Covid-19 brings the end of US exceptionalism
The Covid-19 pandemic spells the beginning of the end of a deflationary era which started in the 1980s, posits Davis Hall, head of Asia capital markets at Indosuez Wealth Management, as central banks around the world adopt unorthodox monetary policies to weather today’s unprecedented environment.
Speaking from Hong Kong at a video conference hosted by Indosuez Wealth Management, Hall highlights that four key financial institutions have indicated they will tolerate inflation as an outcome of various liquidity and debt provisions.
These include the Federal Open Market Committee, the European Central Bank, the Bank of England and the Reserve Bank of Australia. “They’re going to intentionally allow inflation to overshoot as the only means to hopefully repay all of this debt... But there’s a risk that all of the central banks are too loose for too long,” Hall warns.
Weakening US dollar
In addition, the shock the pandemic has wrought on the world’s economies could usher in a decade of “de-dollarisation”, says Hall, as the greenback begins to lose its lustre as the global reserve currency. This comes amid mounting criticism of Trump’s mishandling of the Covid-19 crisis and volatility from the upcoming US presidential election in November.
The Chinese renminbi, for now, is still a tiny sliver as a reserve currency. Yet, it has grown fast and is growing in importance, says Hall. According to the International Monetary Fund, the share of the renminbi in global reserves has now doubled to 2% from 1% in 2016.
“If Trump were to lose, the dollar will be more vulnerable under Biden and the US investment climate will be very different with higher taxation and maybe less ‘gung ho’ than before with Trump’s lax regulation,” says Hall.
While Hall warns against reading too much into pre-election polls, he sounds the death knell for US exceptionalism, no matter the outcome of the election. Citing annual debt servicing obligations to the tune of US$700 billion ($949 billion), the US’ debt is “a ticking time bomb”, says Hall, and the country is “essentially bankrupt”.
He explains: “US Treasuries are not necessarily any longer the ultimate safe haven asset class… Before, they had better growth; they didn’t have negative yields, they had positive real yields; and they had a much higher US interest rate. So, nobody wanted to sell the dollar.
“But now because US interest rates have come down, it’s really cheap for foreigners to hedge the currency risk of holding US equity and high-tech companies within their portfolios. They’re now exposing the dollar’s underlying fundamentals, which I believe are extremely fragile… Only now are the chickens coming home to roost.”
The US dollar has weakened in recent months. The US Dollar Index, which tracks the greenback against a basket of other currencies, has lost nearly 5% over the past three months. Hall believes the drop might be indicative that the US dollar has been “a little bit oversold”, and for nimble players, it is a chance for one last punt as a rebound might happen if Trump is re-elected.
“(Investors) must use this as an opportunity to diversify towards what we believe will be the better safe havens going forward,” he says.
Bullion has seen a similarly reckless history of late. Gold prices have doubled since the day Trump beat Hilary Clinton in 2016, says Hall. The “exceptional” increase is showing signs that gold is overbought, however, and gold will become more vulnerable if geopolitical tensions ease, such as with a smooth transition of power in the US come January if Biden wins the presidency. The election is scheduled to be held on Nov 3.
“If Trump is [re-elected], gold can continue to do well as an alternative to fiat currencies or paper currencies. I think real assets will continue to outperform,” says Hall. “In the short term, we could see a pullback in profit taking [for gold] and we need to be ready to profit from that correction.”
Consumer behaviours
Besides monetary and fiscal policies, varying consumers’ behaviours will also play a key role in shaping markets. Ahead of the US elections in November, Trump might dole out more benefits to stimulate spending. As it is in the DNA of US consumers” to be spendthrifts, the domestic market should not underestimate loosening purse strings in the coming months — and the more so if unemployment numbers continue to improve. “There will come a time when confidence will return and maybe it will come from vaccine optimism,” says Hall.
However, consumers in other economies, such as Europe, are more careful. Without a viable vaccine on the horizon, consumers across the pond remain tight-fisted in response to insecurity about the future.
“I give an example of my own country, the Netherlands,” says Arjan De Boer, head of markets, investments and structuring at Indosuez. “This year, the prediction is that there will be 25% less automobile sales compared to last year. That’s a massive number. In fact, that will bring sales to the lowest numbers since 1968.”
Nine months into the year, Europe is still grappling with the fallout from the pandemic. There are some 5.1 million reported cases as of Sept 20, with 640,000 from Spain alone. While the continent’s GDP is expected to return to growth in 3Q2020, De Boer points towards the “significant, double-digit losses” seen in 2Q2020 as a negative overhang for the region’s economies.
Last quarter, the UK reported the steepest GDP fall in the region at 20.4% q-o-q, with similar declines posted by Spain (–18.5%), France (–13.8%), Italy (–12.4%) and the EU (–11.9%). “These are staggering numbers. Q3 could be positive but it will remain negative for a year as a whole,” adds De Boer.
Though dependent on exports and tourism, Switzerland has had the best currency in the region during Covid-19, says Hall, pointing to the Swiss franc trade-weighted index rising more than 60% over 20 years. “Our view is that if we start to see some Covid-19 vaccine optimism, and when we start to see economies improving, the Swiss franc is vulnerable to giving back its strength.”
New safe haven
In contrast to its dreary views on the US, the Indosuez analysts are upbeat about China’s prospects and potential for investors. According to Hall, the idea of “first in, first out” explains China’s rapid recovery from the Covid-19 outbreak, traced to a wildlife market in Wuhan, Hubei. “People are starting to embrace a new theme that China is managing much, much better than anybody else… The Chinese currency has been the surprise of the year for me since May.”
He cites a comment made in June by Guo Shuqing, chairman of the China Banking Regulatory Committee. “China values very much the normal monetary and fiscal policies we are practising now. We will not flood the economy with liquidity, still less employ deficit monetisation or negative interest rates,” said Guo.
Compared to the West, the new currency environment will favour more orthodox monetary policy, says Hall, adding: “This is very different from what the US, Japan, Europe, Britain, Australia are now embracing.”
Hall believes that if not for currency risk, there should not be a 250 basis point premium between the Chinese government’s ten-year bond and US Treasury bonds with the same maturity. “I think the new ultimate safe haven of this decade will be Chinese government bonds,” says Hall.
“Foreign investors are only just waking up to these attractive yields and starting to put more unhedged currency risks of the Chinese currency into their portfolios,” he adds. “I think in this environment, with better growth, better Covid-19 management, less need for currency devaluation and a change of their business model, China could be one of the surprises for the years ahead.”
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