By Shayne Dunlap, manager of the Pacific G10 Macro Rates Strategy
Investors don’t need to be accurate about the future to make high returns, but having a good understanding of the key macro drivers is essential to understanding risks.
Politics and economics are in an era of great flux, accelerated by disruptive technology. These four factors are morphing global markets, yet create a fertile trading environment for those looking to exploit relative value opportunities.
Political volatility
We have all heard the famous saying that a week is a long time in politics, so trying to look ahead into the next three years is a particularly challenging task given the current environment.
Perhaps Trump will not win the coming US election – he could be curtailed by a number of issues such as the Roe v Wade female vote.
Ukraine may well win back territory as US and Europe provide meaningful arms and ammunition. And China could distance itself from Russia as Putin’s power becomes vulnerable, throwing up huge concerns about legacy nuclear weapons and a Russia breakup.
Closer to home, a new Labour government in the UK may decide to review the current version of Brexit and create a softer form of agreement – a change in policy that could be justified should intelligence come to light detailing foreign interference in the UK referendum.
None of the above outcomes are out of the question, but unfortunately neither is the opposite.
See also: Rathbones: 81% of investors expect UK equity growth over next year
We are living in changing times where, after the Soviet Union’s demise, the uni-polar US’s role as the world’s only policeman is rapidly being replaced by a multi-actor model of China, Russia, India, Turkey and even Europe.
This new playing field may take some time and there are likely to be mishaps to sort out – which is not ideal when nuclear armed players are involved.
The geopolitical risks that have been generally dismissed by the markets as temporary or inconsequential until now may be fundamentally underpriced in the future.
Economic uncertainty
We could also see renewed economic momentum in China after it has stabilised the property market and state-owned enterprises elevate commodities.
Internal policy is increasingly focusing on developing domestic demand – a significant turn from the past – but it could possibly be a reaction to increasingly hostile tariffs from western nations.
A soft landing in Europe and the UK could lead to a maximum of four to six interest rate cuts in total and we could see the US limited to one to three cuts as inflation and the economy pick up post-election.
Irrespective of election outcomes, fiscal spending may not recede as some expect, keeping economies hot and fiat money cheapening. High-for-long rates will ultimately start biting inefficient sectors, and dispersion could begin to increase across investments. High refinancing costs of illiquid private equity investments could also cause shockwaves.
We challenged the idea of immaculate disinflation. Financial markets are currently pricing a swift return to 2% inflation without a substantial increase in unemployment or deceleration of economic activity as credit spreads remain tight and equity valuations are elevated.
The under-priced danger is a second wind of demand that would reignite inflation and force the Fed back into tightening mode. Early signs show that consumers are sensitive to lowering rates, which could accelerate demand, buoyed by job security and rising wages.
Will shrinking central bank balance sheets rock the boat? The unwind of unprecedented expansion of global central bank balance sheets has been very smooth thus far, although the ECB is due to begin unwinding their most radical PEPP policy that was heavily skewed towards peripheral countries.
A lot was made out of simultaneous increase of central bank balance sheets and asset price inflation over the last decade and a half. Yet we have not seen the opposite dynamic during the reversal of these policies.
If the rising tide floats all boats, who will not be wearing trunks when the tide goes out?
Legitimising cryptocurrency
The Gold Council could launch a gold digital currency, which will push the precious metal’s price higher as it is tokenised on blockchain and fully backed by its own actual collateral.
This could start eating cryptos lunch. With 2% global supply each year, it could show the stability and digital liquidity to be a new base currency and could be adopted by many emerging market countries.
Other stable coins backed by gold have tried, but this one would be different. Having a legal, legitimate, and fully transparent auditable track, from the mine to your electronic wallet, would be a game changer. You would in fact be buying a unit of verified digital gold, not a meme token backed by gold – there is a difference!
See also: Will central bank dreams of a ‘soft landing’ become a reality?
As fiat central banks continue to print money as though it is made of paper and rely on the past glories of balanced or surplus budgets to keep the faith, one wonders when someone call out the emperor for not wearing any clothes.
Fiat money continues to be undermined by multiple issues. Wars, green energy transition, ageing populations are all incredibly expensive. These ever-increasing burdens need to be financed by shrinking working age populations in many of the western economies.
When do the debt numbers become untenable and what are the consequences? De-dollarisation has started, as the weaponisation of foreign reserves held at external central banks can be frozen should you fall foul of international law. A gold digital currency could provide a liquid stable solution.
Adoption of AI
Artificial intelligence is an powerful tool for increasing productivity, mainly in services, but initially without the joblessness. However, the next generation will likely wipe the floor with what has come before.
The long-term effect might be severe deflation as intelligent 24/7 robots and software kill the competition (human bargaining power). The developed world could then dissolve into three-day working weeks supplemented by universal basic income (UBI) that will placate the masses.
The unfortunate side effect could be that the developing economies are no longer on the industrial revolution conveyor belt, as sourcing ever cheaper human labour is no longer essential for global capitalism to flourish.
In fact, the growing uncertainty of protecting trade routes through flash points such as the South China Sea or Gulf of Aden will compel more home grown automation. This will then truly drive mass economic migration as international developed market demand stagnates, unless a concerted effort is made to provide meaningful economic development in emerging countries.
See also: Time for silver to outshine gold?
