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Editor's Note: Hamish Risk | July 1, 2020
Today’s Macro Briefing focuses on the dollar as an increasing number of observers, as featured in yesterday’s briefing, believe the currency is set for a bout of secular weakness as low rates, high deficits and weakening reserve status finally take their toll. But HSBC maintains, just as we reported in March, that the dollar remains enthralled to vacillations in risk and that the often-heralded demise of the currency is overdone. Risk appetite is also on the mind of Capital Economics, which argues that further boosts in animal spirits are likely to send the euro – and eurozone assets –higher. For its part, Economic Perspectives cast doubts on how long the Federal Reserve can keep credit and equity markets in suspended animation before an inevitable correction, while TS Lombard explains why an expansion in US fiscal policy aimed at boosting infrastructure spending is what is needed to create a “good” US economy. Elsewhere, Cornerstone Macro assess the state of play of electric vehicle adoption in the light of increasing interest among investors in ESG concerns.
electric vehicles energy transition ESG Cornerstone Macro
1. Electric vehicles – not IF, but how disruptive and how fastWe regularly highlight Cornerstone Macro’s research on fixed income, equity, energy and macro strategy, which is consistently relevant and of high quality. What might be less well known about Cornerstone’s work – but shouldn’t be – is that they have built up a strong body of work with the ESG arena, with a range of thematic deep dives into various sectors and industries that are important components in any ESG conscious portfolio. Today we highlight the latest research published by Jan Stuart and Jonathan Aronson where they assess the state of play in the electric vehicle market and question when it could displace oil demand from combustion engines. As they point out, the quality of the vehicles themselves is not the issue, but the pace at which they can truly disrupt the market. This to a large degree will be determined by government policy, in China potentially driven by fuel security concerns and strategic industrial policy, and in Europe, where environmental concerns are likely to drive subsidies for electric vehicle manufacture in the strategically important auto sector. Even with those tailwinds, warns the pair, investors should not expect significant disruption until the 2030s, however, while growth constraints, particularly around the supply of lithium, cobalt and nickel needed in battery production – could also undermine the widespread adoption of electric vehicles in the longer term. Cornerstone have this year also published pieces: ”Nuclear Offers a Scalable Zero-Carbon Solution Once Safe, Efficient Reactors Move from Paper to Pavement,” and ”Hydrogen’s Potential Comes with Tradeoffs” and ”Tracking and Ranking Energy Equities of “The Great Energy Transition,” and ”Exponential Growth in Computing is Not Sustainable.”
US economy US fiscal policy TS Lombard
2. Polarizing politics of stimulusSteven Blitz at TS Lombard says continued high levels of initial unemployment claims should leave no illusion about the US recovery being quick, and nor should renewed concerns about the coronavirus leave any illusion that leisure and hospitality will pull in workers in the coming expansion, as it did during the one just ended. In the end, what is needed to create a “good” economy is large-scale government spending on infrastructure, he says, and the political fight over what fiscal stimulus entails has just begun. The US election will determine the bias of the full outcome of the fiscal programme, says Blitz, with the Democrats’ proposal emphasising their climate/clean energy priorities, including electric vehicles, energy efficiency and support for renewable energy production. Republican infrastructure spending, meanwhile, focuses on transportation – roads, bridges, and tunnels, he says. Crucially, says Blitz, what is left out of this month’s coronavirus relief bill in order for it gain passage will important as that will set the battle lines for the 2021 fight over the fiscal blueprint for the coming expansion.
Asset purchase programs Federal Reserve QE Economic Perspectives
3. How long will the Fed be able to keep markets in suspended animation?The Federal Reserve’s strategy for the corporate credit market is akin to doctors placing patients in suspended animation as they look for a cure – aimed at stabilising the price of credits that would otherwise be in mortal danger, says Economic Perspectives’ Peter Warburton. Between March and June, he says, investors have been reminded that central banks can boost financial asset prices, but the big question is whether they can they print the corporate profits that could justify today’s heady valuations. Warburton notes unit profits for the US non-financial corporate sector fell at an annualised pace of 43% in the first quarter. With political minds focused on the restoration of personal incomes rather than corporate, he says, engineering an impressive earnings recovery will be tricky. Indeed, according to Warburton, failure to reverse the downturn in global profitability implies another hard landing for global equity – and credit – prices.
currencies Equities European assets Capital Economics
4. More upside for the euro and many eurozone assetsWhile the euro and many euro-zone assets have rallied significantly over the past two months, Franziska Palmas at Capital Economics thinks there is scope for them to make more headway this year. This recovery, she says, has in large part been due to investors’ renewed optimism generally, as the global economy has shown signs of bouncing back quickly and central banks have expanded their stimulus measures. Risky assets in general have gained ground and the dollar has weakened across the board, as safe haven demand has unwound, says Palmas, but rising risk appetite alone cannot account for the full extent of the rally. She argues the other key factor that has boosted the euro and many eurozone assets is the step-up in EU policymakers’ efforts to avoid another debt crisis, and that they would gain more ground if, as expected, the EU rescue fund was approved and a significant share of money were distributed in the form of funds. In addition, says Palmas, provided that recent renewed outbreaks of coronavirus do not result in nationwide lockdowns or behaviours that prevent a further recovery in global economic activity, eurozone equities could also benefit from a renewed outperformance of those sectors that were hit hardest during the March sell-off. As for the euro, she says improved risk appetite is likely to suppress haven demand for the dollar, sending EURUSD significantly higher towards $1.20.
carry trade currencies HSBC
5. Reports of the dollar’s death are greatly exaggeratedRecent dollar weakness is simply a “risk-on” reversal of earlier dollar strength and not the start of a secular decline in the dollar that many other market participants are wrongly predicting says HSBC’s Dominic Bunning. He says, reports of the dollar’s death are –once again – being greatly exaggerated, but given the ramifications of a dollar bear market it is a view that needs to be taken seriously. Bunning outlines the cyclical, structural and political bear cases for a weaker dollar, and finds that while some arguments have merit, none is so convincing as to point to an imminent secular decline in the currency. The dollar, he says, is in the middle of the pack in G10 yields, and not set to become a funding currency, while record twin US deficits are nothing new and the dollar has rallied in the face of these pressures before, and, furthermore, the currency is still central to the global financial system and has no clear rivals to its reserve status. To be clear, Bunning is not looking for a stronger dollar, but expects greater differentiation in G10 FX, based on fiscal firepower and relative balance sheet expansions. In this world, and for the foreseeable future, he says, the dollar will remain resilient but without a clear directional trend.