It’s increasingly debated whether the post-COVID economy will shift to a higher inflation path. We feature Man Group on the early signals of such a shift and their rationale for how this will play out. On monetary policy we also feature PIMCO on what could trigger YCC from the Fed, BlackRock on how to exit negative rates, and OMFIF on why bonds are losing their investment appeal. Paul Krugman also gives his take on the Fed’s role in the stock market rally.
On fiscal policy and inequality we feature Angus Deaton and Anne Case on how post-COVID America will see widening inequalities and despair, and we have a take on Narendra Modi’s fiscal mistakes.
We are delighted to have Lord Mervyn King as our podcast guest this week. If you have any questions you would like me to put to him, please do email them to me.
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It’s increasingly debated whether the post-COVID economy will shift to a higher inflation path. We feature Man Group on the early signals of such a shift and their rationale for how this will play out. On monetary policy, we also feature PIMCO on what could trigger YCC from the Fed, BlackRock on how to exit negative rates, and OMFIF on why bonds are losing their investment appeal. Paul Krugman also gives his take on the Fed’s role in the stock market rally.
On fiscal policy and inequality, we feature Angus Deaton and Anne Case on how post-COVID America will see widening inequalities and despair, and we have a take on Narendra Modi’s fiscal mistakes.
We are delighted to have Lord Mervyn King as our podcast guest this week. If you have any questions you would like me to put to him, please do email them to me.
Enjoy!
Bilal
Invesco on municipal bonds, and why Krugman believes US equities are in a bubble
US Municipals: A Tale of Two Markets and a Knight in Shining Armour (Invesco, 6 min read) Invesco sees the rising spread between yields on investment-grade municipal bonds and US high yield as an opportunity for investors. Potential defaults in the municipal market are unlikely given the Fed’s Municipal Liquidity Facility (MLF). [Bullish High Yield Municipal Bonds]
Market Madness in the Pandemic (NY Times, 4 min read) Paul Krugman believes the recent rally in Hertz and US stocks indices was partially encouraged by the Fed, but this optimism has now turned into FOMO (fear of missing out). This reminds him of the ‘dot dot-com bubble of the 1990s, except on a vastly accelerated timetable.’ [Bearish US Equities]
Bonds No Longer the Go-To for Investors (OMFIF, 4 min read) ‘In addition to no coupon returns, longer maturity, low-coupon bonds are sensitive to changes in yields. Rising government deficits have contributed to increased longer maturity issuance. Both effects have contributed to a substantial rise in the interest rate sensitivity of major bond indices. The sensitivity of US Treasury indices was below 6.5 until 2010 and has now reached 8.7, a 33% increase in risk.’ [Bearish Fixed Income]
How to Identify Market Bottoms (Variant Perception, 5 min read) One leading indicator is the VIX index. ‘Over the past 25 years, you can see that whenever the VIX has been above 30 for more than three months, this has always led to large rallies. It pays to buy panic and fear. In 2002 and 2009, this marked the bottom of the bear market. In 1998 and 2011, it marked an intermediate bottom along the way of a bull market.’ [Bullish US Equities]
Preparing for private-equity exits in the COVID-19 era (Mckinsey, 8 min read) PE exits have fallen 70% YoY globally in May. Firms are now using tactics such as investing in growth areas (i.e. PPE equipment), improving business models (i.e. diversifying revenues to reduce cyclicality) and revamping value creation (i.e. using tech to cut costs) to take advantage of this waiting phase.
PIMCO on the Fed, and Man Group on a resurgence in inflation
Fed Shifting Focus from Crisis Management to Easy Financial Conditions (PIMCO, 6 min read) PIMCO expects the Fed will continue the current pace of asset purchases till the end of 2020. Yield curve targeting is also a possibility if the market starts to price in a hike following a Q3 rebound in growth. [Bullish Rates]
Revisiting the Monetary Policy Endgame (BlackRock, 5 min read) Permanence of negative interest rates potentially results in the same problems they were designed to prevent (low inflation, low growth). The only viable solution for global policymakers is to focus on creating an environment for ‘profound investment’ in technology (i.e. 5G) to facilitate long-term sustainable growth. [Bullish Tech]
Inflation Regime Roadmap (Man Group, 35 min read) They predict higher average inflation (4%) in DM and, as a result, expect negative real rates over the next decade. One indicator to monitor is the stock-bond correlation, which rises sharply during an inflationary regime and could provide an early signal. [Bullish Inflation]
Inflation with COVID Consumption Baskets (NBER,10 min read) ‘The COVID inflation rate is higher than the official CPI in the US, for both headline and core indices’, and a similar pattern is observed in 10 out of the 16 other countries. Social distancing has also introduced bias in the weights of CPI measurement as consumers are spending more on food relative to transportation. [Bullish Inflation]
How Modi’s fiscal policy is hurting India, and Angus Deaton on inequality
Modi’s Fiscal Follies (Project Syndicate, 6 min read) ‘If households decide to save more and consume less during an economic slump, then the correct policy response is to increase government spending. Unfortunately, Indian Prime Minister Narendra Modi’s government is doing the opposite during the current pandemic-induced downturn.’ [Bearish India]
United States of Despair (Project Syndicate, 8 min read) Angus Deaton and Anne Case believe ‘those entering the labour market in 2020 will have a lower earnings path throughout their working lives, possibly creating the despair that brings death from suicide, alcohol, or drug overdoses. In other words, the most likely post-COVID America will be the same as pre-COVID America, only with even more inequality and dysfunction.’ [Bearish US]
What is Next in the Policy Revolution? (Advisor Perspective, 5 min read) Combined fiscal and monetary stimulus in developed markets has cushioned the economy more than the estimated fall in the GDP. This now raises a risk of ‘policy fatigue’ leading to an early exit or a cutback, especially in the US, which saw the labour market improve significantly in May.
Schroders expects a U-shaped recovery, and BlackRock is confident about US consumers
Why We Think the Recovery Will Be U-shaped (Schroders, 6 min read) The difficulty in lifting lockdowns (danger of a second wave of infection), cautious consumption (especially in travel, hospitality and leisure sectors), a rollback in government support and falling capex (mainly to prioritize debt reduction) will all weigh on global growth. Pre-COVID levels of activity will only be seen by end 2021. [Bearish Global Growth]
Robotic Labour: The Automation Channel of Pandemic-Induced Uncertainty (VoxEu, 8 min read) Sylvain Leduc finds that COVID-19 uncertainty could stimulate more investment in automation despite lower aggregate demand. The net effect of automation can in fact boost employment. [Bullish Smart Manufacturing]
The US Consumer Is Bowed, Not Broken (BlackRock, 4 min read) First, transfer payments in April cushioned personal income. Second, the consumer came into the pandemic in better shape than the previous financial crisis: high wealth levels, low debt, and debt servicing cost at multi-decade lows. Finally, housing, the largest asset for most families, is also holding value well. All of this will support consumption and, consequently, growth. [Bullish US Consumption]
How the killing of Georg Floyd will change American politics, and East Asia decouples from the US
The Killing of George Floyd and the Final Fracturing of the Democratic Party, Labor, and Civil Rights Coalition (CounterPunch, 6 min read) The death of George Floyd could disunite the Democratic party further and, in turn, impact the election outcome with Trump likely to exploit such a split. [Bearish Democrats]
East Asia Decouples from the United States: Trade War, COVID-19, and East Asia’s New Trade Blocs (PIIE, 28 pages) Trade agreements like the Progressive Agreement for Trans-Pacific Partnership (CPTPP) and the Regional Comprehensive Economic Partnership (RCEP) ‘will raise global, national incomes in 2030 by an annual $147 billion and $186 billion, respectively. They will yield especially large benefits for China, Japan, and South Korea and losses for the United States and India.’ [Bullish East Asia]
How can currency become international, and how monetary policy impacts stock valuations
Jumpstarting an International Currency (BOE, 35-page read) Central bank policies that reduce the cost of credit for working capital in a foreign currency can jumpstart the process towards international currency status. BoE researchers found that when RMB swap lines were established it led to an increased use of RMB internationally.
The Asymmetric Effects of Monetary Policy on Stock Price Bubbles (OFCE 21-page read) Tight monetary policy has a more powerful effect on stock valuation relative to expansionary policy. This asymmetry becomes even stronger during economic expansion relative to slowdowns.
Duration-Based Stock Valuation (NBER, 28-page read) When a counterfactual fixed income portfolio is constructed to match the duration profile of the aggregate stock market (their dividends), ‘it has performed as well, if not better, than the US stock market in the past five decades, while exhibiting similar levels of volatility’. [Bullish FI Portfolios]
Chinese travel recovery, and different dimensions of the ‘New Cold War’
China’s Travel Recovery Gains Steam: How Families Are Planning Their Summer Vacations (Mckinsey, 8 min read) Hotel occupancy has recovered to 60% and domestic airline passengers to 50%. According to a Mckinsey survey, domestic travel in China will accelerate during summer mainly driven by family travel.
The Shape of Asia’s New Cold War (Project Syndicate, 7 min read) ‘If China pushes its model as aggressively as the Soviet Union once did, the new cold war will have all the ingredients – and all the myriad tensions – of the original Cold War. The more assertive China is in selling its own model, the more likely democratic countries will be to unite against it in the name of their own ideological system.’
Why China is lagging in ESG, and how Vanguard is trailing behind rivals like BlackRock
Why China is Missing Out on Trillions in Sustainable Investment (Pension&Investments, 6 min read) The Chinese stock market is dominated by retail investors who seek fast returns and do not view ‘profit and social value together’, and companies can raise funds without publishing information about sustainability. As these companies do not report about ESG, they do not qualify for global ESG funds.
Institutional Investing in the Time of COVID-19 (Mckinsey, 9 min read) According to their survey, one emerging lesson from the crisis is that institutions are committing more to ESG factors. 70% stated they would fully integrate ESG consideration across all their investment processes.
Can ESG Benefit from a Quantitative Approach? (ETF Trends, 2 min read) ESG can utilise quantitative filters and incorporate big data to generate alpha for investors. One such data strategy is that of Goldman’s Motif Data Driven World ETF (GDAT).
Vanguard Trails Rivals After ‘Dragging Its Feet’ on ESG (Portfolio Adviser, 6 min read) ‘Vanguard’s voting record with respect to ESG shareholder resolutions is poor, and little disclosure of its engagement activities does not help to paint a better picture of its stewardship programme’. Additionally, rivals such as BlackRock and UBS are gaining more traction within passive ESG space.
(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.)