Money Trends / Liquidity
In this <i>Special Report</i>, we revisit our list of signpost economic indicators introduced two years ago to identify if the U.S. and Euro Area were falling into a "Secular Stagnation".
Weak employment will push out the timing of rate hikes to something closer to BCA's view of a September increase. It is also supportive of our asset allocation call two weeks ago to overweight Treasuries.
The Turkish central bank has almost exhausted its foreign exchange reserve. It has been printing money to keep interest rates lower, and sustain the credit boom in the economy. Such policies are unsustainable and the currency will plunge anew. Currency depreciation will push up market-based interest rates. Stay short/underweight Turkish risk assets. A new trade: Short 2-year local currency government bonds.
Long-term fundamentals are often poor predictors of the outlook for currencies over the subsequent 12 months. For shorter time horizons, investors should focus on the medium- and short-term currency determinates introduced in this <i>Special Report</i>.
China has fallen into the same "fiscal trap" that ensnarled Japan in the 1990s. Unprofitable investment projects undertaken by SOEs are a necessary evil. The underlying problem is not overinvestment, but an economy that is demand-deprived. Meanwhile, structural factors will ensure that savings remain high. Any efforts by the authorities to curb credit growth will result in a sharp economic downturn. China will continue to generate excess capacity and export deflation to the rest of the world, which is good for bonds. We recommend going long Chinese banks, the most hated equity sector.
The reflation rally continues. Despite our bearish outlook for the year, we think the risks of the current rally lie to the upside given China's redoubling of stimulus at the expense of reform. Populist troubles are picking up in Europe, but we maintain our positive structural view and note that the migration crisis is slackening. Rather, the greatest risks of populism continue to flourish in the Anglo-Saxon world with Brexit and Trump.
Historically, carry trades have generated very large profits with limited volatility. Since 2008, this has not be the case. Going forward, carry trades should continue to underwhelm.
Policy easing works with a time lag, and the previous easing measures should continue to feed through to business activity. The recent decline in the trade-weighted RMB should lead to continued improvement in the industrial sector's performance for at least the next two quarters.
The near-term (next month or two) market dynamics in EM risk assets remain a coin toss. Beyond that the outlook for EM risk assets remains downbeat. EM financial markets are complacent and there are many potential negative EM/China developments that could derail the current EM rally. A new trade: go long the KOSPI / short EM overall equity index.
Japan is in a liquidity trap: bad economic news is good for the yen while good economic news is bad for the yen. Chinese reflation could help risk assets in the months ahead, but poor EM fundamentals will reassert themselves later this year. The yen bull market is not over yet. The BoC was more positive on growth than anticipated. The BoE's Super Thursday was a non-event.