With so many macro developments this week, we’ve snuck two Exclusives into our Podcast Playlist letter. Former DB economist and FT writer Caroline Grady gives her take on the ECB’s strategic review. Meanwhile, former Nomura macro scenario & risk analyst Manan Shah writes on how markets are likely to respond to the China virus.
Back to the podcasts: we feature two 2020 outlooks, one from the sell-side (Deutsche Bank) and the other from the buy-side (Franklin Templeton). Both are bullish on the world but emphasise different risks. One of those risks, trade, is elaborated on a Cato podcast, which gives a pessimistic read on recent trade deal news.
Then we have a podcast that features a positive take on the US airline industry from Goldman’s equity analysts. Finally, we look at the future of hydrogen and efforts in Venice to replace diesel-powered boats with cleaner hydrogen. Is it a really a miracle molecule?
ECB’s Green New Deal? (4 min read) The ECB’s first strategic review in more than 16 years is now officially underway. The findings will shape the future of monetary policy, most likely with an amended inflation target and improved communication. The inclusion of climate change in the review was duly confirmed, triggering some euro weakness on concern this could be used to engineer further expansion of monetary policy. But for now, President Christine Lagarde will take comfort in the moderate improvement in growth and inflation dynamics that allow the current policy parameters to remain firmly on hold….
(Caroline Grady │ 24th January, 2020)
What China Virus Means For The Markets (3 min read) Since mid-December an outbreak of a pneumonia-like new virus has been reported in the Chinese city of Wuhan (population 11mn). Genomic data was made publicly available in mid-January enabling scientists to study its genetic fingerprint. Officially known as 2019-nCOV by the WHO, the virus’ genetic makeup is similar (70%) to the deadly SARS virus (Severe Acute Respiratory Syndrome) but “appears clinically milder” in terms of severity, fatality rate and transmissibility….
(Manan Shah │ 24th January, 2020)
The House View: 2020 Outlook – Gaining Speed (Podzept, Deutsche Bank Research, 11 min listen)
• DB’s thematic research team presents a fairly positive view of the global economy.
• The Phase 1 trade deal between the US and China, the Conservative party majority following the UK general election, and last year’s rate cuts by major central banks have all eased earlier downside risks.
• Top risks to this view are geopolitics (rising tensions in the Middle East) and trade (not just the next phase of US-China negotiations but also forthcoming US-EU and UK-EU trade negotiations). Lesser risks are recession, from weaker Chinese and European growth, and from Brexit.
• GDP growth expectations – Global: growth to accelerate to 3.3% in 2020. China: expected to remain at 6.1% as both consumption and exports lose momentum. US: moderate slowdown to 1.9% as a resilient consumer keeps the record-long expansion in place. Euro Area: subdued growth of 1% with downside risks from trade, Brexit, and pressure in the auto sector.
• Monetary policy set to remain accommodative. Fed and ECB on hold this year, BoE to cut in January, and China to maintain RRs after the cut in early January.
Why does this matter? Accelerating global growth and the Fed being on hold should keep equity markets on track for further gains this year and worries about corporate profits in check. EMs should benefit from an improved external environment and further space to cut rates where inflation allows. (Bullish global macro)
On My Mind: Will The US Economy Survive The Politics In 2020? (Talking Markets with Frank Templeton, 12 min listen) Sonal Desai, Franklin Templeton’s Fixed Income CIO, discusses concerns and ideas for the US in the year ahead.
• US politics will be the main source of volatility this year given the November election. Some radical policy proposals from leading democratic candidates could significantly change the business environment with a negative impact on economy and markets.
• Deregulation has supported growth much more than is appreciated and any reversal could have a significantly negative effect.
• On the macro side, US GDP growth is projected at a fairly healthy 2.5-2.75% this year. Public spending and debt are likely to keep growing, stretching treasury valuations further. The Fed is likely to keep rates anchored at low levels, leading to asset prices bubbling up.
• It’s dangerous to assume low inflation will stay forever. The labour market is strong, and this is beginning to show up in corporate labour costs. Technological advances are not guaranteed to be disinflationary forever.
• Loose monetary policy may be sowing the seeds of future financial instability. Secular stagnation may not be so secular after all, and productivity growth may not remain sluggish once digital innovation finally makes its way through the economy.
• Finally, Desai believes the global shift towards greater nationalism is here to stay, and (as we have recently discussed on Macro Hive) she sees growing US-China tech rivalry evermore present.
Why does this matter? Like Deutsche Bank, Franklin Templeton is bullish on growth. However, they both emphasise Trump’s deregulation as a key driver, which could be unwound with a Democrat win in the upcoming US election. Also, they appear more concerned about inflationary pressures building.
Reasons For Concern In Two New Trade Deals (Cato Daily Podcast, 11 min listen)
• Cato analysts review the Phase 1 US-China deal and the USMCA that was passed in the Senate last week. Phase 1 is a mixed bag. It prevents further escalation in tariffs and potentially removes trade barriers on agriculture, if it works. But it keeps nearly all existing tariffs in place.
• It’s also more about managed trade and guaranteed purchasing, which is a bad precedent, not to mention whether the commitments are even feasible. On dispute resolution, the US can still unilaterally impose future tariffs under the deal.
• Phase 2 is expected to deal with the deeper structural issues creating trade distortions, namely subsidies and SOEs, alongside lowering existing tariffs. Given Phase 1 took nearly two years to achieve, it is unlikely that any near-term progress is made on Phase 2. The November US election also reduces any likelihood of progress this year.
• USMCA excludes any clause to prevent future imposition of Section 232 tariffs (these currently cover steel and aluminium where partial exemptions were granted to Mexico and Canada). There is nothing in the deal to prevent the US from threatening Mexico and Canada with future tariffs. As such, uncertainty remains.
Why does this matter? Trade tensions were a significant source of market uncertainty during the past two years and led to a slump in global trade, investment, and manufacturing. They also sparked fears of a global recession. Confidence has now improved, but signs that tensions could re-escalate would quickly reverse this.
• Top questions for the airline industry this year: 1) will the airlines be able to offset cost inflation from (highly unionised) labour and airport maintenance, and 2) what happens when/if the Boeing 737 Max is recertified.
• Southwest, United, and American were the US airlines most impacted by last year’s grounding of the 737 Max. Profits were quickly impacted as airlines are a relatively high-fixed-cost industry (cancellation of flights hurts). But the grounding was a clear positive for those without the 737 Max – like JetBlue and Delta.
• Goldman’s propriety unit revenue index shows hotel occupancy rates and oil offer real time information on revenue trends.
• Industry consolidation is the biggest driver of profitability improvement – the top 4 players in the US now have > 80% market share. Potentially, there’s room for more consolidation at lower cost airlines.
• Improved profitability/cash flow in the past decade means airlines can reinvest: more product options, better consumer satisfaction.
• Industry is different this time, albeit still cyclical, especially business travel. The variable cost share has increased (more leasing, partnering) product differentiation. Most of the industry has used expansion to deleverage balance sheets.
• Also looks at trends for the next 5-10 years, including use of data from an operational standpoint to avoid cancellations and improve maintenance schedules.
Why does this matter? The podcast offers a different view on US airlines from the typically negative ones around disrupted supply chains and the sizeable overall hit to US growth from halting production of the 737 Max. (Bullish US airline stocks)
Hydrogen: The Answer To Climate Change (World of Business – BBC Radio, 26 min listen)
• The BBC reports from Italy on whether hydrogen can be the fuel of the future.
• They use Venice as their example. Venice’s poor air quality has led to a proposed solution of hydrogen-powered boats replacing the diesel engines, which are causing irreparable damage to the city’s monuments. But the law currently prohibits the fuel to be used in boats.
• Is hydrogen the magic molecule that some believe? Views are mixed. Much quicker refuelling compared to batteries leaves clear benefits for long distance transport. But high costs and image problems pose hurdles.
• It’s also not really a green fuel – more like grey, with fossil fuels needed to make hydrogen. One solution is to use renewables to make hydrogen.
• Another problem is the need to change existing designs (like gas-based central heating) to achieve a structural shift in demand for fossil fuels.
• Italy has successfully tested hydrogen in a handful of factories but the scale remains small.
• Is it all too little too late for Venice? The city’s small size is seen as a good test bed for hydrogen and a way to make the city part of the solution to climate concerns, rather than just a symptom.
Why does this matter? Hydrogen-powered cars (from companies such as Toyota) are slowing coming on the market and may, like electric vehicles, start to become more common and affordable. Wider use of electricity and hydrogen-powered (from renewables) transport will help cut pollutants. And given the increased focus on ESG in investment mandates, companies like Toyota, or those promoting hydrogen boats in Venice, may benefit from a reallocation of assets towards greener investment.
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