a rafter of market themes - real vision

A Rafter of Market Themes

9th September 2020

Macro Strategies Portfolio Management Team

John Floyd, Head of Macro Strategies, Portfolio Manager [email protected]

Andrew Bloomfield, CFA, Associate Director & Assistant Portfolio Manager [email protected]

RECORD CURRENCY MANAGEMENT2

Cementing an era of depressed growth and real rates

Pandemics depress real interest rates for prolonged periodsEuropean real natural rate of interest following pandemics and wars

A half-century explosion in debt underpins global economic fragilityContributions to global debt, % of GDP

Source: Federal Reserve Bank of San Francisco, IMF calculations. Shaded bands are 1 and 2 standard error bands.


As growth falters, financial repression prospers

As growth falters, financial repression a tried and tested strategyUS contribution to debt stock as % of GDP

Source: Record, Markit, Federal Reserve Bank of San Francisco.

-30

-20

-10

0

10

20

30

40

50

30 40 50

60

70

80

90

00

10

Implied Real yield

Growth

Budget

Debt / GDP

The economic recovery is losing its steam Markit Composite PMIs

0

10

20

30

40

50

60

70

Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Aug-20

United States Euro Area United Kingdom

Germany France Italy

Spain Japan Australia


Yet markets priced optimistically

Source: Record, Shiller, Macrobond.

Latest: 30.63

0

5

10

15

20

25

30

35

40

45

50

1885 1895 1905 1915 1925 1935 1945 1955 1965 1975 1985 1995 2005 2015

10th percentile 90th percentile

US high yield spreads divorced from realityICE BofAML option-adjusted spread, basis points

0

500

1,000

1,500

2,000

2,500

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Thrice in a century has CAPE been hereCyclically adjusted P/E on real S&P 500


0.1

1

10

100

1000

0 20 40 60 80 100 120 140 160 180 200

Log

scal

e

Days since >0.1 per million

US COVID-19 cases stabilising as European cases grow7-day rolling average daily cases per million

United States Australia Germany

Spain France Japan

UK South Korea Italy

The US dollar hasn’t lost its hegemony yet

Source: Record, Google mobility reports, European Centre for Disease Prevention & Control.

USD a function of relative COVID dynamics and financial conditionsUS dollar index and relative mobility

92

94

96

98

100

102

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

14

16

18

DX

Y (l

agge

d 1

0 d

ays)

US/

EU r

ela

tive

mo

bili

ty (g

oo

gle

dat

a)

US - G9 Mobility (LHS)

DXY (RHS, lagged 10 days)


No challengers for reserve status

Source: Record, Macrobond.

-20

-15

-10

-5

0

5

10

15

Per

cen

t o

f 2

01

9 G

DP

US is a large economy with an open capital accountGeneral government balances and current account deficits, % of GDP

Fiscal Balance (2020 IMF etc.) Current Account (latest) Dual Deficits

-200

0

200

400

600

800

1000

-15 -10 -5 0 5 10 15 20ch

ange

in U

SD R

eser

ves

hel

d b

y ce

ntr

al b

anks

Quarterly % change in trade-weighted US dollars

Central banks accumulate more reserves when USD weakTrade-weighted USD (% y/y) vs. USD COFER reserves (y/y)


USD down cycle requires exceptionalism elsewhere

Source: J.P. Morgan, Record, Macrobond.

80

90

100

110

120

130

140

150

160

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

Secular downtrend in dollar yet to be confirmedUS real effective exchange rate

-25

-20

-15

-10

-5

0

The US: best of a bad bunch?1H 2020 GDP growth, % quarter-on-quarter

2Q 2020

1Q 2020


The euro’s strength should concern the ECB

Source: Record, J.P. Morgan.

80

85

90

95

100

105

110

115

1.0

1.1

1.2

1.3

1.4

1.5

1.6

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Strong trade-weighted euro a worry for the ECB inflation mandateEURUSD and trade-weighted euro

EURUSD (LHS)

Euro nominal trade-weighted index (RHS)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2012 2013 2014 2015 2016 2017 2018 2019 2020

US

Euro Area

The ECB should act to avoid a deflationary mindsetUS and Euro Area 5y5y inflation swaps (inflation expectations)


Euro optimism excessive

Source: Record, CFTC, Macrobond.

1.04

1.06

1.08

1.10

1.12

1.14

1.16

1.18

1.20

1.22

-80

-60

-40

-20

0

20

40

60

80

100

120

140

160

180

200

220

EUR

USD

(lag

ged

10

day

s)

US/

EU r

elat

ive

mo

bili

ty (g

oo

gle

dat

a)

Relative COVID-19 case curves reversing in favour of USRelative COVID-10 new cases and EURUSD

US-EU new COVID19 cases per mil, 7-day average

EURUSD (RHS, lagged 10 days)

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Investors positioned for Eurozone dynamismNet Non-Commercial futures positioning (% open interest)


Italian and peripheral spreads mispriced


Peripheral spreads10-year government yields minus Germany 10-year yield

60

70

80

90

100

110

120

130

1/1/

2006

1/1/

2007

1/1/

2008

1/1/

2009

1/1/

2010

1/1/

2011

1/1/

2012

1/1/

2013

1/1/

2014

1/1/

2015

1/1/

2016

1/1/

2017

1/1/

2018

1/1/

2019

1/1/

2020

1/1/

2021

Italy has been unable to adjust competitivenessUnit labour costs index, 2006 = 100

Italy Spain Greece Portugal Ireland


Canadian maple leaves late to bloom early to fall

80

100

120

140

160

180

200

95 97 99 01 03 05 07 09 11 13 15 17 19

Household debt % of disposable income

Canada

United States

Source: Record, StatCan, Macrobond. “Changes in wealth across the income distribution, 1999 to 2012”, Uppal, LaRochelle Côté (2015).

• Canadian household debt is particularly high

• Residential debt to equity has grown from c. 1x pre-GFC to c. 1.5x

• CMHC downside economic scenario sees house prices drop by 18%

➢ Corresponds to c. 45% loss of homeowner equity

➢ Knock-on effect of approx. 2.2% drag on consumption,

1.3% drag on GDP growth

60

100

140

180

1970 1980 1990 2000 2010 2020

House price to income ratios, index

Canada United States


The challenged three – Turkey, South Africa, Brazil

Source: Federal Reserve Bank of San Francisco

0

10

20

30

40

50

60

70

80

90

100

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

2018

2019

General government debt to GDP (%)

Turkey

South Africa

Brazil

-14

-12

-10

-8

-6

-4

-2

0

2

4

20

04

20

05

20

06

20

07

20

08

20

09

2010

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

20

20

20

21

Fiscal balance as % of GDP (IMF WEO)

Turkey

South Africa

Brazil

-10

-5

0

5

10

15

20

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

20

20

Real policy rates (%)

Turkey

South Africa

Brazil

-20

-15

-10

-5

0

5

10

15

19

98

19

99

20

00

20

01

20

02

20

03

20

05

20

06

20

07

20

08

20

09

20

10

20

12

2013

20

14

20

15

20

16

20

17

2019

20

20

Real GDP annual growth rates (%)TurkeySouth AfricaBrazil


Pandemic exposes vulnerabilities within EM


BRL

CLP

CNY

COP

CZK

HUFINR

IDR

MYR

MXN

PEN

PHP

PLN

RON

RUB

ZAR

KRW

TWDTHBTRY

0

10

20

30

40

50

60

70

80

90

100

-14 -12 -10 -8 -6 -4 -2 0

Gen

eral

go

vern

men

t d

ebt

% o

f G

DP

(4Q

19

)

Fiscal balance as % of GDP (2020 IMF estimate)

Debt / Deficit dynamics worrying in some EMsEM government debt vs. fiscal balance

The largest deficits are in countries with already high debt levels e.g. South Africa, Brazil.

BRL

CLP

CNY

COP

CZKHUF

INR

IDR

MXN

PEN

PHP

PLN

RON

ZARKRW

TWD THB

TRY

-4

-3

-2

-1

0

1

2

3

4

0.0 2.0 4.0 6.0 8.0 10.0 12.0

Rea

l po

licy

rate

Reserve adequacy (Reserves / STED + CAD)

Some facing choice between economy and external stabilityEM real policy rate versus international reserve adequacy

Turkey stands out as having inadequate reserves without a sufficiently supportive rates


Real policy rates


BRL

CLP

COP

MXN

PEN

CNY

INR

IDR

PHP

THB TWD

KRW

CZKHUF

PLN

RON

ZAR

TRY

-4

-3

-2

-1

0

1

2

3

4

-40 -35 -30 -25 -20 -15 -10 -5 0

Rea

l po

licy

rate

Latest GDP Growth %y/y minus 5-year average

Real policy rates correspond to economic damageEM real policy rates and economic growth vs 5-year average

BRL

CLP

CNY

COP

CZK

HUF

INR

IDR

MYR

MXN

PEN

PHP

PLN

RONRUB

ZAR

KRW

TWD

THB

TRY

0

5

10

15

20

25

0 50 100 150 200

Tou

rism

as

% o

f ex

po

rts

Trade as % of GDP

Damage likely lasting in open, tourist-dependent countriesTrade openness and tourism as % of exports


Stuffed Turkey?Negative real rates and excess credit

Source: CBT.

-5

0

5

10

15

20

25

30

2016 2017 2018 2019

% p

.a.

A dollop of negative real rates…negative for the first time since 2017

Policy rate

Expected inflation

Real policy rate

0

5

10

15

20

25

30

35

40

45

50

2014 2015 2016 2017 2018 2019

M2

mo

ne

y s

up

ply

(%

y/y

)

Go easy on the credit…TRY loans and money supply have exploded


And a history of external indulgence…that needs

to be rolled over

-60

-40

-20

0

20

40

60

80

100

120

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Curr

en

t a

cco

un

t d

eficit fin

an

cin

g (

12

m,

$b

n)

A sweet tooth for deficits…funding the deficit is an annual affair

NEOReservesOther investmentPortfolioFDICA deficit

Exte

rna

l d

eb

t re

pa

ym

en

t sch

ed

ule

($

bn

)

Source: CBT, Barclays. Note: NEO stands for net errors and emissions, FDI stands for foreign direct investment, CA stands for current account.

Stuffed Turkey?Debts and deficits

The banking sector and central bank are funding the deficit, with

minimal incoming FDI and portfolio investor outflows


-60

-40

-20

0

20

40

60

Dec-18 Mar-19 Jun-19 Sep-19 Dec-19 Mar-20 Jun-20

Tu

rke

y F

X r

ese

rve

s (

$b

n)

Nothing organic about these reserves…as net reserves are now negative

Net foreign assets

Net foreign assets adjusted for forwards and futures

Forwards and Futures position

Qatar swap line

boosts reserves

5.8

6.0

6.2

6.4

6.6

6.8

7.0

7.2

7.4

7.6

US

DT

RY

Sp

ot ra

te

Market forces coming home to roost …the heat at 7.0 is demagnetizing

CBT unofficially peg

the lira, tighten

capital account

Source: Macrobond, IMF. CBT swap book based on monthly data, interpolated through the month.

Stuffed Turkey?What reserves?


Butterflies flapping above the Bosphorus…feedback

mechanisms are often subtle at first

-10

-8

-6

-4

-2

0

2

4

6

Jan-18 Jul-18 Jan-19 Jul-19 Jan-20 Jul-20

Tu

rkis

h b

an

kin

g s

ecto

r n

et

FX

po

sitio

n

More cooks in the kitchen…Turkish banks utilised to stabilise currency

BIS

re

po

rtin

g b

an

ks’ e

xp

osu

re to

Tu

rke

y (

20

19

$b

n)

Source: Banking Regulation and Supervision Agency of Turkey, BIS, Barclays. Banking sector FX position includes both on balance sheet and off balance sheet positions.

Stuffed Turkey?The banking sector


USDTRY – sharpest depreciation episodes

Feb-01 to Oct-01 -58.4%

May-06 to Jun-06 -23.0%

Aug-08 to Oct-08 -32.1%

Sep-16 to Jan-17 -24.7%

Jul-18 to Aug-18 -31.3%

Average -33.9%

Source: Macrobond.

Stuffed Turkey?A history of depreciation episodes


Additional information

Issued in the US by Record Currency Management (US) Inc. All opinions expressed are based on our

views as of August 21, 2020 and may have changed since then. The views expressed do not represent

financial or legal advice. We accept no liability should future events not match these views and strongly

recommends you seek your own advice to take account of your specific circumstances. This material is

provided for informational purposes only and is not intended to reflect a current or past recommendation,

investment advice of any kind, or a solicitation of an offer to buy or sell any securities, or any of our

products or investment services. Any reference to our products or services is purely incidental and acts as

a reference point only for the purposes of this note. The views about the methodology, investment strategy

and its benefits are those held by us. All beliefs based on statistical observation must be viewed in the

context that past performance is no guide to the future.

Regulated status

Record Currency Management (US) Inc. is registered as an Investment Adviser with the Securities and

Exchange Commission and as a Commodity Trading Adviser with the US Commodity Futures Trading

Commission.

a rafter of market themes - real vision

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