Making sense of this world

By Brunello Rosa

17 June 2019  

In our latest Market Update and Outlook, published last week ahead of the upcoming quarterly asset allocation, we reviewed the major macroeconomic, political, geopolitical and market events of the last six months. We then provided an outlook for the next six and next twelve months, as well as further ahead in the future. 

From a macroeconomic perspective, the last six months have seen a synchronised deceleration of the global economy, starting from its three main regions (US, Eurozone and China), in spite of upward surprises in Q1 GDP growth. The ongoing trade and tech war between US and China, which is likely the beginning of a new Cold War, which we called Cold War II, is taking its toll on the global economy. The US and China (ahead of a possible truce, yet short of a full deal that would resolve their economic disputes) are importing less from each other, which is likely to benefit only a few select economies, such as Vietnam, Taiwan, Chile, Malaysia and Argentina. In our recent analysis we discussed why we believe that a controlled escalation, or contained commercial warfare, is more likely for the time being than a full-scale trade war or a full deal being reached between the two countries. 

But trade wars, tech wars and the disruption to global supply chains is not the only factor affecting the global economy. Geopolitical tensions are on the rise irrespective of trade tensions (with the US still being the instigator of these tensions). We discussed the risk of miscalculations and accidents taking place in the US-Iran standoff, and last week there was indeed an attack on two oil tankers in the Gulf of Oman, the gateway for over a third of the world’s shipped oil. Even if the situation in the region is set to remain tense for some time, oil prices still fell on a weekly basis, in response to the slowdown in the global economy. Also in the Middle East, the Turkish government confirmed its S-400 arms deal with Russia, after Turkey’s Defense Minister stated that “the language used in a letter sent by the US regarding Turkey’s removal from the F-35 fighter jet program does not suit the spirit of alliance".  

Finally, the regional geopolitical mess that is Brexit, with its potential global implications (the Fed quoted it among the most relevant cross-currents recently weighing on market sentiment), could deteriorate further, if the UK were to go for a no-deal exit following the arrival of the country’s new prime minister (Boris Johnson is the frontrunner). In fact, last week the House of Commons rejected (with a 309-298 vote) a motion designed by the opposition intended to block a “no-deal” exit on October 31st. 

With all of this taking place, and as fiscal policy remains constrained, central banks are already on the move. Joining the Fed, ECB, PBoC and BOJ, the Swiss National Bank (SNB) also claimed last week to have room to further ease its policy stance, and, also for this purpose, introduced its own SNB Policy Rate, in substitution of the 3m Libor target range. This week, the Fed will provide further indication as to whether or not it wants to proceed with its precautionary cuts, which the market now considers certain to be implemented by year end, considering the various cyclical and structural factors dampening upward pressures on US inflation. At the same time, Norges Bank will likely confirm that it will remain at odds with all other G10 central banks, and will likely proceed with its pre-announced 25bps increase in its policy rate. 

After a very volatile semester, the price of risky assets (primarily equities) and the price of long-dated government bonds are supported by this renewed dovishness of central banks. However, if the damage to the global economy proves to be larger than is currently estimated, central banks will have to do much more than a few insurance-based cuts to prevent a recession and severe market correction in the next few months. 

18 June 2019

Modi’s (Unexpected?) Landslide Victory 

In defiance of the chronically-wrong foreign policy commentariat, far from being reduced, Prime Minister Narendra Modi managed to win another famous victory in the just-concluded Indian parliamentary elections. With enthusiasm at a fever pitch (the 67% voter turnout was the highest rate ever), Modi’s BJP-led Hindu nationalist coalition won fully 352 seats (out of 542 contested) in the Lok Sabha, the Indian parliament’s lower house. 

To put his thumping victory in perspective, outshining even his landslide win in 2014, the BJP personally won 303 seats, with fully 55% of the overall vote. The second-place rival Congress Party, long the natural party of government in India since the country’s modern founding, came in at slightly less than 10%, netting only 52 seats. All sides accept that the 2018 vote was almost entirely a referendum about Modi, and Modi alone. Once again, he bestrides the sub-continent like a colossus. 

There is little doubt that whatever events had occurred in the run-up to the vote, the Prime Minister would have safely managed another term in office. However, his overwhelming victory found him taking advantage of a very specific set of circumstances. A February 14, 2019, Pakistani-inspired terrorist attack in the disputed region of Kashmir left 44 Indian soldiers dead, stoking the fires of Indian pride. Campaigning on a mantra of Hindu nationalism, Modi portrayed himself as the strong leader India needs in such perilous times. Congress, led by the listless, ineffectual scion of the Nehru/Gandhi dynasty, Rahul, had next to no answer to Modi’s stirring orations. 

Modi’s Disappointing First Term In Power

For once, the commentariat was not entirely wrong in predicting the 2018 vote could well see Prime Minister Modi being taken down a peg. For in policy terms, as discussed in R&R’s trip report, Modi’s first-term record has been disappointing, especially given all of his glittering promise. 

Unemployment remains one of the government’s greatest failures, with the true rate of 6.1% being revealed by a leaked government document, amounting to a 45-year high. Equally galling, the prime minister’s disastrous demonetization programme, designed to root out endemic corruption, was ill-conceived and ill-devised, leading the country to experience the shock of a cash shortage in 2016-17. 

There have been some significant successes along the way, but even these seem to pale in comparison to what was hoped for. It is true that Modi’s first term boasted an impressive average growth rate of 7.4%, while inflation has generally remained under control. While GDP has tumbled from this enviable perch over the past three quarters, it is projected to once again roughly match this average in 2019-20. 

Modi’s greatest success was the July 2017 enactment of the Goods and Services Tax (GST), which for the first time in its history made India a single market. Foreign Direct Investment (FDI) has also increased, from $25 billion in 2014-15 to $45 billion in 2018-19. The Modi administration has not compiled a bad record in its first term by any means, but nor has it set the policy world ablaze.  

For rather than adopting a bold programme of root and branch economic reform in overcoming the ramshackle Indian system, making it fit for purpose in the new multipolar era, Modi has instead proved a more competent caretaker of the old, Congress-devised, state-centric system. 

What Should We Expect In The Prime Minister’s Second Term? 

Frankly, the political risk odds, at leastdomestically, are on more of the same. Modi seems keen to restructure and streamline government ministries, and to embark on a worthy $1.4 trillion infrastructure investment project, to be ideally completed by 2024. All this is worthy, if a little unexciting. 

What will probably not happen, based on the empirical evidence of his first term, is that Modi will suddenly become a bold champion of the free market, rather than the competent steward of the old system that he has been. In other words, don’t look for either labour market or land reform, which would actually shake up the Indian status quo and dramatically further open its economy to the market. 

Over foreign affairs, look for the Prime Minister to be more ambitious. Modi, in line with US designs, seems determined to push back against increased Chinese influence in the Indian Ocean Rim (IOR), starting in the Maldives. Delhi’s increasing trajectory in informally aligning more and more with Washington is likely to accelerate, particularly as China continues to extend its reach throughout Asia. To facilitate this, look for Modi to do what it takes to avoid a debilitating trade war with the Trump administration. 

The Prime Minister, keen to any slights to India’s growing power, and in line with his Hindu nationalist BJP base, will grow ever harder-line towards both China and Pakistan. In other words, Prime Minister Modi’s second term will see a congealing of both the nascent US-India and opposing China-Pakistan alliances. 

As the recent vote shows, Narendra Modi is an easy man to underestimate. However, it is understanding what the true keys to his success are that allows us to peer into the crystal ball, and accurately make sense of India’s glittering future. 

(This is an excerpt of Dr. Hulsman's latest article, which you can read here)

Dr. John C. Hulsman is the widely-read Senior Columnist for City AM, the newspaper of the city of London. Dr. Hulsman is also a Life Member of the US Council on Foreign Relations. His most recent work, the best-selling, To Dare More Boldly; The Audacious Story of Political Risk, was published by Princeton University Press in April 2018 and is available for order on Amazon. He can be reached for corporate speaking and private briefings at https://www.chartwellspeakers.com. 

Week 17 - 23 June 2019

Fed On Hold And PMI Likely To Remain Stable

In the US, the Fed is expected to remain “on hold”, with policy rates unchanged at 2.50%. 

In the EZ, the PMI is likely to remain stable (Markit PMI composite June, c: 51.7; p: 51.8). 

In the UK, the BoE is expected to leave interest rates unchanged at 0.75%.

The Quarter Ahead: Geopolitical Tensions To Weigh On Global Growth, Cbs To Ease

Despite the US-Mexico deal, the threat of new tariffs is still pervasive. In the US-China trade dispute, the meeting between the US Treasury secretary and the PBoC Governor did not deliver progress, leaving investors “in a wait and see mode” until the G-20 Summit. So far, the trade tensions resulted in: 1) the US and China importing less from each other, especially of the goods subject to higher levies; and 2) a few countries – i.e.: Vietnam, Taiwan, Chile, Malaysia and Argentina - becoming major beneficiaries.

In the UK, a hard-Brexit is more likely, as the House of Commons rejected (309-298) a motion designed by the opposition to block a “no-deal” exit on October 31st. 

Central Banks are likely to ease policies. Responding to a deteriorating global outlook and rising risks (largely from US trade 

policy), key CBs – i.e.: the Fed, ECB, BOJ and PBOC - made clear their readiness for monetary accommodation; possible measures include: i) liquidity injections; ii) funding support; iii) interest rate cuts; and iv) restarting QE. 

In the US, the Fed is likely to shift its stance towards easing, due to a slowing global economy. Market expectations of a rate cut in 2019 stayed at 99% and the probability of one rate cut in July rose to 68%. 

In the EZ, the ECB stated that it is “ready to combat any further slowdown that threatens (…) price stability”, and is “willing to cut interest rates and resume bond purchases, if necessary”. 

In Japan, the BoJ will: i) deliver “a bigger monetary stimulus if necessary”; and ii) consider easing further if momentum toward its 2% inflation target is lost.

In China, to maintain stable market liquidity in H2-2019, the PBoC: i) injected USD14.51bn into the financial system through open market operations; and ii) pledged to “keep its monetary policy prudent, neither too tight nor too loose". 

In Turkey, the government is likely to confirm the S-400 deal, after the Turkish Defense Minister stated that “the language used [in a letter sent by the US regarding Turkey’ removal from the F-35 fighter jet program] does not suit the spirit of alliance".contracted for jet manufacturing will be cancelled.  

Real Economy: Low US Inflation Fuels Fed Rate-Cut Expectations

In the US, softer-than-expected inflation in May (a: 1.8% y-o-y; c: 1.9%; p: 2.0%) led the markets to expect the Fed to cut rates, especially if escalating trade tensions continue to weigh on the outlook. Yet, retail sales rose, showing an improved consumer sentiment (Retail sales May, a: 0.5%; c: 0.6%; p: 0.3%). 

In China, exports beat expectations, led by shipments - brought forward to anticipate a potential tariff increase (Exports May, a: 1.1% y-o-y; c: -3.9%; p: -2.7%). Inflation rose for the third straight month in May to a 15-m high (CPI May, a: 2.7% y-o-y; c: 2.7%; p: 2.5%). 

In Turkey, the MPC kept the policy one-week repo rate unchanged, at 24.0%.

Financial Markets: Expectations Of CB Monetary Easing Is Driving The Markets

Market drivers: Interest rate indicators, if viewed in isolation, seem to be signaling adverse scenarios. The 10Y/3M UST spread has been inverted for the past 21 days (10 days is seen as a “recession threshold”). However, the markets expect major CB to step in to: i) support growth; ii) cushion downside risks; and iii) engineer a soft landing. Going forward, “bad economic news” – being perceived to increase the chances of CB stimuli - will become “good news” for asset prices. 

Stocks: w-o-w, global stocks rose (MSCI ACWI, +0.3%), led by the US (S&P 500, +0.5%). Volatility fell (VIX S&P 500, -1.0 points to 15.3, 52w avg.: 16.4; 10y avg.: 17.3). 

Bonds: globally, indices rose w-o-w (BAML Global bond index, +0.1%). 

FX: the USD strengthened against a basket of currencies (DXY, +1.1%) and the EUR fell (EUR/USD, -1.1% to 1.121). EM currencies stalled (MSCI EMs, 0.0% at 1,623). 

Commodities: Oil prices fell w-o-w (Brent, -2.0% to 62.0 USD/b), despite an attack on two oil tankers in the Gulf of Oman, the gateway of over a third of the world’s shipped oil, increasing tensions between the US and Iran.