Europe’s increasing growth prospects, particularly relative to the US’s, aided by last week’s agreement on a €750bn European recovery fund, is one factor behind ongoing calls for USD weakness. We feature the latest from economist Stephen Roach on the US-Europe economic divergence and the dollar decline, and JPMorgan on why European assets should benefit.
On China, the chief economic advisor at Allianz, Mohamed El-Erian, gives his take on why escalating US-China tensions leave Australia and Singapore in a difficult position. We also feature blogs on the country’s fiscal dilemma and need for institutional reform.
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Europe’s increasing growth prospects, particularly relative to the US’s, aided by last week’s agreement on a €750bn European recovery fund, is one factor behind ongoing calls for USD weakness. We feature the latest from economist Stephen Roach on the US-Europe economic divergence and the dollar decline, and JPMorgan on why European assets should benefit.
On China, the chief economic advisor at Allianz, Mohamed El-Erian, gives his take on why escalating US-China tensions leave Australia and Singapore in a difficult position. We also feature blogs on the country’s fiscal dilemma and need for institutional reform.
Enjoy!
Bilal
Global COVID-19 Tracker – Belgian Restrictions, China Largest Spark Since March Belgium is experiencing an upturn in cases. The country’s weekly change in 3d moving average is 212%, the highest among countries with over 10,000 daily cases. From Wednesday, new stricter rules will apply, as the prime minister looks to avoid total lockdown.
(Bilal Hafeez, Sam van de Schootbrugge | 28th July, 2020)
Stephen Roach on the USD decline, and bullish calls on gold
Gold Is Within Striking Distance of Its All-Time High. Here’s How to Play the Rally (Advisor Perspectives, 6 min read) Frank Holmes of US Global Investors expresses a bullish view on gold and likes streaming companies and metal royalty (including Franco-Nevada and Royal Gold). Judy Shelton’s appointment to the Fed is another factor in his constructive view on gold. [Bullish Gold]
From American to European Exceptionalism (Project Syndicate, 7 min read) Morgan Stanley’s former chairman for Asia, Stephen Roach, highlights the US’s projected 2.6% of GDP C/A deficit this year versus the EU’s 2.7% surplus. Given reduced domestic savings in the US and a very expansionary fiscal stance, this divergence in external balances is set to widen, causing further USD weakness. [Bearish USD]
2Q20 Earnings: Guide Me to Your Profits (JP Morgan Asset Management, 10 min read) Given the ‘potential for further US dollar weakness going forward, we are inclined to take on a bit more value exposure in portfolios [US equities]. A global reflation trade would support some of the sectors that have been hit the hardest over the past few months, and valuations are attractive; the industrial and financial sectors look particularly interesting’. [Bullish Value]
The New Silk Road Routes: Why Investors Should Care (Amundi, 12 min read) Countries involved in the Belt and Road Initiative (BRI) represent more than 70% of the global population, 55% of global GDP and 75% of energy reserves. Nigeria, Kenya, Egypt and the Philippines could benefit, as could energy, transport, real estate and metals.
Nathan Tankus on large CB balance sheets, and how YCC can increase market volatility
The Way People Talk About the Federal Reserve’s ‘Big’ Balance Sheet is All Wrong (Notes on Crisis, 7 min read) A large central bank balance sheet does not distort the functioning of the financial market, argues the director of research at the Modern Money Network, Nathan Tankus. One argument is that a significant part of the balance sheet comprises government securities.
Fed to Keep Rate Vol Based Leading to Higher Vols in Other Assets (Variant Perception, 2 min read) Earlier ‘yield capping’ by the Fed to reduce fixed income volatility led to other asset classes having higher vol. FX volatility surged due to excess liquidity, and equity volatility rose when yield curves were flatter.
Raising the Inflation Target: How Much Extra Room Does It Really Give? (Cleveland Fed, 29 page read) When prices adjust more frequently, the potency of monetary policy declines. This paper finds that raising the inflation target from 2% to 4% gives monetary authorities only 0.51-1.6pp extra room for monetary policy. Getting the full 2pp intended extra room requires raising the target to more than 4%.
Inflation Volatility in Small and Large Advanced Open Economies (ECB, 23 page read) Over the last two decades, when controlling for monetary policy activity, inflation volatility has been similar among countries. Indeed, contrary to expectations, point-targeting central banks are only weakly associated with higher inflation swings. These results imply that small and large advanced open economy countries are exposed to global fluctuations to a comparable extent.
JP bullish on Europe, and country-level analysis of government actions and their COVID outcome
Is the EU Recovery Fund a Game-Changer for Investing in Europe? (JPM Asset Management, 2 min read) ‘Countries across Europe now have an equal shot at a strong recovery out of the COVID-19 crisis, instead of high-debt countries being weighed down by their fiscal constraints…this lower break-up risk means that European assets need to embed less of a risk premium, allowing for higher equity valuations, lower bond spreads and a stronger currency.’ [Bullish Europe]
A Country Level Analysis Measuring the Impact of Government Actions, Country Preparedness and Socioeconomic Factors on COVID-19 Mortality and Related Health Outcomes (Lancet, 7 page read) Low levels of national preparedness, scale of testing and population characteristics are associated with increased national case load and overall mortality. Countries with higher obesity, age and slower lockdowns exhibit higher caseloads. Countries with higher GDP, income dispersion and obesity suffered with higher mortality.
PPP programme and US employment, and why teleworking jobs are less vulnerable during recessions
Unemployment in Today’s Recession Compared to the Global Financial Crisis (IMF Blog, 2 min read) Unemployment in teleworkable jobs remained lower both during the 2008 recession and the 2020 pandemic crisis, which indicates factors unrelated to social distancing might be at play. People in teleworkable occupations are less vulnerable to downturns as they are highly skilled and more educated.
An Evaluation of the Paycheck Protection Program Using Administrative Payroll Microdata (MIT, 25 page read) Using administrative data from the world’s largest payroll processing firm, the Paycheck Protection Program is estimated to have boosted employment at eligible small firms by 2-4.5%. This would suggest that the PPP has increased aggregate US employment by 1.4-3.2mn jobs through the first week of June 2020.
How black voters can boost Biden’s chances of winning the presidency, and El-Erian on US-China tensions
Is a China-US ‘Rivalry Partnership’ Possible? (Project Syndicate, 6 min read) The chief economic adviser at Allianz, Mohamed El-Erian, believes Sino-American escalation could have adverse implication for ‘dual option’ countries like Singapore and Australia (who have strong security links with the US but strong economic ties with China). This aspect of foreign policy is where the government will find themselves unprepared. [Bearish Australia and Singapore]
Why Black Lives Matter Could Put Biden in the White House (Schroders, 5 min read) Black voters are a primary demographic for the election, making up 13% of the US electorate. For example, a 7% increase in black voter turnout across all states would make a change in the outcome of the election. ‘Trump won by such a narrow margin in key swing states that a 7% rise in turnout in each state would flip Pennsylvania and Michigan to Democrat – 36 electoral college votes – costing Trump his majority.’ [Bearish Trump]
Changing characteristics of haven assets, and FX/capital flow co-movement during global stress
The Influence of the COVID-19 Pandemic on Safe-Haven Assets (Vox EU, 7 min read) ‘The findings suggest that the character of safe-haven assets has changed since the 2008 crisis. Gold, the traditional safe-haven asset, has lost its glitter. However, the Swiss franc, the US dollar and US Treasuries retained their safe-haven status, and Tether, a cryptocurrency, shows some promise.’ [Bearish Gold]
The Global Effects of Global Risk and Uncertainty (BOE recently publish in JIMF, 25 page read) The effects of shocks to global financial uncertainty on real economic activity are shown to be stronger in countries with a higher degree of trade and/or financial openness. Using realised volatilities on 1,000 risky assets, the output responses are also heterogeneous across countries but, in general, negative and persistent
Global Market Inefficiencies (JFE, 38 page read) Estimating monthly fair values of 25,000 stocks from 36 countries, trading strategies based on deviations from fair value are shown to earn significant alpha in most regions. Global equity markets are inefficient because a country’s pre-transaction-cost alpha is positively related to its trading costs but exceeds country-specific institutional trading costs.
Emerging Market Currency Risk Around ‘Global Disasters’: Evidence from the Global Financial Crisis and the COVID-19 crisis (CEPR, 10 page read) Studying excess returns from holding a portfolio long in emerging market currency and short in US dollars, the co-movement between exchange rates and capital outflows is shown to be strong during times of global distress. This matters for macroeconomic policy in EM’s.
Yu Yongding on China’s policy dilemmas, and Michael Pettis on the importance of institutional reform
China’s Fiscal Dilemma (Project Syndicate, 6 min read) Yu Yongding, former monetary policy committee member of PBoC, highlights the dilemma the Chinese government faces in H2 2020. If it adopts an expansionary fiscal policy, public finance will worsen rapidly. But if the government reduces public expenditure it risks the economy growing less than 2.5%. His stance? Adopt targeting infrastructure investment (financed by government bonds).
China’s Economy Needs Institutional Reform Rather than Additional Capital Deepening (CEFIP, 14 min read) For China, the fastest way to develop in the 1980s and 1990s was to have rapid investment growth. But now it has reached its ‘Hirschman level’ (capital investments have become concentrated). Economist Michael Pettis believes the only way to grow rapidly now is to have necessary institutional reforms that allow Chinese workers and businesses to ‘absorb the higher levels of investment growth.’
Why some ESG companies outperform
ESG Investing Stands Out During COVID-19 Volatility (Invesco, 4 min read) Invesco compared S&P 500 performance with top-ranked ESG companies within its constituent for 12 months ending 30 June 2020. Top-ranked ESG companies (Quintile 1) outperformed (20.05% vs 7.51% S&P 500). Outperformance was attributable to the quality of management, which is the most overlooked nonfinancial component of fundamental analysis. [Bullish ESG]
Mutual Fund Performance and Flows During the COVID-19 Crisis (NBER, 18 page read) Counter to popular beliefs, the most active funds underperformed passive benchmarks during the COVID-19 crisis. Funds with high sustainability ratings perform well, as do funds with high star ratings.
(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.)