By Bilal Hafeez 01-08-2019
In: post | Newsletter

Macro Hive Weekly Brief: Fed Curveball / Market Illiquidity / Pound Down

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(total reading time: 10 mins)

We’ve hit the headlines! Business Insider recently covered Macro Hive on their website: ‘An analyst who just ditched his investment bank job is already winning big research clients on his own – and it’s a sign the financial world is getting flipped on its head’. Many have reached out to ask how they can get involved with the ‘Hive’ – if you have an op-ed idea or you want to intern, just contact me on this email.

Onto today’s newsletter, then. US rates expert, George Goncalves, wrote a Hive piece ahead of the Fed meeting, and in the end, the Fed delivered a 25bps cut yesterday, which was in line with his base case view. Perhaps the surprising part of the Fed’s decision was how cautious they were. Fed Chair Powell characterized the cut as ‘a mid-cycle adjustment’ rather than ‘the beginning of a long series of rate cuts’. The markets didn’t like it (equities sold off and yield curve flattening) and neither did President Trump (‘as usual, Powell let us down’). I write more about this in my special report, ‘What Investors Are Thinking: the July Scan’. The bottom line is that just as investors were giving up on higher rates, the Fed has become less dovish.

Stepping back, one consequence of the prolonged period of low rates across the world is their impact on asset market valuations and, more importantly, market liquidity conditions. This week, we’re lucky to have Salomon Sebag write for us. He spent over 25 years at JPMorgan managing trading books from EM to interest rate derivatives, and in this issue he covers these topics.

The third special report is on the pound. I write about how new Prime Minister Boris Johnson is following the Trumpian model of deal-making. Expect more talk of hard Brexit and a continued rocky path for the pound.

In our curation of external content, we feature the Japanese take on overcoming deflation, how wealthy Americans are ready to invest, and the PIMCO view on a dollar policy. On China, we highlight pieces on the war games with the US, Yale’s Stephen Roach’s positive view on China, and genomic editing of crops.

Finally, I’ve recently started giving talks on wellbeing and my area of focus right now is the ‘comparison mindset’. Judging our success against others’ often affects us for the worse, so I’ve come up with some tips on a healthy approach to self-evaluation. I’ll also be talking about this in Switzerland soon.

That’s all for now.

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What Investors Are Thinking: The July Scan (3 min read) Triangulating positioning, forecasts and topics, we find that investors appear to be giving up on higher bond yields, they seem concerned about Europe and broader global debt dynamics and they are bearish the dollar. The big risk would be higher US yields and the dollar. (August 1│Bilal Hafeez)

Are Markets Under Anaesthetics? (3 min read) No one knows how the patient will feel when QE anaesthetic is ultimately reversed, and in the meantime, one has to remain cautiously invested and continuously monitor market conditions. But the increasing occurrence of flash crashes in recent years is a stark reminder of what will happen when CBs decide to call time on their policy of buyers of last resort. (August 1│Salomon Sebbag)

Boris’s Trumpian Pounding (2 min read) The pound has plunged to new lows. Both GBP/USD and EUR/GBP are now only 2-3% away from their valuation extremes that we are flagged in our bearish sterling note from last week. And assuming a Trumpian approach to trade negotiations, the bumpy ride for the pound will likely continue in the near term. (July 30│Bilal Hafeez)

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Overcoming Deflation: Japan’s Experience and Challenges Ahead (Speech at the 2019 Michel Camdessus Central Banking Lecture, 10 min read) A persistent deflationary environment combined with low interest rates has been troubling Japan for decades. Now it’s no longer the only case – a number of developing economies have followed suit. In this speech directed to the IMF, the Governor of Bank of Japan, Haruhiko Kuroda, explains how Japan escaped deflation using a two-pronged, powerful monetary easing approach (‘QQE with Yield Curve Control’) but is still struggling to reach the 2% inflation target. Kuroda believes that inflation expectations play a big role in recovery, but with stagnation embedded in the Japanese consumer and investor mindset, it takes a lot to break. Further, this has kept wages low, even though unemployment has fallen to 2.5% and the Phillips curve has flattened as a consequence. Amidst a global environment of uncertainty, the Governor holds his stance on aggressive monetary policy stimulus as the remedy.

Why does this matter? In the US, inflation hasn’t hit its goal sustainably since the Fed formally adopted it in 2012. Stubbornly low inflation has also hiked the risk that expectations for future inflation will drift lower. In light of the Fed rate cut this week, it’s worth taking stock of Japan’s experience.


Wealthy Americans are Increasingly Willing to Invest (UBS Survey, 2 min read) UBS Global Wealth management conducts a useful quarterly survey on US investor and entrepreneur sentiment. The latest data shows an improvement in optimism on the overall global economy – 41% were positive, up from 37% last quarter. This is largely driven by bullishness on US stocks; 37% expressed an intent to invest more, up from 26%. The next most attractive region for investing was the EU, probably as a result of the recent promises from the Central Bank of fresh stimuli.

Why does this matter?  A bullish US market investor sentiment is evident with S&P500 and other benchmark indices tapping new all-time highs, engineered by the US Fed dovishness. But the bond market appears much more concerned, with the yield curve inverting.


U.S. Dollar Policy: Through the Looking Glass of U.S. Currency Intervention (Pimco, 4 min read) As we have previously discussed, the US is seeking a weaker dollar given Trump’s export ambitions and hopes for higher growth. Indeed, the dollar is estimated to be 10% overvalued relative to fundamental macro factors. Global Strategist Gene Frieda and US Economist Tiffany Wilding don’t foresee a significant currency intervention, but it’s not impossible. In this article, they explore the conditions under which a currency management policy would be plausible. The US treasury manages the Exchange Stabilization Fund, which whilst only $95 bn in size, has done a successful job of intervention before. This has only been possible with the help of the Fed and international peers. Without the support of the latter, however, there is a risk of a deprecation strategy being perceived as the sole weapon against China and a predictor of further war escalation.

Why does this matter? Previous episodes of intervention were short-lived. Since 1995, only in exceptional circumstances has a US administration resorted to it, so there isn’t much evidence that Trump’s plan would work today.


“Let’s Forget about 2% Inflation” (Econbrowser, 3 min read) As a handy follow up to the above curation, in this piece Jeffrey Frankel, a Professor at Harvard’s Kennedy School of Government, argues for the importance of inflation expectations as a method to stimulate economic activity in a zero-bound interest rate world.  This has been done by the US, Japan and the EU alike. But how did they set expectations? He claims that a sincere announcement by the Central Bank of a promise to aim at 2% target inflation, combined by quantitative easing acceleration, is a good strategy. However, it hasn’t fared so well – neither Japan nor the US have reached the target yet, despite low unemployment levels. A recent working paper that’s is also discussed in this article, however, argues to the contrary – setting inflation expectations has little effect on household and business decision making. Central Banker’s fixation on an inflation target might not be so necessary after all.

Why does this matter? Most economies are fixated on monetary policy as a primary stimulus tool and a 2% inflation target has been a long-standing holy grail. In a rock-bottom rate environment, it might be worth taking stock of why most countries struggle to reach that – and whether it should be a target at all.


Double-counting of Investment (VoxEU, 5 min read) Robert Barro, Professor of Economics at Harvard, argues that the most widely used measure of economic activity – GDP – is somewhat incorrect. He claims that it includes gross or net investment twice – when it occurs and then further, when additional rental income results from enhanced stock of capital. For example, Tesla builds a battery factory that costs $1bn, lasting for 20 years, over which $3.3bn of revenue is recorded. GDP would then include $4.3bn, whereas it should only count the $3.3bn. Barro proposes an alternative measure: a present discounted value of consumption. And he also shows how it relates to GDP. In addition, he provides a capital income/labour income decomposition for both measures, claiming that current GDP measures overstate capital income’s share.

Why does this matter? Barro joins the chorus of people arguing for new measures of economic activity. However, he doesn’t make clear why his measure is better than say just looking at consumption or why recasting the capital income share is important.

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How the U.S. Could Lose a War with China (The Atlantic, 3 min read) Last week we discussed China’s brand new white paper on National Defence. Now, amid their mounting economic quarrel, the US is expressing its concern over China’s aggressive military expansion. War simulations show that if a conflict were to erupt, China has the capability to triumph. And even though outright warfare seems unlikely, the country has clearly stated that it won’t hesitate to use force over Taiwan if the island declares independence. With Taiwan a close US ally, tension continues to rise as Washington ups its naval activity across the Taiwan Strait.

Why does this matter? China’s intent remains unclear to the US. Most of the 2020 Presidential candidates agree that China is a major national threat. How a bipartisan demonization of China plays out is yet to be seen – war simulations can only go so far.


China’s Long View (Project Syndicate, 3 min read) Unlike the rest of the World, China seems unconcerned by its slowing GDP Growth. In this article, Stephen Roach, a senior fellow at Yale University, who takes a bullish stance on China, argues that Jinping maintains a long term, stable approach to policy. Unlike many of the Western economies, China is enjoying fiscal and monetary leeway with plenty of room for rate easing and infrastructure spending. Further, Beijing portrays patience in their strategic decision making, and policymakers aren’t planning any sways no matter who wins the 2020 Election or what their views are on China. Further, Roach sees the Huawei restrictions from the US as inevitably harmful but short-lived – China has the potential to build its own chip industry within only two years, as opposed to the expected ten.

Why does this matter? China appears resilient to short-lived headwinds and attacks from the US. Don’t be quick to judge, however. As we have previously discussed, China’s corporate defaults are at record highs and consensus predicts another halving of the Chinese economy.


To Feed its 1.4 billion, China Bets Big on Genome Editing of Crops (Science Magazine, 7 min read) Disease can strike cops on a massive scale, seriously disrupting food supply. And when a population of 1.4bn relies on crop produce, consistency in harvest is vital. Using a natural bacterial immune system called CRISPR, China is modifying plant DNA in the hope of improving the texture, longevity, and taste of its crops, turning them resilient to any damage. But the efforts are pre-emptive, given limited natural resources, and there is a long way to go before modified crops are brought to market – China first has to clarify its regulatory stance.

Why does this matter? CRISPR is essentially a GMO tool, which is generally frowned upon by consumers. In China, however, it might be necessary to feed an ever-expanding population. Syngenta, the Swiss chemical company that was acquired by ChemChina in 2017 for $43bn has already assembled a large R&D team exploring CRISPR. A number of start-ups are also popping up. Investors should be wary, however, for CRISPR remains controversial, especially after recent medical scandals where Chinese doctors used it to genetically engineer babies.


China Makes Concession on US Farm Goods in ‘Frank’ and ‘Constructive’ Talks (SCMP, 4 min read) The anticipated progress in the US-China trade talks is now materialising. In a meeting this week China agreed to start buying soybeans and other produce from the US. Even though China is in no rush to end the trade talks, since, as we mention above, their economy is resilient enough to withstand the turbulence, Beijing is opting for cooperation, opening its economy to more foreign investment. Trump, who needs an attractive deal to boost his re-election chances will favour this. Meanwhile, Wall Street is lobbying for an easing of Huawei’s ban.

Why does this matter? Brexhaustion – a recently coined term defined as apathy towards Brexit discussion; well perhaps we are seeing something similar emerging around the US-China trade talks. Hopeful investors are finally seeing some progress, but it seems like a long way to go with much back and forth to come.


Beijing Axes Individual Travel Visas for Chinese Tourists Visiting Taiwan (Taiwan News, 3 min read) Ahead of Taiwan’s 2020 Elections, China anticipates that the island will call for independence, partly ‘externally’ driven (pointing to an unwelcomed push from the US). To add insult to injury, Taiwan supports Hong Kong’s stance on anti-extradition protests. Beijing has expressed serious worry about the country’s overall sovereignty status. As a first step in demonstrating discontent, China has suspended issuance of individual travel visas for citizens of 47 regions. Taiwan saw 1.7m Chinese tourists last year, a 30% increase from the previous period. The restrictions might reduce the number of visitors by 700,000 between August and February.

Why does this matter? China restricting citizen access has happened before in 2015 without any significant impact, but now there is evidence of a more serious, underlying conflict at play. For now, China has proposed that Taiwan be governed under a ‘one country, two systems’ structure similar to Hong Kong. China’s control appears to be weakening – both in a geopolitical sense with the number of states seeking independence and in an economic sense with Baoshang Bank’s sudden failure pointing to wider liquidity issues.

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