Weekly – Investment Advisor – 07 February 2019
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The Fed and, later, European central banks adopted unconventional monetary policies in the aftermath of the Great Financial Crisis (2008/9). The BoJ had done it before. The idea was to induce a collapse of real interest rates into negative territory and provoke asset price reflation. This controverted process had stayed confined to developed economies up to now… Indeed, real interest rates in emerging economies have remained globally clearly positive over the past decade in spite of the significant and long-lasting fall of nominal rates. Because of many legitimate reasons emerging central banks refrained from implementing ZIRP (Zero Interest Rates Policies), or quantitative easing process. Among them one could evoke economic ¨fragility¨, and the low level of development / sophistication of banking systems (hence the absence of necessary tools for doing it), not to mention the dependence to foreign sources of funding.
- But on January 25th 2019, the PBoC launched ¨Central Bank Bills’ Swap¨
Towards, ultimately, a new monetary policy regime
Over last months, PBoC supplied ample liquidity to banks through its usual funding / repos operations. But still, Chinese banks did not lend enough yet, namely because they are plagued with lots of non-performing loans. PBoC has therefore lately opted for a more radical approach, very discreetly. It actually decided to launch Central Bank Bills (CBB) to… support the market of Banks’ Perpetual Bonds (BPB). This operation is smartly presented as an additional provision of liquidity to banks… But in practice, this features the recapitalization / bailout of ailing Chinese banks, under a process very similar to BoE ¨Funding for Lending¨ scheme, or ECB’s ¨Long-Term Repo Operations (LTROs)! Chinese policy makers refrained from discussing the topic of their insufficient solvability.
From now on PBoC, financial institutions as well as insurance companies will be allowed to purchase BPBs. These securities may also be exchanged against (highly liquid) CBB or pledged for it. As a reminder, CBB don’t have to be repaid, hence they are considered as ¨quasi-equity¨ (Tier I or Tier II) on balance-sheets, like preference shares or contingent convertibles.
So far, so good!? As a matter of facts, one could object that it will take a lively credit demand to do the trick. And lot of inertia was actually observed in Japan and Europe before, under comparable circumstances, when growth was decelerating. But let’s face it, China is special i.e. a command economy. The Party and its decision makers will most likely ¨convince¨ economic agents to comply with authoritative recommendations…
For now, the stage has been set for unorthodox type of operations. But no calibration, no objective, no timing has been communicated by the central bank yet. This removes pressure to PBoC and allows it to test for the process. When the acquisition of a significant amount of BPB by PBoC will enlarge its balance sheet, the Chinese Central Bank will be obliged to acknowledge for a ¨major¨ shift of its policy into QE type of operations.
- The confidential bailout of ailing Chinese banks and the officious PBoC QE have just started
- This was almost unnoticed, as investors are mesmerized by the latest poor macro figures and by day to day trade war talks
- Markets have not yet taken full measure of the acceleration of the Chinese reflation
- Watch for the official start of Chinese QE or the reduction of policy rates, which would eventually trigger a brutal catch up of Chinese assets / markets
Currencies : The word patience is the new Fed leitmotiv
As widely expected, the Fed did not raise its Fed Fund rates. The FOMC confirmed the early January Powell comments and stated that it can afford to be patient in raising them. The Fed is waiting to see better global data, a robust improvement in risk sentiment and higher inflation. So, it switches off its autopilot mode.
The Fed is now evaluating the balance sheet run-off. It seems ready to end its balance sheet shrinking sooner rather than later. As we highlighted some months ago, the Quantitative Tightening will end this year, perhaps by reducing the selling pace soon. It confirmed that the appropriate balance sheet size is larger than initially expected. Last year, most of the Fed members expected it to be around $2.5-3.0trn. Now, the consensus has moved closer to our own target, around $3.5trn. An announcement could come as early as the March meeting, or otherwise in May.
This also suggests that halting the balance sheet shrinking will be implemented before any rate cut. All in all, the changes show that the Fed seems ready to react quickly and sharply to negative shocks and implement easing measures to prevent a significant growth slowdown. The Fed is making a pause in H1 and will try to raise rates again at some point in H2, if no material shock materializes.
The market welcomed the dovish signals, sending the EUR/USD and Emerging currencies higher. The message cements the sense of a Fed on hold for some months at least, which is key.
The market would now be focusing on fundamentals ahead of the debt ceiling talks. The US federal deficit will drive the USD. This means that the USD carry momentum is fading, notwithstanding a few more hikes down the road. The USD is vulnerable to such a shift as the positioning is still stretched on USD longs.
- The Powell comments were dovish
- The Fed will end its hiking cycle this year
Currencies : Break out on Emerging currencies
The recent Fed Funds accommodative tone is specifically the kind of external driver that lifts all emerging assets. The below table shows the opposite correlation between the USD trade weighted index and the emerging fixed income and currencies. No matter whether it is FX or bonds, EM assets suffer in an environment of a rising USD and outperform in a weaker USD context.
The “lower for longer” US rates and the bearish USD dynamic add further firepower to resurgent investors’ inflows into EM assets.
The attractiveness of emerging bonds is particularly notable. The global growth is slowing, and the disinflationary trend persists, so investors will once again jump into the search for yield pattern.
- For the first time in around a year, emerging currencies are finally catching real demand
- Amongst emerging local currency bonds, we favor Russia, Brazil and South-Africa
Gold : Central bank purchases at 50-year high
In 2018, central banks bought 651.5 tons of gold ($27 billion), the second record for a year (the first was in 1967), and net purchases reached a record since the end of the convertibility of the dollar into gold in 1971. For central banks, gold is again becoming a diversification asset. These purchases come mainly from emerging countries.
Purchases concentrated on a few central banks, Russia, Turkey and Kasakstan. Russia bought 274.3 tons, Turkey 51.5 tons and Kasakstan 50.6 tons.
European central banks have begun to increase their gold positions, particularly Poland (12 tons) and Hungary (31.5 tons). India, Mongolia, Iraq and Azerbaijan also contributed to net purchases.
The objective of all these emerging central banks is the de-dollarization of their reserves.
The yuan is becoming a commercial and loan currency, and will gradually become a diversification currency for central banks. And gold is gaining power, because for the moment, central banks can’t offset the dollar and the yuan for 1 to 1. It is a slow but irreversible process, because the dollar is still the undisputed world trade currency.
Vladimir Putin believes that the policy of sanctions and extraterritoriality of US law against many countries undermines confidence in the dollar as a universal payment instrument. “A classic error of empires” according to Putin. In 2017, Russia and China announced their willingness to do trade business without the dollar; it started with oil and gas. China pays its oil imports in yuan, including Saudi oil. In early 2018, China created its own market to trade futures on oil, which is an alternative to Brent and WTI.
In recent years, gold has been a good asset for diversification and protection in a portfolio. The price of gold ounces has increased in recent weeks thanks to the decline in real interest rates and the closing of speculative short positions. But the de-dollarization could materialize by a structural increase in the price of gold, for the long term.
There are many ETFs invested in physical gold, but we prefer gold companies that offer leverage with rising gold prices, particularly those that have made acquisitions like Barrick Gold (Randgold for $18.3 billion), which is a low-cost producer, and Newmont Mining ($10 billion for Goldcorp).
- We maintain our positive bias on gold
- GAM physical Gold EUR / CHF / USD
Backed by physical gold deposited in Switzerland
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