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By Bilal Hafeez 30-06-2020
In: post | Newsletter

Top Picks: Peak Dollar / How To Play The US Election / EM Debt Cleanup

(8 min read)
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Peak USD calls are mounting. Evaporating rate differentials, better growth prospects elsewhere and the huge funding need going forward all argue for an end to the decade-long trend of USD strength. But for JPM Asset Management risk aversion still favours the dollar short-term. Stephen Roach sees the end to USD strength as more about whether the US finally loses its exorbitant privilege. We also feature BlackRock’s bullish view on European peripheral bonds.

On politics, Nouriel Roubini gives his take on why plutocracy has been a factor behind the recent civil unrest in the US while Paul Krugman discusses the COVID spikes in red states. We also feature Amundi on how to play the US election.



Hive Indicators

Global COVID-19 Tracker – Latest Restrictions In US And UK / EU Decides On Travel In the DM world, US recorded a 1.6% increase in cases with 39,591 new cases. It marks the seventh consecutive day of more than 34k new cases. In the last seven days, the US states with the largest increases were Mississippi, Florida, Louisiana, Arizona, and Nevada.

(Bilal HafeezStefan Posea | 30th June, 2020)

Coronavirus Update

Bearish USD calls and BlackRock are bullish on European government bonds

What is the outlook for the US dollar? (JP Morgan AM, 5 min read) A federal funds rate remaining at zero for the next two years, alongside better growth and equity market performance overseas will make US financial assets less attractive and put pressure on USD in the long term. However, short term factors such as COVID uncertainty and US-China tensions favour the USD. [Bearish USD (Long Run)]

The COVID Shock to the Dollar (Project Syndicate, 7 min read) The USD could plunge by 35% in next 2-3 years predicts Morgan Stanley’s former chief economist , Stephen Roach, driven by negative domestic savings and the COVID policy response. Protectionism, deglobalisation and decoupling will add to the dollar’s decline.

Why We Are Warming up to Europe (BlockRock, 5 min read) They remain overweight on European peripheral government bonds given significant policy support in Europe and expectations for a stronger H2 recovery than in the US. European equities may also be upgraded. [Bullish European Peripheral Government Bonds]

US 2020: the COVID election – part i (State Street, 5 min read) ‘From a market perspective, the worst outcome would be a narrow loss for President Trump that he refuses to accept, plunging the US into a constitutional crisis far worse than the 2000 Florida recount’. Under this scenario, expect moves to safe havens such as the yen, Swiss franc and gold. But capital outflows could also be driven by home bias; triggering the end of the strong dollar cycle. [Bearish USD]

The importance of independent CBs in the COVID world and why William Blair doesn’t see higher inflation

Necessary, suitable and proportionate (ECB blog, 5 min read) ECB Executive Board member Isabel Schnabel argues that without measures such as PEPP Euro area growth would have been around 1.3pp lower over the next two years and the inflation mandate out of reach. Compared with a policy rate of -1.7% needed to achieve the same impact as asset purchases the benefits of PEPP outweigh the costs. And temporary deviations from the capital key are justified to ensure smooth transmission of monetary policy.

Money and debt: Paying for the crisis (VoxEU, 11 min read) Monetisation of government debt by central banks can transform current credit and funding risks into future inflation risk. Central bank independence is crucial for inflation expectations to remain anchored in such an environment.

Where Is the Inflation? (William Blair, 5 min read) Advanced economies will continue to see low inflation as ‘an expanding central bank balance sheet is not a recipe for inflation. In part, this is because capital requirements force banks to hold larger deposits with the central banks. More importantly, while central banks can encourage banks to extend more credit, ultimately the banks are the ones calling the shots’. [Bearish Inflation]

Roubini on the US protests and why the US had less fiscal success than France

The Main Street Manifesto (Project Syndicate, 6 min read) Current protests in the US are not only a response to systemic racism and police brutality but also represents an uprising against plutocracy, according to Nouriel Roubini. Trump came to power as people thought he would help reduce wealth inequality. But he failed his promise and ‘governed like a plutocrat’. [Bearish Trump]

The US has outspent France on job retention and other support for SMEs but had less success (PIIE, 2 min read) US PPP allowed 33 cents on nonpayroll expenses for every $1 spent on payroll giving a free lunch for firms that had no intention of laying off workers to take up the scheme. Additionally, ‘size exemptions’ and strong banking relations played its part to crowd out firms that were in most need of these funds.

How Inequality Fuels COVID-19 Deaths (Project Syndicate, 8 min read) Countries with high levels of inequality, including Mexico, Brazil and US account for half of global deaths due to COVID. Jeffrey Sachs believes this is primarily because inequality amplifies political polarisation and limits public trust making an effective response to the crisis more difficult.

IMF Latam growth outlook and how the markets ignore the shape of the recovery

Outlook for Latin America and the Caribbean: An Intensifying Pandemic (IMF Blog, 6 min read) The region has become the new global epicentre of COVID-19. The Fund now expects the region to shrink by 9.4% in 2020, which is four percentage points worse than their April projection. A mild recovery+3.7% is forecasted in 2021. [Bearish Latam Growth]

Is determining the shape of the global economic recovery much ado about nothing? (Invesco, 3 min read) The shape of recovery will be varied across different sectors of the economy leaving the debate over U, V, W of limited relevance for markets. As slow recoveries and accommodative policies are better for financial markets Invesco sees another long market cycle ahead for the US.

Financial Conditions Have Eased, but Insolvencies Loom Large (IMF Blog, 5 min read) ‘The recession could be deeper and longer than currently anticipated by investors. There could be a second wave of infections, with ensuing containment measures. Geopolitical tensions or broadening social unrest in response to rising global inequality could lead to a reversal in investor sentiment. Finally, expectations about the extent of central banks’ support could turn out to be too optimistic’.

Amundi on how to play the US election and how the pandemic creates difficulties for the IMF

America Didn’t Give Up on Covid-19. Republicans Did. (NYT, 6 min read) Rising COVID cases in Republican-controlled states, such as Arizona, Florida and Texas, reflect Republicans brushing aside public health advice and rushing to reopen the economy according to Paul Krugman. Blue states, on the other hand, have low cases as democrats are promoting social distancing, and wearing a face mask. [Bullish Democrats]

Biden’s election momentum and financial markets (Amundi, 12 min read) The market is not pricing in the risk of Biden as president or ‘Democratic sweep of Congress’. With the uncertainty of the election outcome, Amundi prefer US Agency mortgage bonds and TIPS to neutralise any interest rate risk associated if new administration came in power. They project Biden’s tax reform would reduce S&P 500 earnings estimate for 2021 from an average of $170 to $150 per share.

IMF’s epic virus challenge (OMFIF, 4 min read) The IMF risks a situation where it cannot lend freely due to budgetary constraints. Financing gaps would require difficult judgement and conflicts of interest with the private sector on debt relief could arise.

Alt data helps catch market signals early and scars of COVID on growth.

How alternative data can lend clarity amid uncertainty (BlackRock, 5 min read) Foot traffic indicated a Chinese rebound in May. Similarly, natural language processing provided timely signals on the direction of fiscal policy globally by measuring sentiment from thousands of analyst reports. [Bullish Alternative Data]

Scarring body and mind: the long-term belief-scarring effects of covid-19 (NBER, 31-page read) Long term changes in behaviour and ‘perceived probability of an extreme, negative shock’ in the future is shown to have substantial and persistent long-run cost for the US economy. According to the model, one-year loss during the pandemic is 6-9% of GDP. However, the damage from belief scarring mechanism is up to six times as large. [Bearish US Growth]

The Great Debt Cleanup (Project Syndicate, 7 min read) EM debt restructuring and cancellation should be allowed in some instances as international markets appropriately discipline EM economies through the threat of capital flight. A new international body is needed to decide in which situations debt forgiveness is appropriate for EM to prevent escalation of crises.

LGIM on why China debt risk is low and novels ways China exerts political pressure

What has the crisis meant for debt levels in China? (LGIM, 4 min read) Legal & General’s China credit scorecard that tracks 14 indicators across four sectors (macro, property, corporates, and banks) shows only five areas of medium stress (economy-wide leverage, growth, profits, SME confidence, and NPLs). The absence of significant stress makes them confident that China does not face a typical EM style credit risk. [Bullish China]

China has a new way to exert political pressure: weaponising its courts against foreigners (The Conversation, 5 min read) Communist party intervenes in a legal matter if it deems the context to be politically sensitive. The sudden death penalty of Gilespie (Australian who was convicted for drug smuggling) was used as a part of Chinese political arsenal to signal a warning to Australia for their recent anti-china rhetoric.

Macro implication of ESG practises and Charles Schwab on SRI performance

The Effect of Firm-level ESG Practices on Macroeconomic Performance (Oxford Sustainable Programme, 19-page read) Firm-level ESG practices are positively associated with GDP per capita in both developed countries and emerging economies. One-point increment (out of 100) in the average E, S, and G performance leads to 0.06%, 0.10% and 0.19% increase in the log of GDP per capita, on the global scale. [Bullish ESG]

How Well Has Socially Responsible Investing Performed? (Charles Schwab, 8 min read) SRI funds return performance ranks around 50th percentile relative to the peer group. SRI also have similar volatility relative to equity peers. However, during significant market drops (2008 and 2020) It held value better than peers. [Neutral ESG]

(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.)