiencies as the dominant factor for the Euro area, and we feature his recent speech identifying the factors synchronizing inflation globally. We also feature our recent podcast guest, Martin Wolf, on why he thinks the likelihood of higher inflation has risen but ultimately remains modest. On markets we feature a bullish case for gold and why low bonds returns are not the unusual.
We also feature markets veteran Susan Wegener with her take on Angela Merkel’s legacy following last week’s Franco-German proposal for a €500bn recovery fund. Plus our daily COVID tracker.
Enjoy!
Bilal
Merkel’s Legacy Moment (4 min read) Of the events that COVID-19 has suspended or cancelled, the commemoration of the 75th anniversary of Victory in Europe Day was not one; the end of World War II was sacrosanct.
As Walter Steinmeier, President of Germany, gave his speech on 8 May 2020, did he think what effect his words would have on Angela Merkel?
(Susan Wegener | 26th May, 2020)
Global COVID-19 Tracker In the DM world, no country sees an increase in cases or deaths larger than 1%, except for Canada which saw a 2% increase in deaths. Surprisingly, Spain got a 7% decrease in deaths but that is most probably related to the revised numbers recently released, which brought down the COVID related deaths by nearly 2000…
(Bilal Hafeez, Stefan Posea | 26th May, 2020)
Bull case for the yellow metal, and how markets have not priced rising US-China tensions.
You Can’t Just Print More Gold (Advisor Perspectives, 4 min read) A bullish thesis for gold. M2 growth, which historically is positively correlated with gold prices, has now shot up to 23% YoY in the US (the highest since 1981). Negative rates benefit gold, and the UK recently auctioned bonds at negative yields, which may be followed by other countries like the US. Finally, big investors, including Paul Tudor Jones, Paul Singer and Crispin Odey, are also in the long gold camp.
Are stock investors too complacent about a full-scale blowup between China and the US? Here’s what Wall Street experts say (MarketWatch, 7 min read) The consensus is that markets are not pricing in the Sino-American escalations, which could be detrimental for the US recovery and make markets volatile as we come closer to the US elections. Currently, markets are rejoicing at the re-opening of the economy and the possibility of a vaccine for the virus.
Low Bond Returns Are Nothing New (A Wealth of Common Sense, 3 min read) The most significant risk for fixed income portfolio is inflation, not duration risk (rising interest rate). Total real returns across the spectrum of different maturity between the 1940s to 1980s was negative despite very high nominal returns. The era between 1980 and 2019 generated low nominal returns but outperformed since the 1920s in terms of real returns. Current low nominal returns are not something unusual.
Philip Lane on inflation synchronicity, and Martin Wolf on why the pandemic may not be inflationary.
Philip R Lane: International inflation co-movements (BIS, 7-page read) Lane believes three factors, namely economic globalisation (global value chains), financial globalisation (co-movements in credit cycle), and international migration flows have synchronised inflation globally. He further considers trends such as increasing digitalisation leading to divergence in the inflation co-movement in the future as service sectors grow (which are ‘less tradeable than manufacturing’).
Why inflation might follow the pandemic (FT, 6 min read) Martin Wolf believes that pandemic, just like war economy has led to an enormous increase in public spending and monetary loosening. But unlike wars, the probability of inflation rising in the UK is low due to different structural factors at play. His advice ‘Hedge against it. Do not bet your shirts on it.’
Monetary Policy Transmission: Borrowing Constraints Matter! (Bank Underground, 6 min read) Changes in interest rate is more potent if more households within the economy are indebted. ‘This is likely driven by the direct effect of consumption, but also an amplification from spending through to changes in firm and labour market behaviour – or what economists call general-equilibrium effects’.
How the middle class in the US is shrinking, and how labour market trends during COVID may deepen income inequality.
The Decline of the American Middle Class: Evidence from the Consumer Expenditure Surveys 1988–2015 (Journal of Family and Economic Issues) The size of America’s middle class is declining, and the results are robust across three different definitions (including owning a car and taking a family vacation,). Based on one of the definitions it is estimated that the middle class shrank from 51.7% in 1988 to 40.6% in 2015.
Corporate sector vulnerabilities during the COVID-19 outbreak: Assessment and policy responses (VOX EU, 10 min read) Without immediate government interventions, around 30% of European firms would have experienced liquidity shortfall after two months of lockdown. In terms of a single policy response, wage relief is found to be the more successful instrument relative to tax relief and debt moratorium policies. However, once all three measures are combined liquidity risk halves to 16%.
Corporate Hiring under COVID-19: Labor Market Concentration, Downskilling, and Income Inequality (NBER, 26-page read) ‘Big data on job-vacancy postings reveal several dimensions of the impact of COVID-19 on the US job market. Firms have cut back on postings for high-skill jobs more than for low-skill jobs, with small firms nearly halting their new hiring altogether. New-hiring cuts and downskilling are most pronounced in local labour markets lacking depth (where employment is concentrated within a few firms), in low-income areas, and in areas with greater income inequality.’
How macroprudential tools can help EM prevent recession, and signs of an incipient recovery in the US.
Why Are Average Hours Worked Lower in Richer Countries? (IZA Institute of Labor Economics, 32-page read) It turns out it is not due to the distortionary taxes, which are more common in the developed countries. Its more to do with the fact that as labour incomes rise, workers’ preference for leisure become more attractive and hence the substitution away from an extra hour of work.
Dampening the Impact of Global Financial Shocks on Emerging Market Economies (IMF, 3 min read) A 60% spike in VIX can result in around 2% of GDP equivalent in capital outflow for an EM economy in one quarter. Strict macroprudential regulations can help emerging markets avoid recession resulting from these volatile capital outflows. They also allow EM economies to set an independent monetary policy based on domestic fundamentals (rather than changes in US rates).
Six High-Frequency Indicators for the Eventual Recovery (CalculatedRisk, 3 min read) The uptick in gasoline consumption, rise in total travellers, a gradual increase in hotel occupancy and diners re-opening are signs that travel and entertainment sector in the US is getting back on track – albeit slowly.
A case for Chinese-led global order, and the rise of corporatism in the US
The Future of Global Power (Project Syndicate, 6 min read) Within the Sino-American rivalry, the US is focused on short-termism by trying to focus inwards. In contrast, China is using this opportunity to fill this power vacuum to establish itself as a global power. Even within a Chinese-led global order, Europe will still have to side with the US due to the alignment of strategic interest. For this reason, it should avoid becoming dependent on China.
Terence Corcoran: BlackRock and the rise of corporatism (Financial Post, 6 min read) Corporate influence within the US political sphere is growing. One example is the recent overwhelming influence of BlackRock: from an adviser to the Fed for the $750bn intervention in the credit market to Fink (CEO of BlackRock) now being viewed as a strong contender for Treasury Secretary in Joe Biden’s administration.
Franco-German fund move amid ECB manoeuvring (OMFIF, 4 min read) ‘Profiting from a crisis-induced surge in her popularity and a sharp fall in support for the extremist anti-euro Alternative for Germany, Merkel – planning to step down next autumn – is seizing the chance to secure her legacy as a European integrationist. But this brings a potential drawback. Even if the plan gets off the ground, it will be her successor who has to achieve the monumental task, with the rest of the EU, of making it a success.’
How football matches are making markets inefficient, and why it is tough to forecast economic outcomes during a pandemic.
Stock return co-movement when investors are distracted: more, and more homogeneous (ECB, 21-page read) During 59 high profile FIFA World Cup matches which overlapped with trading hours, it was discovered that investors become side-tracked from stock-specific news and global news. As a result, this increased the sensitivity of individual stocks prices to the price action of the market index (convergence of beta).
Why Economic Forecasting Is So Difficult in the Pandemic (Harvard Business Review, 6 min read) First, the pace of frequent policy changes is difficult to keep up with and incorporate within models (i.e. how do you model a lockdown with no end date?). Second, amid the pandemic economic data that is collected may be unreliable (i.e. there are sampling errors due to the low response rate). Finally, forecasting the evolution of this pandemic is tough and requires adopting models from epidemiology, which is novel for an economist.
How China is on a path towards a ‘new cold war’, and how Xi’s foreign policy is damaging China
The End of Hong Kong (The Atlantic, 8 min read) Last week China enforced sweeping security laws on Hong Kong in response to the pro-democracy demonstrations that erupted last year. Through these laws, China will be able to tackle any political dissent directly and gain more autonomy over Hong Kong. This is one among several aggressive actions taken by China in Asia recently (including sinking a Vietnamese vessel).
China is taking a risk by getting tough on Hong Kong. Now, the US must decide how to respond (The Conversation, 6 min read) ‘[This] has the potential to become a diplomatic crisis. There’s a chance Beijing may have miscalculated the situation, and the US and its allies will retaliate with economic or other punishments.’ The actions have put China on a path leading towards a ‘new cold war’ against its western rivals.
China is its own worst enemy (The Strategist, 5 mins read) From denying independent international inquiry of the origins of the virus to the recent imposition of security laws in Hong Kong, Beijing is isolating itself and damaging its image. Economies such as Japan and the US have already initiated actions by incentivising relocation of supply chains away from China, and India’s new rule requires government authorisation before any investment in China.
How to differentiate between committed ESG funds vs greenwashing, and why ESG may exacerbate income inequality
Anatomy of a bona fide ESG fund (The Business Times, 7 min read) How do you differentiate between a real investment firm committed to ESG and one just greenwashing via marketing? One key differentiator is whether the funds have been a signatory to the United Nations Principles for Responsible Investments (UNPRI) for at least three years with a grading of A+. Additionally, ask whether the fund practices stewardship. This can be analysed by how the fund used its proxy votes ‘for’ ESG initiatives.
UK asset managers shun traditional asset classes and line-up alternatives, multi-asset and ESG fund launches for 2020 (Institutional Asset Manager, 5 min read) ‘59% have seen a substantial increase in client demand for specialist ESG/Responsible Investing products, and 76% have seen a substantial increase in demand for ESG integration across their whole product range.’
No J in ESG? (National Review 6 min read) ‘ESG investing, intentionally or otherwise, rewards exactly the corporate behaviour that is creating alarm. Companies with few buildings, few formal employees and a light carbon footprint tend to show up well on ESG screens. But allocating capital to them leads to a deepening of inequality and intensif[ies] the problem of under-unemployment”.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)