By Bilal Hafeez 18-07-2019
In: post | Newsletter

Macro Hive Weekly Brief: Fed’s Coming Blunder / Pound Down / Unloved US Equities

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(total reading time: 9 mins)

There’s still much head scratching among investors over the Fed’s pivot to dovishness. Indeed, since Chairman Jerome Powell’s testimony last week, US inflation has edged higher, retail sales have picked up, and regional manufacturing surveys have bounced. This divergence between the economy and the Fed’s new stance could lead to a policy error. At least, that’s what renowned global economist Phil Suttle argues in our lead special report. I learnt a lot from Phil in my early days at JPMorgan, and thoroughly recommend checking out his other writing, too.

The pound hit multi-year lows earlier this week on the possibility of a harder Brexit. Some investors are looking to buy at these levels, but I’m reluctant. In this piece I set out the reasons for my bearishness: not only does the UK have Brexit to contend with, but the leadership of critical bodies from the BoE, ECB, EU, and even the UK government are all changing in next six months. These will probably disrupt considerably the negotiation and execution of any coherent Brexit plan.

The lack of foreign participation in US equity outperformance has always been remarkable to me. We got the latest US capital flow data this week, and it showed the thirteenth consecutive month of foreign selling. So even though many aspects of US equities may seem like a bubble, the behaviour of international investors contradicts this. After all, they were piling in during the dot-com boom.

In our remaining roundup, the Fed can’t quite resurrect the Philips curve and finds that global forces are dominating inflation trends; manufacturing indicators may no longer be reliable predictors of recession; and leading academic Dani Rodrik finds that cultural forces as much as economics are driving populism. On the micro side, we learn from Ben Thompson at Stratechery about the difference between platform and aggregator companies, and from The Conversation that Luxembourg is becoming a hub for the space industry. On China, US tech companies are becoming involved in Chinese spying, the WTO could be breaking apart, and Chinese credit defaults are picking up.

Finally have you ever wondered what is fire? Well, the excellent American physicist Richard Feynman gave an awesome answer in a 1983 BBC interview –  I feature his talk in my latest blog. (The simple answer is ‘stored sun’!)

That’s all for now.

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The Fed’s Upcoming Blunder (4 min read) The Fed’s surprising pivot dovishness will have a limited positive impact on the real economy. Instead, it will fuel financial excess, reduce policy options during a downturn and question the credibility of the Fed. (July 18 │Phil Suttle)

Political Turbulence To Keep Pound Down (2 min read) The pound is falling to new lows. It’s too early to bottom-pick, though: valuations are not at an extreme yet, inflation is below target and level of political change both in the UK and EU is extremely high as Brexit approaches. I’d expect more pound weakness to come. (July 17│Bilal Hafeez)

Global Investors Shun US Equities (2 min read) Latest data show foreigners continue to sell US equities despite US outperformance. The lack of inflows partly explain why the dollar has not performed better given US economic strength, but also suggest US stocks are not heavily positioned in which could spur additional gains. (July 18 │Bilal Hafeez)

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Why Is Inflation Low Globally? (Federal Reserve Bank of San Francisco, 7 min read) The San Fran Fed tries to recover the reputation of the Philips Curve, but struggles to find a relationship between the unemployment rate and inflation across either developed or developing countries. They do find that inflation expectations play a significant role in influencing inflation in developed countries, while past inflation plays a significant role in affecting future inflation in developing countries. But all countries have suffered from falling inflation, which can’t be explained by the Philips curve. San Fran Fed pins this down to common underlying factors, such as increasing trade openness, global supply chains, and greater capital and investment flows across countries, which have been pulling down prices even before the 2008 crisis.

Why does this matter? This work suggests larger structural forces are dominating the path of inflation, and so central bank actions are unlikely to have much impact on inflation. Instead central banks may simply be influencing financial markets rather than the real economy. 


Is Manufacturing’s Potency Fading For US Business Cycle Analysis? (The capital spectator, 3 min read) The article makes the good point that today, manufacturing is just 11% of GDP and each dollar of output requires 25% less energy than in 1999. Meanwhile services have become even more vital, at 70% of output, and are less volatile, smoothing out the business cycle. Continuing to rely on the manufacturing cycle for predicting recessions, therefore, may be misguided. Indeed, since 2008, it has given several false signals, notably in 2015-6, when manufacturing growth went into negative territory but wasn’t associated with an economy-wide recession. Similarly, the yield curve inversion is an overly used predictor, which the recent extraordinary monetary policy might have degraded. This suggests we should use a wider range of indicators instead.

Why does this matter? This year in particular, many have signalled an upcoming recession based upon the collapse of manufacturing measures. This analysis cautions against relying too heavily on the sector, and consequently is more sanguine about the outlook.


What’s Driving Populism? (Project Syndicate, 4 min read) Professor Dani Rodrik, one of the foremost authorities on globalisation and populism, argues that both economic and cultural rifts between traditionalists and younger generations are giving rise to mounting populism. Older generations are increasingly alienated in the community as younger generations adopt values, such as secularism, personal autonomy, and diversity. Yet although the older generation represent a smaller portion of the population, they tend to be more politically active. Meanwhile, economic shocks, such as greater foreign import penetration, have supported the rise of nationalist politics such as Brexit and Donald Trump’s election victory. Together these forces are breeding populism.

Why does this matter?  Many investors see populism as driven by economic forces, but there’s a large cultural component to it, too. This makes predicting the end of populism more difficult and suggests policy uncertainty could be with us much longer. 


Shopify and the Power of Platforms (Stratechery, 9 min read) Ben Thompson is one of the best commentators on Big Tech and is particularly keen on differentiating between platform companies like Microsoft, which facilitate relationships between suppliers and users, and aggregator companies like Google and Facebook, which intermediate and control those relationships. In the article he applies this filter to Amazon, and we learn that it’s clearly an aggregator because it captures most of the value of its third-party retailers through both branding (everything is delivered in Amazon packaging) and logistics (Amazon fulfilment centres). Its true competitor is not a company like Walmart, therefore, but rather a platform company like Shopify, which enables retailers to become online business while remaining in the background.

Why does this matter? Investors need to recognise the threat to aggregator companies are platform companies. More so, that the differentiation that platform companies enable comes from the bottom up, via their use of many retailers, rather than from the top down as is the case with Walmart.


How Luxembourg is Positioning Itself to be the Centre of Space Business (The Conversation, 3 min read) A number of governments and private firms are exploring near-Earth asteroid mining. These investments can be risky but offer the potential for high returns. Luxembourg is positioning itself as an attractive location for space ventures with its satellite sector now representing 2% of GDP, and substantial further investment earmarked. The Luxembourg Space Agency was set up in 2018 as a start-up investment vehicle and the country is now home to over fifty other companies in the sector, enjoying a well-established regulatory, tax, and R&D environment. However, several multi-million US investments have recently fared poorly, which suggests the sector is still high-risk.

Why does this matter? While Europe may not lead in space tech, it is carving out a niche in providing an attractive location for space investment.

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How U.S. Tech Giants are Helping to Build China’s Surveillance State (The Intercept, 5 min read) The Intercept has found that US companies appear to be helping China’s efforts to gather data. Their investigations suggests Semptian, a company based in Shenzen, is formally collaborating with Google and IBM to develop a mass surveillance system. The technology is placed within China’s phone and internet networks to secretly gather the content of phone calls, emails, text messages, and location data. Moreover, they found that Semptian mostly targets those who openly oppose President Xi Jinping, democrats, and human rights activists.

Why does this matter? This opens a new front for potential regulatory action against Big Tech. It also provides an important counterpart to the recent story of tech leader, Peter Thiel, calling out Google on potential Chinese infiltration into their systems, which prompted a response from President Trump.


World Trade Organization Opens the Way for Chinese Sanctions Against US Tariffs in Obama-era (Reuters, 2 min read) This week WTO judges found that the US did not fully comply with a World Trade Organization ruling and could face Chinese sanctions if it refuses to remove certain tariffs that break WTO rules. This relates to investigations carried out between 2007 and 2012 (so before President Trump) on Chinese products such as solar panels and wind towers.  The current administration has challenged the finding. The top WTO court, the Appellate Body, however, has a staffing problem as President Trump has been blocking the process to reappoint members – the Body is supposed to have seven members, but by December this year it will have only one. This could cause a temporary collapse of the court.

Why does this matter? This case shows how the WTO has lost most of its effectiveness in dealing with trade between the two largest nations. Moreover, the collateral damage of the US withdrawing support for WTO could mean the trade body may not be able to function for other countries too. And this could start to figure into Brexit discussions.


China’s Corporate Defaults at Record High – at Last! (VOX EU, 5 min read) A staggering 56% of Chinese firms enjoy an AAA-rating versus only 6% in the US thanks partly to large scale issuance by Chinese state-owned companies. Suspicion over these ratings has resulted in only a 3% holding by foreign investors. However, the first ever bond default in China in 2014 unleashed series of further defaults, defining a new dynamic in the local bond market – implicit government bailouts are no longer a given. This process has accelerated with 4 private firms recently defaulting at once. More market based ways to rate bonds can now be used, which this article suggests is a step towards market development.

Why does this matter? The recent surge in defaults could reveal the true health of the economy, potentially leading to repricing at significantly lower values. Moreover, the wider use of market pricing for credit could introduce more contagion across bonds, which could accelerate the default cycle.


President Xi, Still the Deglobalizer in Chief (Council on Foreign Relations, 4 min read) Headlines often tell us that the US is reversing globalisation, but this chart focused article succinctly shows that in fact China is to blame. Senior Fellow Brad Setser compares GDP growth with trade openness. Typically, economic development is associated with more openness. This was certainly the case with the US, but it hasn’t been so with China – their imports have lagged. That’s no surprise, though, since the government isn’t shy about its import-substituting industrial policy. It aims to not only bring production of foreign firms home, but also intends to build local indigenous industries. Trump, on the other hand, is disrupting these efforts partly by reversing dollar strength to boost US exports.

Why does this matter? We need to watch China’s industrial policy to understand the scale and pace of de-globalisation. For now, at least, it appears to be accelerating, which suggests that Chinese growth will provide less support for trade partners.


Apple Tests AirPods Production in Vietnam as it Cuts China Reliance (Asian Review, 4 min read) The headline is a bit misleading: Apple’s ties with China remain strong. But it has asked its Chinese supplier, Goertek, to set up production facilities in Vietnam. The logistics are changing in reaction to the US-China trade war and because of rising labour costs in China. Vietnam is cheaper and yet keeps production close to China. Other tech companies are following suit, however President Trump has recently threatened to impose tariffs on Vietnam, which could threaten these shifts.

Why does this matter? This piece is a great breakdown of a large scale trend: the trade war is pushing US companies to include other Asian countries in the final links of the supply chain, whilst maintaining their use of China where they can. Vietnam seems to the big winner at the moment, though others could follow. Needless to say the US is not seeing any onshoring.

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