Policy

The "reflation trade" is breaking down. Brexit risk is partly at fault; the bigger issue is the lack of a global "spender of last resort." Globally, savings must equal investment. The problem is that desired savings are rising and desired investment is falling. Policy is increasingly reflecting this reality: Fiscal austerity is yielding to stimulus, the obsession with fighting inflation replaced with talk of helicopter money/other radical solutions. Bond yields are likely to stay depressed for the next two years, but could then begin to rise much more than current market expectations. We are closing our short EUR/JPY trade.

The exponential rise in banks' non-standard credit assets has occurred in spite of the government's efforts to contain and regulate it. The government does not have full control over shadow banking and non-large banks. These have become a large part of the credit system. Hence, the assumption that the central government in Beijing can sustain any rate of credit growth it desires is overly simplistic. Short small bank stocks in China.

At current levels, Treasury yields are consistent with our assessment of fair value. Further, the Fed's Labor Market Conditions Index does not suggest an imminent recession. Expect payrolls to stabilize above levels consistent with further progress on wage growth and inflation, allowing the Fed to hike rates later this year.

The 1990s mid-cycle slowdown is an appropriate analogue to current market conditions. A lower dollar was the key ingredient the easing in monetary conditions that resolved this episode. This suggests that today, as the sole economic lever left, the greenback has further downside. Go short USD/SEK. Go long a basket of NOK, CAD, AUD and NZD against the USD.

The disappointing May payroll report does not foreshadow an imminent economic downturn. The Japanese government's decision to postpone next year's VAT increase and introduce fresh fiscal stimulus should help jumpstart growth. On the flipside, the Fed is likely to restart its hiking cycle in September and the Chinese government will crack down later this year on what it regards as excessive credit growth. More worryingly, the odds of Brexit have increased over the past few weeks. Go tactically short European stocks (in dollar terms).

The median voter theory is one of the few genuine theories of political science. It assumes that voters have limited policy priorities and that politicians want power. Therefore the latter will adjust their stances to satisfy the largest swath of voters. The median voter in the Anglo-Saxon world is shifting to the left, and regardless of what happens in the Brexit referendum or the U.S. election, this shift will be the most consequential development for markets.

The median voter theory is one of the few genuine theories of political science. It assumes that voters have limited policy priorities and that politicians want power. Therefore the latter will adjust their stances to satisfy the largest swath of voters. The median voter in the Anglo-Saxon world is shifting to the left, and regardless of what happens in the Brexit referendum or the U.S. election, this shift will be the most consequential development for markets.

Abenomics has disappointed, but not failed. The Bank of Japan could move to debt monetization next year, which would be positive for Japanese equities and negative for the yen.

The RMB has been steadily depreciating versus the U.S. dollar and has dropped to a new cyclical low versus its trade-weighted basket. All the while, Chinese domestic interest rates have lately drifted higher. When global investors wake up to these dynamics, global share prices and EM risk assets will likely sell off anew. In Mexico, initiate a new yield curve trade: receive 10-year / pay 1-year swap rates.