Monthly Archives: March 2017

Macron vs Le Pen, does it matter?

No matter who wins the French presidency, either of them has to co-habitat with other parties in the National Assembly. That means obstacles to implementing new domestic policies. That implies initial optimism/pessimism with whoever wins the presidency could quickly fade as people gradually discover that new (radical) policies are hard to get through in the French parliament. In that case, investors have to again “forget” about French politics and instead focus on fundamental analysis, e.g. the France/EZ growth momentum, ECB rate path and status of structural rigidity.

The nearer the election is, the sooner we need to forget about politics.



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Cyclical or secular bear bond market?

If you believe that income inequality causes low productivity which has led to secular stagnation, then Trump’s policy – tax cut and probably delayed infrastructure spending – seems to exacerbate inequality. Then secular stagnation is not averted. Low (real) bond yield is then here to stay. That means the recent rise in DM bond yield probably indicates a cyclical rather than secular bear market in government bond.

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The ECB “cut the rate” by 500bps, and yet….

According to Wu-Xia ECB shadow rate,, the impact of the extended ECB QE program since beginning of 2015 is equivalent to a rate cut of more than 500bps. The shadow rate is computed based on (mostly) bund yield curve.

Even though ECB QE has significantly pushed down the bund yield, EURUSD and EZ equity barely moved since 2015. Equity valuation measure such as P/B ratio barely changed from the end-2014 level. This is in sharp contrast with what happened during with Fed QE episodes (2010 – 2014) when US equity prices got a big boost from the unconventional stimulus. Even by ECB standard, a 500bps cut is a substantial cut within a short period of time.

In a word, the result of stimulus is disappointing.

What caused the disappointment? One explanation could be the clogged banking sector in EZ. Credit growth as % GDP has been steadily rising in the US since 2012, while the same ratio has been declining in EZ until stabilizing a bit recently. Despite 500bps easing, the EZ bank lending still does not keep up the pace with the economy.

And yet while EZ needs more credit to boost the economy, headline inflation is fast approaching 2%. Monetary tightening when credit growth is still weak? That would certainly dampen future growth in EZ.

Not jealous about ECB’s job. Draghi is right to be dovish. And the problem with the banking sector is immense – and only monetary policy is not enough.

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EM assets’ downside risks seem to be subsiding…

  • The Chinese and American leaders are going to have a talk, removing a key downside risk for EM trade outlook.
  • That NAFTA is to be repealed is in consensus…anything else bad could happen to Mexico?
  • USD stops rising rapidly, good (at least not bad) news for EM assets in general.

Any new downside risks (mostly unlikely, but who knows…)

  • Oil price back down to $40?
  • Base metal starts to correct as liquidity flows out amid Fed tightening?

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Should one be deeply concerned about repeal of NAFTA on Mexico?

Yes, the repeal of NAFTA may hurt the Mexican trade and economy. However, is the signing of NAFTA a large driver that affects Mexican trade (as % GDP), and Mexican trade with the US (as % GDP) over the past two decades?

Other external and domestic factors may play a more important role in driving those ratios:

  • China entering the global value chain since 2001 (the country being admitted to WTO) with competitive labor cost
  • China gradually losing its labor cost advantage following rise in RMB and strong income growth
  • Global financial crisis that halted the rising trend of global trade
  • Protectionist moves across the globe following the growth downturn after the GFC
  • The 911 terrorist attack followed by the US strengthening its grip on borders and immigration
  • The substantial improvement in Mexico’s sovereign fundamentals since 1994/1995 peso crisis

If the Mexican balance sheets are stronger than before, then Mexico is better positioned than before to weather the growth downturn/inflation pressure resulting from the repeal of NAFTA. In other word, repeal of NAFTA is an external shock to Mexico, but the country may be in relatively resilient position to weather the shock.

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Behind Chinese infrastructure investment – the motives

Infrastructure investment seems to be in almost everybody’s interest. Almost everyone likes it:

  • Citizens like more metro lines, faster trains, more schools and more hospitals – that adds value to the flats they bought.
  • Businessmen like the fast, punctual and very affordable high-speed trains (incredible value for money), as well as the incredibly efficient and affordable postal/logistics system across the country.
  • Local government officials like to build new things (something to add to their CV as they climb up the bureaucratic ladder).
  • The pro-growth camp of the central government likes infrastructure investment as well: it supports short-term growth and may even bring into long term benefits. Equally important, central government has more control/visibility around infrastructure-related funding (e.g. policy bank loans) than the commercial bank loans directed to the property sector.

The only ministry that may be uncomfortable with the fast increase in infrastructure investment is probably the Ministry of Finance, as infrastructure investment increases central (and gross) government debt burden as well as fiscal deficit. However, the Chinese government bond still enjoys strong liquidity – still popular among state banks for use as capital buffer. Hence no worry about fiscal borrowing cost.

Given monetary tightening and cooling the property market is on the way, one shouldn’t be surprised if the authority doubles down on infrastructure investment.

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The BoJ yield curve control goes more than targeting a yield number

I believe the impact of the BoJ YCC policy is not merely anchoring the 10-year JGB yield. After all, BoJ can change the target from zero to other number if desired, which would lead to mark-to-market profit or loss of JGB holders, depending on whether the new number is negative or positive. In other word, YCC policy could still lead loss in holding JGBs.

More importantly, I believe the most impact of the YCC policy is its dampening effect on yield volatility, which historically is driven by volatility in inflation and rate expectation, external environment and other short-term noise. While the short-term noise still exists, long-term yield volatility should significantly decline given the relatively infrequency of BoJ changing its long-term target rate.

The dampening in JGB volatility means dampening in the volatility of other long duration assets, such as investment grade corporate credit, prime property and infrastructure assets. It substantially increases the risk-adjusted return attractiveness of those assets, sending their prices even higher. And such dampening effect should still exist even when BoJ decides to move the target rate from zero to other number.

Vice versa, if BoJ decides to taper/give up the YCC policy, then prices of those assets should suffer.

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