There’s been a recent flurry of articles highlighting the downsides of recent extreme monetary policy, especially through increasing financial instability. We feature two of them. Meanwhile, IMF former chief economist Raghuram Rajan argues that EM countries that have easy access to foreign savings have worse growth outcomes.
On markets, Blackrock overweights China, new research finds that alternatives increase risks to portfolios and a blog argues that low real rates are supporting stocks. Finally, given the heightened tensions between China and the US, we also feature both Chris Patten and Nicholas Lardy on the meaning of recent moves.
We also feature 2 new exclusives, the first from Dominique Dwor-Frecaut on Trump’s press conference on China last Friday. I also wrote on the latest insights in Asia FX.
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There’s been a recent flurry of articles highlighting the downsides of recent extreme monetary policy, especially through increasing financial instability. We feature two of them. Meanwhile, IMF former chief economist Raghuram Rajan argues that EM countries that have easy access to foreign savings have worse growth outcomes.
On markets, Blackrock overweights China, new research finds that alternatives increase risks to portfolios and a blog argues that low real rates are supporting stocks. Finally, given the heightened tensions between China and the US, we also feature both Chris Patten and Nicholas Lardy on the meaning of recent moves.
We also feature 2 new exclusives, the first from Dominique Dwor-Frecaut on Trump’s press conference on China last Friday. I also wrote on the latest insights in Asia FX.
Enjoy!
Bilal
President Trump China Press Conference: More Bark Than Bite, So Far (4 min read) Bottom line: markets rallied on Friday’s Trump press conference on China as it turned out more a list of threats than actual actions and Trump did not announce that he was pulling out of the phase 1 trade agreement. But his distrust of China is a long held belief, and he is likely to make good on some of these threats in a manner that does not threaten long term market performance and supports his re-election prospects. So Chinese-US news are likely to remain a source of market volatility though not of broad-based performance reversal…
(Dominique Dwor-Frecaut | 1st June, 2020)
Asia FX Insights (5 min read) The risk rally in markets continues. Some of this is due to optimism around the reopening of economies around the world, especially the US. This should see economic activity pick up and a return of some normality. So far, we have yet to see second waves of COVID cases in any major economy, which has helped fuel the optimism.
It also helps that the European Union (EU) appears to be going down the path of sharing fiscal risk across the bloc in the form of the EU Recovery Fund. This has seen the euro strengthen and Italian spreads narrow…
(Bilal Hafeez | 2nd June, 2020)
BlackRock bullish on China, and a bearish case for alt. investments
China’s path out of virus lockdowns (BlackRock, 3 min read) BlackRock sees China’s economy back on-trend growth by late 2020. For this, they are ‘overweight in equities and credit in Asia outside Japan’. They see future US-China decoupling bullish for their portfolio as exposure to both the US and China in the future could provide added diversification benefits.
Do Alternative Investments Dampen Portfolio Volatility? (CFA Blog, 3 min read) Alts do not outperform the 60/40 portfolio and instead of dampening risk actually enhance it by 22%, which is due to their correlation with traditional asset class (bonds and equities) increasing lately.
Why Are Stocks Doing Well? (TheMoneyillusion, 2 min read) Equities valuations are a function of future cash flow discounted at a real interest rate. Expectation of a permanent fall in the equilibrium real interest rate has helped boost valuation. Other factors (albeit less critical) include the hope of a V-shaped recovery and shift of ‘national income from labour to capital’ during the pandemic, making tech companies profitable.
Against negative rates, and the intricacies of the ECB’s Phillips curve model
The Limits of Extreme COVID Monetary Policy (Project Syndicate, 3 min read) The expanded use of unconventional monetary policy tools risks exacerbating existing vulnerabilities and reducing the effectiveness of the signally quality of interest rates. Instead, a wide-scale fiscal response aided by other tools such as the European recovery funds is needed.
The Phillips Curve at the ECB (ECB, 50 page read) A structural Phillips curve, where inflation deviations are a function of slack, inflation expectations and mark-up, explains inflation dynamics through 2013-17 mostly via reduced slack. The model has more difficulty explaining recent low core inflation, although inflation expectations have played a role.
UK Negative Rates Could Do More Harm Than Good (OMFIF, 3 min read) Financial stability risks, the reversal rate (where interest rate cuts become contractionary), endangered banking sector profitability, and signalling expectations of a deep downturn are all reasons to avoid a move to negative rates in the UK.
COVID’s impact on female employment and hysteresis
The Short-Run Macro Implications of School and Childcare Closures (VoxEU, 5 min read) Female employment has been disproportionally affected during the COVID crisis due to both the larger share of women working in the service sector and the logistics of school closures. In Germany, this could mean an 11% reduction in the labour force and worsening gender equality.
The Lasting Scars of the Covid-19 Crisis: Channels and Impacts (VoxEU, 5 min read) Hystereisis (or scarring) from COVID could occur through the impact on i) unemployment, ii) education, iii) investment, iv) liquidity issues at viable companies, and v) loss of job-specific skills.
Why relying on external financing can reduce growth, and the benefits of reduced tourism
When is Debt Odious? A Theory of Repression and Growth Traps (University of Chicago, 40 page read) Access to foreign savings can increase wasteful government spending and result in lower growth than where a country has no access to debt. Debt ceilings and fiscal transfers can be effective in this situation.
Global GDP Themes and Forecasts (Advisor Perspectives, 2 min read) A useful visual summary of global growth dynamics and their key drivers. Latin America stands out as one of the hardest hit regions and one where ‘inflation and unemployment are likely to remain stubbornly high’.
Tourism Drop in CEE and CIS – Many Losers but Also Some Beneficiaries? (Bond Vigilantes, 3 min read) Reduced outbound tourism can provide an economic boon where the travel balance is in deficit. Ukraine’s central bank expects the C/A deficit to narrow for this reason. But any positive economic impact depends on tourism spending being redirected internally.
Trump’s soft stance on China, and the need for UK leadership to protect democracy in Hong Kong
Trump Finally Gets the War He Wanted (Defense One, 4 min read) ‘…the president claimed moral and Constitutional authority and ordered federal law enforcement and the US military to turn against Americans who opposed him’.
An Embattled Trump Unveils A New China Policy (The American Conservative, 3 min read) China hawks including Tucker Carlson and Steve Bannon (advisors to the administration) want more hostile policy towards China, whereas Trump holds a relatively softer stance.
We Are Hong Kong (Project Syndicate, 4 min read) Chris Patten (the last British governor of Hong Kong) believes that the China-Hong Kong relationship was sailing smoothly till 2013. After that, Xi started to toughen his grip on civil society and international control (Uighurs camps and militarization of the South China sea). He calls for the UK to show leadership by putting the liberal democracy of Hong Kong as an agenda for next month’s G7 meeting.
Reviving the EU banking union, and best practices on data during COVID
Beyond the Pandemic: Eight Proposals to Revive the Banking Union (VoxEU, 4 min read) Europe’s banks are better capitalized and regulated than prior to the debt crisis, but the goal of diversified risk sharing through banking union and an EU-wide deposit insurance scheme remains incomplete. COVID’s impact on solvency threatens to reverse the partial progress made.
Keeping Economic Data Flowing During COVID-19 (IMF Blog, 3 min read) Delayed or imprecise data during COVID can complicate the policy response and assessment of the economic impact. IMF recommendations on best practice to compile inflation, trade and growth data include i) prioritizing components, ii) using alternative datasets, and iii) greater transparency on methodology.
Did the Dollar’s Position as the Leading Reserve Currency Help Hold Treasury Yields Down This Spring? (CFR, 8 min read) Large foreign selling (>$300bn) of USTs, the result of EM central bank selling reserves to offset capital outflows, was accompanied by USD appreciation and falling yields in March. This was because the Fed stepped in and bought even more USTs than foreigners sold.
China overtakes the US economy (on ICP data), and why the EU won’t interfere with a rising China
Who Has the World’s Largest Economy? (Project Syndicate, 7 min read) The World Bank has published the results of the International Comparison Program (ICP), which calculates price levels and GDP for 176 countries. China’s total real income surpassed the US on a PPP basis for the first time in 2017 according to ICP data, but lags the global average in terms of income per capita. This suggests China hasn’t surpassed the US as an economic powerhouse just yet.
Hong Kong Security Law: China Weighs Risk the US Will Go for ‘Nuclear Option’ and Cut Beijing from the Dollar Payment System (South China Morning Post, 2 min read) Risk exists that the US can impose financial sanctions like those placed on Iran and Russia. It’s a ‘low probability event’ for the following reasons: it can turn the ‘cold war’ into a hot one, China holds 4.4% of total US national debt, and this will increase the internationalization of the Yuan (which the US doesn’t want).
Why Europe is Irrelevant to Challenging China (Balding’s World, 6 min read) The EU will not prioritize or interfere with China-affiliated geopolitics. First, Europe is not a political entity with autonomous decision making. Instead, each state has a different kind of relationship with China without any united voice. Second, Europe’s institutions and international alliances (i.e. NATO) has been broadly to solve Eurocentric problems (i.e. the threat of the USSR).
Trump’s latest move on Hong Kong is bluster (PIIE, 2 min read) Nicholas Lardy points out that even if Hong Kong’s special trade status is revoked the economic impact on China and Hong Kong would be marginal. Re-exports account for 95% of Hong Kong’s exports, with the majority produced in China and therefore already subjected to higher tariffs.
Credit Suisse picks top ESG fund managers, and how US hurricanes could setback growth for decades
Credit Suisse names Europe’s top ESG fund managers (Wealth Manager, 2 min read) The equity research team used Morningstar data to study ESG fund flows, integration, trend and performance. DWS was its top pick, and second place went to Amundi. Other top picks included Schroders, SLA and EMG for their well-devised approaches to ESG.
Dual Threats: COVID and Climate Change (Advisor Perspective, 3 min read) With hurricane season on the horizon in the US, ‘some of the regions hardest hit by the pandemic may also have the greatest exposure to hurricane risk and costs from wind and flooding damage. For example, we estimate Miami-Dade County with a joint COVID/Climate annualized loss of 2.6% to 2030’.
(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.)