By Bilal Hafeez 07-07-2020
In: post | Newsletter

Exclusives On BI’s Debt Monetization / US Labour Market Distortions + Top Picks: Buiter On The Fed / Perils Of EM QE

(8 min read)
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M&G’s warning on the risks of EM QE comes as Bank Indonesia becomes the first major EM central bank to formalise a deal to buy debt issuance directly. We feature leading Asia strategist Mirza Baig on why the debt monetization plans look contained, while John Tierney continues his series on the underlying weakness in US labour market data. PIIE also highlight classification problems in US labour market data, something we also wrote about in our deep dive last week.      

Bullish small caps and gold are the main market calls we feature this week. JP Asset Management also present their case for balancing quality and cyclical stocks during the upcoming earning season.   

On macro we feature BoE Chief Economist Andy Haldane on how the UK must avoid high long-term youth unemployment, Willem Buiter on the Fed’s problematic policy framework, and the OECD on how to manage increased state ownership. On politics, Putin’s relection bid, the top priorities in a Biden presidency, and the status of a post-Brexit trade deal all feature.      



Bank Indonesia To Monetize Debt (2 min read) Indonesia’s finance minister and Bank Indonesia’s (BI) governor have announced a ‘burden sharing’ plan to fund part of the government’s fiscal stimulus.

The central bank will purchase about IDR397tn of government bonds at zero coupon rate and an additional IDR173tn in two other schemes at concessional rates.

(Mirza Baig | 6th July, 2020)

Bank Indonesia
Us Labour Market

Labour Market Still Labouring: Will It Get The Support It Needs? (5 min read) Last week’s employment report offered several positive indicators for a nascent recovery. Payroll employment jumped by 4.8 million or 3.6%. The official unemployment rate dropped sharply from 13.3% to 11.1%. And temporary unemployment fell by 4.8 million to 10.5 million, showing that businesses around the country are indeed trying to get back into the swing of things.

(John Tierney | 6th July, 2020)

Hive Indicators

Global COVID-19 Tracker – Hospitalizations Surge Across the US In the DM world, the US recorded 47,126 new cases, an increase of 1.6%. Southern states saw a significant growth in COVID hospitalizations with Arizona reaching 89% of its ICU capacity. Texas also registered an all-time high.

(Bilal HafeezStefan Posea | 7th July, 2020)

Coronavirus Update

Gold as a portfolio diversifier, and a bullish case for US small caps

Owning Gold Is as Much About Diversification as It Is about Capital Appreciation (Advisor Perspectives, 6 min read) Hypothetically if the 10-year bond yield drops to 0.00% from today’s 0.68%, it will only provide investors 6% upside – insufficient to cushion 20% or 30% equity selloffs. Gold can replace bonds in a 60/40 portfolio since it exhibits a strong negative correlation with stocks during selloffs. Fundamentally, gold also rises with the growth of money and M2 money supply is growing at 23% YoY in the US, providing room for more capital appreciation.[Bullish Gold]

What Is Today’s Opportunity in Small-Cap Stocks? (Seeking Alpha, 7 min read) Small caps during the first quarter of 2020 underperformed large caps by over 10%, which is the most significant differential in 40 years. Russell investments remain bullish on small cap as they draw attention to a higher expected return, attractive valuation, a shift in investor sentiment (as lockdown eases) and a positive economic cycle as economies reopen.[Bullish Small Cap]

What Does a Second Wave Mean for Equity Markets? (JPAM, 2 min read) Recently, direction of growth has been a critical driver for the S&P 500, and, going forward, the level of growth will be more significant for the markets. The risk to valuation is low; do not expect the lows of March again even if cases rise. Additionally, uncertainty remains elevated amid the upcoming earnings season, and a balance of quality and cyclical stocks for investors can negate this.

Willem Buiter on the Fed’s problematic policies and how QE can be problematic for EM

Three Strikes Against the Fed (VoxEU, 12 min read) The former chief economist of Citi, Willem Buiter, outlines faulty Fed practices: not adopting negative policy rates, ‘non-transparent (quasi-)fiscal actions’ and lenient stress testing failing to fully incorporate the severity of COVID (i.e. L-shaped recovery scenarios were missing). He proposes the following changes: ‘symmetric policy rate around zero’, extending the ban on dividend payments (going beyond Q3 for banks), ‘new equity issuance’, and conducting a complete stress test of the financial system.

QE Goes Global (M&G Investments, 6 min read) QE in EM can become problematic. If investors feel this is used as an alternative to fiscal discipline it could cause significant capital outflow, in turn fuelling currency depreciation and imported inflation. DM found it challenging to wind down QE, and the same could be true for EM. Additionally, some EM (i.e. South Africa and Turkey) have suffered from lack of credibility and independence in the past, and investors may raise similar concern in the future. [Bearish EM QE]

The Theory of MMT Falls Flat When Faced with Reality (Part II) (Advisor Perspectives, 6 min read) ‘We fear that MMT, which promises “free everything” with no consequences, instead delivers inflation [no accurate measure of inflation exists hence it appears low on the surface], generates further income inequality, and ultimately higher social instability and populism. Such was the result in every other country which has run such programs of unbridled debts and deficits.’

Joseph Stiglitz on US policy priorities

Priorities for the COVID-19 Economy (Project Syndicate, 7 min read) A V-shaped recovery in the US is a fantasy, says Nobel laureate Joseph Stiglitz. He foresees a contracting labour-intensive sector during the COVID crisis further fueling rising inequalities in the US. He believes investment towards green transition would be highly stimulative for labour-intensive industries. In contrast, he criticised the Fed action for supporting the junk-bond market, which raises the concern of ‘moral hazard’ and limits ‘dynamism’ and ‘growth’ in the long run.

COVID Dominance: Pandemic Shocks and Fiscal-Monetary Policies in the Euro Area (VoxEU, 15 min read) Adjustments in Eurozone credit default swap spreads have diverged substantially from levels implied by models. This article tries to explain why, citing mortality outcomes, fiscal announcements and COVID-19-specific factors as major contributors. Specifically, they find that systematically riskier countries have issued less stimulus in relation to GDP. Also, mortality outcomes and policy announcements, rather than traditional determinants like fiscal space and systematic risk, drove EZ CDS adjustment over the pandemic period.

Andy Haldane on the UK’s economic outlook, and accounting errors in US unemployment rates

State Ownership Will Gain Importance as a Result of COVID-19 (VoxEU, 12 min read) Globally, state-owned enterprises are among the largest and fastest expanding multinational companies. The current pandemic is likely to see state ownership increase. This column, set out by the OECD, emphasises three key post-COVID guidelines for governments: be strict on recovery, set conditions for exit, and rely on independent valuations of investments and divestments.

The Second Quarter – Speech by Andy Haldane (Bank of England, 23-page read) The BoE chief economist remains optimistic about the recovery in the UK post COVID. However, he expressed concerns regarding the limitation of the interest rate close to zero in solving structural issues in the economy (such as high rates of unemployment or sectoral shifts). He believes the most critical risk currently to avoid is the recurrence of high and long-duration unemployment rates, especially among young people like that seen during the 1980s.

US Unemployment Rate Falls Again, but Little Progress After Accounting for Recalls From Temporary Layoffs (PIIE, 6 min read) Jason Furman and Wilson Powell III identify how the official US unemployment rate is understated. Official number showed a fall from 13.3% in May to 11.1% in June, but this figure classifies two million people ‘not at work for other reasons’ as employed. Adjusting for such misclassifications, ‘the realistic unemployment rate’ is 13%. They further demonstrate that if all the temporary layoffs are recalled, the ‘full recall unemployment rate’ will be 7%. This still suggests a deep recession. [Bearish US]

What Biden should do if he is elected, and ING on trade deal post Brexit

Will Russia’s Constitutional Changes Allow Putin to Hold on to Power? (CFR, 4 min read) Putin’s constitutional amendments have made him more powerful than ever. But the COVID crisis, lower energy prices and young people losing interest (indicated by poll numbers) could imply Putin’s party, United Russia, may have a hard time securing parliament majority in next year’s election. If these trends go on, Putin’s 2024 election campaign could become challenging as well.

Post-Brexit Trade Deal Still Possible Despite Rollercoaster Talks (ING, 6 min read) UK-EU talks ended a day early but ING is confident a deal is still forthcoming. However, they remained concerned about business preparedness after the transition period. ING estimates 240,000 firms in the UK only export to the EU, and many of the SMEs have thin margins and cannot deal with the additional costs associated with customs clearance, transport costs and tariffs (if no deal happens). [Bearish UK]

After the Liberal International Order (Project Syndicate, 7 min read) If Biden gets elected, he should not try to restore US-led international order; instead, he should strengthen rules-based international institutions (i.e. UNSC). It is only through these that we can promote democracy and human rights and solve the challenges of climate change, pandemics, cyber-attacks and terrorism. Another dilemma for Biden will be to find a way for the US and China to cooperate in delivering global public goods while competing for global power.

Liquidity of new 20-year, and gold’s correlation with real yields

How Liquid Is the New 20-Year Treasury Bond? (Liberty Street Economics, 8 min read)  The trading frequency, trading volume and trade size of this new issue remains lower than the 30-year. In terms of liquidity, the bid-ask spread is also wider than the 30-year bond, and order book depth too is lower, averaging around $11 million (vs 19 million 30-year). Nonetheless, the bid-ask spread has shown signs of tightening in May, which could be a sign of improving liquidity and trading conditions going ahead.

Falling Real Yields Suggest Gold Price Will Continue to Rise (The Capital Spectator, 5 min read) Gold will continue to have upside momentum since downside pressure on the real yield is still strong due to extremely dovish Fed policies. Correlation between 10-year TIPS (a proxy for real yield) and gold has risen from 0.59 in 2019 to 0.75 this year (based on rolling 10-day changes). [Bullish Gold]

Macroprudential Policy and COVID-19: Restrict Dividend Distributions to Significantly Improve the Effectiveness of the Countercyclical Capital Buffer Release (VoxEU, 12 min read) Banks in the euro area have historically favoured income adjustments over dividends restrictions during economic recessions. These countercyclical dividend payout ratios place a strain on capital positions precisely when they are at their weakest. In this column, a senior ECB expert shows how curtailing bank dividends during economic downturns can improve the effectiveness of macro-prudential buffers, ensuring households and corporations can access funds during the COVID-19 crisis.

Cross-border capital flows into China are increasing, and digital renminbi rolls out

Despite the Rhetoric, US-China Financial Decoupling Is Not Happening (PIIE, 7 min read) A survey shows 80% of US companies will not relocate their manufacturing out of China. Portfolio investment in Chinese stocks and bonds also continues to grow and has reached RMB4.2 trillion (USD594 billion) for the first quarter of 2020. This will further prompt the US-based global indices provider (MSCI) to increase the weights of Chinese listings. Additionally, delisted Chinese companies in the US can list in Hong Kong, where US investors can still invest or have access to US capital via private markets. [Bullish Globalisation]

China’s Next World-First (OMFIF, 3 min read) Beijing is launching a pilot scheme to test E-CNY in several districts as a broader strategy to mitigate financial stability worries as big tech like Alipay and Wechat now holds 90% share of the local retail payments market. The current implementation wouldn’t disrupt the financial sector because it doesn’t require consumers to open an account at the central bank; issuance and redemption can be carried out by the financial sector.

Bernstein on how ESG can help generate alpha, and top fiscal projects which boost growth and are climate-friendly

ESG Research Helps Reveal Resilience amid COVID-19 (Alliance Bernstein, 5 min read) Investors who integrate ESG factors into their research have an excellent gauge of business adaptability and can use this to generate excessive returns. Bernstein highlights companies that incorporated ESG practices outperformed in the first quarter of 2020 as their forward-looking outlook allowed them to handle unforeseen scenarios effectively – for example, the ability to quickly move operations remotely. [Bullish ESG]

Will COVID-19 Fiscal Recovery Packages Accelerate or Retard Progress on Climate Change? (Oxford Review of Economic Policy 3, 17-page read)  A joint study conducted by top universities surveyed 231 G20 central bank officials, finance ministries and economic experts on fiscal spending effectiveness in terms of the economic multiplier and climate. The findings reveal five areas with high potential: clean physical infrastructure, building efficiency retrofits, investment in education and training, natural capital investment, and clean R&D.

(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.)

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