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Weekly – Investment Adviser – 14 March 2019

PERFORMANCES 2019

EquitiesBonds
MSCI World+11.2%CHF Corp+1.1%
S&P 500+12.1%US Govt+0.8%
Stoxx 600+11.2%US Corp+3.3%
Nikkeï+6.4%US HY+6.4%
SPI+13.1%EUR Gvt+2.4%
China+22.8%EUR Corp+2.4%
Emerging+8.8%EUR HY+4.1
CurrenciesCommodities
USD index+0.4%Gold+1.5%
EURUSD-1.2%Silver-1.1%
EURCHF+0.9%Oil (Brent)+26.0%
USDCHF+2.2%CRB index+8.0%
USDJPY+1.8%
EM FX+1.5%

 

« No, you can’t always get what you want »

Mick Jagger, The Rolling Stones, 1969

 

The Renminbi is engaged in a long-term journey to become one of the most significant currencies. Among numerous signals that Beijing sent on this evolution, in 2014, PBoC and BoE signed a memorandum of understanding on Yuan clearing and settlement in London. In the following years, the quotation of gold and oil in Renminbi began in Shanghai. The IMF confirmed that it is on the path to become one of its reserve currencies of reference included in the basket of reserve assets (SDR).

 

Headwinds to Yuan internationalization

China made lots of efforts in past years to settle a growing share of its imports in Yuan. Long-term supply arrangements with Russia and more recently with Saudi Arabia and Iran symbolize well this. A few years ago, the share of trade settled that way reached about 30% of total imports. There is a growing feeling among forex dealers that the scope of these operations is growing. But practically this proportion declined lately! The recent contraction of world trade, as well as the growing will of the US to contain its arch rival move in the wrong direction. Indeed, the US administration is practically trying to contain Beijing in a process of signing bi-lateral trade agreement with the UK and Europe, just like it has already done with the so-called US-Mexico-Canada agreement…

The Silk-Road initiative is another way of engaging lots of countries into close financial-trade interdependency. Ultimately, this would divert their future bilateral trade from USD settlements. Here also, the pace of this mega project is on a standstill. The ¨hidden¨ neo-imperialist attitude from Beijing is meeting significant resistance.

US geo-strategic efforts to contain China are slowing Yuan internationalization

Like the growing political suspicion among beneficial countries from Silk-Road investments

 

Elusive Liberalization / convertibility?

The opening-up of the capital account of China was, a few years ago, an objective consistent with the rise of the country as one of the largest / mightiest economy in the world. We also observe a drift in the priorities of the Party. Indeed, Xi’s strategic refocusing spells avoiding vulnerabilities of the country, especially towards foreign countries. And, to state the obvious, adversity is rather on the rise these days…

 

Formally, reserve currencies do not need to be fully convertible. Capital controls reigned in France and in the UK in the 70’s and 80’s, not preventing the defunct ¨Franc Français¨ and Pound Sterling to get the status. Practically, it would be a politically issue under the modern international system to agree on same exceptions for China, considering the current dislocation of international relations… A managed convertibility is more likely, whereby it gradually opens up its current account. Just like it is doing for its bond and equities markets and the Yuan.

A total Liberalization of the Yuan may take longer than formerly thought

A managed convertibility is probably the new goal of the Party

  • China will slow the Yuan pace to become a global currency…
  • … and concede ¨some¨ Yuan revaluation to attract foreign capital (there by granting a ¨victory¨ to Trump)
  • Both maneuvers would facilitate a subsequent – complete – liberalization / convertibility…

 

Fixed income. Is the ECB really offering the right answer?

The ECB has been slow to move in its views in the past months, and in one day tried to catch up. It finally, unsurprisingly, acknowledged the economic slowdown, given that its December forecasts were still too high. The ECB still sticks to a rather optimistic scenario of a gradual recovery thanks to a solid domestic demand.

The GDP growth is now expected to come in at 1.1%, 1.6% and 1.5% in 2019, 2020 and 2021. This must be compared with 1.4% for 2019 and 1.5% for 2020 for the consensus; to 1.0% and 1.2% for the OECD in 2019 and 2020 and 1.3% in 2019 for the European Commission. The ECB still considers that risks are tilted to the downside. Inflation does not look alarming. It still favors a very gradual increase in headline inflation but clearly below its 2.0% target.

ECB staff macroeconomic projections

The ECB has unanimously adopted a dovish stance and announced a series of measures/adjustments:

  1. First, it pushed backed its rates guidance, as they should remain at their present levels at least through the end of 2019, compared to through the summer previously. Some members even wanted to extend it to March 2020. Draghi will be the first ECB president who never hiked rates during his mandate. The main risk is that the ECB should not be able to raise rates in this cycle.
  2. And, 7 new quarterly TLTROs, from September 2019 to March 2021, at the refi rate, with a 2-years maturity, will be run. It could seem credit supportive, but the conditions are less generous than in the previous versions. The 2-year maturity is considerably shorter than 4-year previously and the rates will be indexed to the main refinancing rate instead of being fixed. As a result, we do not expect a massive demand. So, the excess liquidity will continue to fall.

TLTROs

All those measures are not a big surprise. The ECB tends to stay ahead of the curve and to avoid an unwarranted monetary tightening. It is now well acknowledged that the main central banks have overestimated inflation. The main idea is not to provide additional easing but rather to keep the balance sheet stable for a longer-than-expected period.

previsions d'inflation de la BCE

  • Hike is off the table for this year. The extension of the ECB forward guidance suggests the next step of the normalization, i.e. a rate hike, is very distant. 2019 will be a dead year for rates
  • The carry-game will continue for the next months

 

Currencies. All the bad news is already discounted

Given that the forward guidance has been extended by more than one quarter (from the end of the summer to the end of 2019, but implicitly to end of Q1 2020), this means the EUR downside risks coming from the ECB should not be pronounced from here. This is due to the already very subdued market expectations about the ECB tightening, meaning the potential for an excessive dovish re-pricing is rather low now. As a result, we do not expect a pronounced collapse in the EUR/USD. The 1.1200 remains a solid support. The extension of the ECB forward guidance today suggests the second step of the ECB policy normalization (i.e. the rate hikes – after the first step being the end of QE) is very distant. This means that a similar rally like in 2017 is off the table (at that time it was caused by the ECB QE tapering expectations). Any significant EUR/USD upside is likely to come from a weaker USD environment.

non-commercial EUR positions

  • The EUR upside is likely to come from external factors like US debt ceiling, or Chinese reflation
  • However, as we do not expect a larger ECB balance sheet, the EUR should not weaken now

 

Equities. Scandinavian washing machine

It was thought to be safe with the Scandinavian banks, even if their stock market valuations were high; investors paid for their strength. The Russian money laundering scandal of Danske Bank’s Estonian subsidiary is involving other Scandinavian banks (Swedbank, Nordea), Dutch banks like ING, ABN Amro and Cooperatieve Rabobank, as well as Crédit Agricole, Deutsche Bank and Raiffeisen. International.

Scandinavian banks were classified as low risk for money laundering and terrorist financing according to the Basel Institute. In 2017, the least risky countries according to the Basel Anti-Money Laundering Index were Finland, Lithuania, Estonia, then in 7th position Denmark and in 9th Sweden. Europe is a single market, but the paradox is that there are 28 anti-money laundering systems; a national and non-cooperative approach. A scheme is being put in place: Nordic banks, via their subsidiaries in the Baltic countries, have become a hub for Russian criminals.

The International Monetary Fund estimates global money laundering at $2 trillion a year. The Scandinavian scandal is therefore only the tip of the iceberg, because the Estonian subsidiary of Danske Bank would only concern $230 billion between 2007 and 2015. Swedbank would be involved in the scandal with $6 billion and Nordea Bank € 700 million.

The fears are the disclosure of much higher amounts, but especially the US sanctions with heavy fines. The stock prices of the banks concerned have fallen sharply and this scandal confirms that it is difficult to invest in the European banking sector.

So far, investors fear more the impact on profitability than a default risk as CDS has not widened that much.

  • This once-again problem for European banks confirms the difficulty of investing in this sector

 

Technology. Huawei attacks the United States

Huawei sues the United States due to a ban to sell its products in the US market. The US government wants to defeat Huawei and other Chinese companies in the 5G infrastructure. The American argument is the risk of espionage in sensitive sectors such as defense.

It’s a joke. First, for the moment, it has never been proven that the Chinese include spy devices in their technology. Second, the United States, like other great powers, are one of the world’s biggest spies; the NSA (United States), the National Security Agency, spied for years on the entire planet, even allies, including Head of States. Facebook, Google, Apple, Amazon hold private data from the all world.

The British and German cybersecurity services recently said that there is currently no evidence of spy devices in Chinese telecommunications and technology products. The Germans propose to put a “no spy” clause with

suppliers of 5G, this being valid for the Chinese, but also for others, Swedes, Finns and Americans. The Germans resist the US anti-Chinese campaign, even if they were shaken by the acquisition of Kuka, a German world leader in automation/robotics, by the Chinese Midea.

Except the United States, Europe and Japan seek to avoid “one world, two standards” in the 5G.

For us, investors, 5G is a major theme for 2019. The 5G theme is progressing well and outperformed equity markets in the consolidation phase observed last week.

  • Buy the 5G theme

 

 

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