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By Bilal Hafeez 25-07-2019
In: post | Newsletter

Macro Hive Weekly Brief: Negative Rates Dilemma / Turkey Troubles / Dollar and Curve

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(total reading time: 12 mins)

Macro Hive Update!

Before going into this week’s newsletter, I thought I’d update you on Macro Hive itself. As you know, our philosophy is to create and curate high quality macro analysis, provide an alternative take, and present it as succinctly as possible.

We’ve been up and running for seven weeks now and we are up to 5,000 unique users of our site. The direct feedback from readers has been very positive, from a senior investment banker highlighting our ‘thought provoking content’, to a CIO at a large asset manager who wrote that they ‘especially like the format…it makes it easier to find the bits I want to read’. Perhaps our best, though, was a partner at hedge fund who said, ‘I’ve been forwarding your email to people saying how good it is!’ Of course, we encourage you to do the same!

But we also know that we’re still a work in progress, and there are aspects of our service that need improving. So if there’s anything you’d like to see changed or included, please let us know. We value your input immensely.

Recently, we’ve beefed up our team (and we’re still hiring). This will allow us to release additional content such as summaries of academic papers, which you’ll find in a new newsletter soon. We also plan a revamp of our website, which you’ll see in the coming weeks. As we’ve mentioned from the outset, we do plan to charge for access to some of the content after the summer testing period. We’ve haven’t decided on the monthly charge yet, but we’ll try to make it as accessible to all as possible.


This Week’s Brief

Back to today’s newsletter. We have three special reports. The first has veteran macro strategist John Tierney discussing policy rates – he argues that trouble comes when countries enter deflation with negative policy rates. The second is on Turkey’s turn towards heterodox policy. Thanos Papasavvas, who previously spent twenty years in asset management, writes that the country is undoing the good work of the past year. In the third, we have FX expert Henrik Gullberg describe how the dollar will fare if the US yield curve steepens.

Finally, in our curation of external content, we highlight pieces on new sources of energy for Europe, new data on US inequality, and on the risks of ETFs. On China, we bring you insights on how the tech sector is laying off workers, on the disruption caused by the recent Japan-Korea spat in the chip sector, and an update on China’s investments in Africa.

That’s all for now.

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Do Negative Interest Rates Work? (4 min read) In light of a potential downturn, macro strategist John Tierney asks whether negative interest rates would be effective to kickstart economic activity. The answer lies in the level of inflation – if it hovers in the positive region of around 1%, moderately negative rates would work. If we see deflation, however, cuts deeper into negative territory would be needed, which would be much more problematic. (July 24│John Tierney)

Turkey’s Erdogan Undoes Hard Work (4 min read) Thanos Papasavvas, founder of ABP Invest, writes on Turkey’s loss of central bank independence under Erdogan and growing internal and external political tensions. Papasavvas maintains a negative outlook on the lira and local bonds. (July 23│Thanos Papasavvas)

US Yield Curve Set to Steepen: How Will FX Markets Perform in Response? (3 min read) FX expert Henrik Gullberg looks at historical episodes to determine how a steepening yield curve would impact currencies. The bottom line is that a steeper yield curve will drive USD/JPY higher while for emerging market FX, the performance depends on why the curve is steepening. (July 22│Henrik Gullberg)

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For details: The Biggest Corporate Debts Visualized in One Chart

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Five Countries in the Eastern Mediterranean are Shaking Up Europe’s Energy Map (The Conversation, 4 min read) For a long time, Russia has been the primary supplier of most of Europe’s oil. With new discoveries in the Mediterranean Sea, things are finally getting a shake up as new players emerge. This article outlines which countries to watch out for. Egypt’s first gas discovery in 2015, the Zohr Field is the largest field in the Mediterranean. Together with 11 new energy projects rolling out, the discovery is positioning the country as a regional hub and is an attempt to counteract the recent political unrest. Cyprus is another prime emerging player, with major discoveries going back to 2011. These, however, might be hindered by the geopolitics tearing apart the Turkish and Greek sides of the island. Israel has not only drilled plenty of gas in the past 20 years, but is strategically cooperating with Greece and Cyprus, building a $7bn pipeline feeding into Southern Europe. Together with Egypt, the four countries are aiming to exclude Turkey from the market.

Why does this matter? Russia’s dominance over the European gas supply is under pressure, which could realistically result in conflict. Turkey recently purchased a Russian anti-aircraft system that could be deployed near disputed gas discovery fields, which is keeping local countries, the EU, and the US on alert.


Wealth Distribution Analysis (Ritholz, 4 min read) In this piece, Barry Ritholz of Ritholtz Wealth Management LLC. debunks US hyperbolic campaign slogans. Whether an incumbent like Treasury Secretary Steven Mnuchin or a challenger like Representative Alexandria Ocasio-Cortez, when it comes to economic performance on income, tax, and inequality, you can fit the numbers to your viewpoint. America is certainly at its wealthiest ever – net assets are at an all-time high at just over $100tn with very manageable debt levels. All is well if you happen to be in the top 10% that hold $75tn of all assets (c.70% of wealth), but as this article explores, the other side of the coin is not so shiny. The bottom 50% hold a mere $6tn of assets, reflecting a wealth of only $100k per household (c.1.3% of wealth). To add insult to injury, the bottom deciles bear most of the total liabilities, too.

Why does this matter? Raegan’s legacy of supply side economics – driven by taxing the rich less and hoping for the growth boost to trickle down to everyone – didn’t work so well. Both wealth and income inequality have increased to extreme levels, which will be an important topic of debate during the incoming presidential election cycle. This could mean the possibility of wealth taxes or anti-trust actions.


Worried Index-Based Strategies are Distorting the Bond Market? The Data Says You Shouldn’t Be (Advisor Perspectives, 4 min read) Funds flowing into ETFs and passive index trackers have grown significantly in the past decade, but not nearly as much as is commonly claimed. Using two different market value methods, Matthew Bartolini from State Street estimates that index-based assets equate to around 3% of the overall global fixed income market. If we take this one step further and strip out mutual funds, we reach as low as 1%. If we look to trading volumes, Bartolini also shows that the high yield ETF primary market, for example, is a miniscule 2.9% of all cash trading volume.

Why does this matter? Ambiguous data might be clouding the perception of ETF’s and overstating their importance in influencing the fixed income market. Data shows there is no passive bond bubble and investors should be confident in using ETFs. Trading volumes and the ETF wrapper do not influence bond prices – it is the issuing company’s fundamentals and the prevailing market risk that do.


US Corporate Cash Is Down: Should Investors Worry? (Advisor Perspectives, 3 min read) When tracking equity quality, which is used as one of the predictors of an incoming sell-off, cash holdings is a key component. This analysis uses three indicators that overall offer comfort when it comes to the current state of US corporate balance sheets. We observe elevated levels of net debt, but those are driven by a decline in cash balances, deployed as share buybacks to extract benefit from the 2017 tax reforms. In line with that, we see that CAPEX has been on a secular decline as a percentage of corporate cash since the mid-80s – cash has been largely returned to shareholders. Furthermore, the cycle isn’t over yet and the Fed is expected to withhold its dovish stance.

Why does this matter? Depleting cash balances of US corporates have raised some eyebrows among investors, but analysis shows that behaviour has been rather conservative and shareholder friendly. Investors shouldn’t be too worried for now. But it’s worth keeping an eye on balance sheets nevertheless – low cash does reduce the cushion if a blow is to happen.


The Lesson of Bretton Woods (Bloomberg Opinion, 3 min read) In light of the 75th anniversary of the Bretton Woods agreement, Tylor Cowen, a Professor of Economics at George Mason University, looks at how this unlikely agreement was first struck and subsequently survived against all expectations into the 70s, exploring the serendipitous side of policy agreements.  Ranging from the unprecedented gold standard that marked the Western world between 1815-1914 to today’s fiat currencies, this piece is a good reminder never to feel too comfortable when it comes to monetary arrangements. It’s a fine line between the unimaginable and the eventual.

Why does this matter? We are all assuming that the current international monetary arrangement of broadly free-floating currencies and no capital controls will remain in place, but that could change. Already we are seeing restrictions on Chinese FDI in the US, the EU is testing ways to circumvent the dollar to allow continued trading with Iran. And of course China is inserting itself into the international financial system.

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China’s Tech Sector Is in Trouble (The Diplomat, 6 min read) Recent US policies have done more to China than threaten the bottom line of Huawei and its peers – they have trickled down to the country’s workforce. This has especially plagued the so called ‘new economy’, given the tech crackdown on data privacy and intellectual property. Tech firms are aggressively cutting costs by laying off employees and squeezing more out of the remaining ones, deploying a 9am to 9pm, 6 day work week. The tech sector is already failing to absorb the 33 million unemployed, displaced wage labourers, causing a worker backlash. Going forward, China has another source of unrest to worry about. The Government is now making job creation its main policy goal, offering subsidies and tax breaks to tech firms.

Why does this matter? Beijing is now focusing on safeguarding the tech sector from shocks, since it’s a key driver of growth and a major source of employment. This would mean extending government control over the sector and decreasing its import dependence on the West.


China Caught in Crossfire of Tokyo-Seoul Chipmaking Feud (Asian Review, 3 min read) South Korea is on Japan’s white list of trading partners. But not for long. It plans to impose export restrictions as soon as August, which would have major cross-country impact on semi-conductor trade in East Asia. The two major chipmakers, Samsung and SK Hynix, are based in South Korea and are responsible for up to 70% of worldwide production. And they predominantly manufacture in China, using materials imported from Japan. Tougher restrictions on the supplying of raw material to continue this production would not only make China an unattractive host, it would hurt South Korea’s GDP. To counteract, President Xi Jinping is aiming to make 40% of the chips needed at home by 2025.

Why does this matter? With US tech restrictions on China and now a spat between Korea and Japan, the chip sector is up in the air. However, keep an eye on the discussion at the World Trade Organisation next month – Japan is aware that export controls look bad and might defuse the threat. This doesn’t appear to be fully priced by the tech hardware sector.


China’s Investment in Africa: What the Data Really Says, and the Implications for Europe (Bruegel, 4 min read) Alicia Garcia-Herrero, Senior Fellow at Bruegel and Jianwei Xu, a Senior Economist at Natixis provide an excellent analysis into how bilateral trade has played a pivotal role in building strong ties between China and Africa. With the fasted growing population in the world but also the lowest rates of flows from abroad, Africa is in desperate need of FDI. The failure of China’s double-digit growth ambitions (as analysed in Prospect Magazine’s piece above) and its lack of natural resources have fuelled large amounts of trade with Africa’s commodity exporters. However, the nature of the investment itself is highly focused on lending in sectors like energy and infra, thus absorbing China’s excess capacity of workers and not generating employment for the surging number of Africans. If sustainability is the goal, this must change.

Why does this matter?  European countries with a colonial past in Africa still hold the top ranks in FDI levels, but China has been catching up. A slowdown of China’s economy, however, would likely lead to a fall in demand for African commodities, given their export dependency. Africa needs to relocate their exporting focus to other regions globally as well as expand trade within the continent. Investors should be monitoring commodity prices, especially metals.


China’s Economic Growth has Halved—and It is Set to Halve Again (Prospect Magazine, 3 min read) Are China’s recent US trade war woes the sole culprit for its slowing GDP growth? In this commentary, George Magnus, a former chief economist at UBS, argues that there are underlying, homemade structural issues at play that appear destructive: the economy is predicted to halve again in five years. Why? Both components of long term growth – productivity and labour force population – are declining, leading trend GDP to slow to 3%. Magnus links this to bureaucracy and the ubiquitous party control, causing restrains to the freedom of the private sector and inefficient markets. Further, after the 2015 Renminbi crisis, the government got serious about deleveraging and limited the credit capacity of large and small borrowers alike. With high debt levels having fuelled growth for a long time, it’s a sobering experience to see growth now sliding off.  ‘No surprise employment’ has been every policy meeting’s top priority – as the above piece draws attention to. Now, if we combine the US trade and tech war with China’s issues at home, the worry is understandable.

Why does this matter? While most expect Chinese growth will fall even if a trade deal is achieved, Magnus is more bearish.  He therefore expects even more dovish actions by Chinese policymakers than the current fine-tuning policies of lower Reserve Ratio Requirements and tax cuts.


China White Paper on National Defense: Separatists Are Top Threat (SupChina, 3 min read) China just released white paper on its global defence policy – a rare event, the first in four years. The paper’s stance is hostile towards US, claiming they undermine global peace, security and incentivize nuclear and missile defence efforts. The text claims that separatist forces in Taiwan and Tibet, pushing for independence are currently the biggest threats to peace and military force could be deployed. There is a worry about advancing military technology deployed by other forces. China’s defence spending as of 2017 was near a record low as a percentage of government spending – c. 5.1%. The paper highlights incoming efforts strengthening and mechanizing the People’s Liberation Army.

Why does this matter? We doubt it’s a consequence that China released the defence paper amid rows in the Western pacific and the raising pressure in the South China Sea. China’s growing closeness to Russia is also becoming an item – this week a joint Sino-Russian patrol flew bombers over airspace claimed by Japan and South Korea, causing a stir.


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