A recent HSBC report argues that the planned financial transaction tax in the Eurozone will have a profound negative impact on investment returns, as well as on liquidity in cash products and derivatives. The tax is expected to be introduced next year and have broad implication well beyond the countries that have agreed to it.
On April 4 Bank of Japan Governor Haruhiko Kuroda unveiled aggressive “Quantitative and Qualitative Monetary Easing” (QQE), in order to meet a 2% inflation target within two years after 15 years of deflation. QQE means a shift of the operating targeting of the central bank to the monetary base, massive planned bond and other asset purchases, and a significant extension of duration in bond purchases. Market commentators almost uniformly concluded that QQE marks an extraordinary policy shift with historical dimensions and significant implication for global asset prices.
A new HSBC report suggests that if and when Quantitative Easing is being reversed it could be a watershed event for sectoral equity performance. Their view is based on the concept of “equity duration”. The long-standing outperformance of low-beta and high-quality stocks, which have longest duration and benefited most from three decades of falling yields, should come to an end and be replaced by relative strength of cyclical, financial and materials stocks.
Galsband and Nitschka claim that the outperformance of high-carry currency trades over the past 30 years reflects a premium for correlation with shocks to equity cash flows. While the finding may sound trivial, its implications are important. In particular, in connection with the negative impact of currency strength on local equity, the fx carry-equity nexus would imply that carry countries’ local-currency equity returns should outperform in crisis times, as they are buffered by the exchange rate and become a better diversifier, when all other correlation increase.
A new IMF paper argues that the short-term negative feedback of fiscal consolidation on economic growth is particularly strong at present, because of lending constraints, limits to monetary easing, and the global scope of restriction. As a result, fiscal tightening in today’s developed countries may, by itself, initially raise debt ratios over and above their trajectory without fiscal action. While the effect may not be lasting, it can lead to dangerous dynamics if financial markets fixate on debt dynamics and governments engage in multiple rounds of tightening.
Ever wondered why an asset or asset class maintains an implausibly high price? A new IMF paper summarizes research on “bubbles”, the phenomenon of a lasting overvaluation. It suggests, for example, that the focus on relative performance among asset managers and the presumption of informed decisions by peers causes herding. Also, limited liability of managers and leveraged institutions encourages upside risk taking. Meanwhile, sell-side research, rating agencies, and accountants often lack the incentives to pre-emptively reveal downside risks. Political and institutional aversion to short selling aggravates overvaluation bias.
Federal Reserve Chairman Bernanke recently explained globally low long-term yields as a combination of anchored inflation expectations, negative real policy rates, and a compressed term premium. The latter is seen as the key development since 2010 resulting from (i) the surge in private demand in the wake of reduced nominal volatility and negative correlation with risk markets and (ii) a surge in public demand resulting from asset purchase programs and FX reserves replenishing. Bernanke emphasizes that the Fed, markets, and forecasters all expect long-term yields to drift higher by 50-75bps per year through 2017. Yet, actually his reasoning would make a sustained directional change in yields contingent on fading crisis and deflation fears.
Citi equity research investigates the relation between currencies and equity markets. It suggests that typically large currency appreciation (depreciation) coincides with underperformance (outperformance) of the equity market in local currency terms. However, the currency moves tend to be larger than the equity moves. This supports the case for hedging local-currency equity exposure against currency strength and USD-based equity exposure against currency weakness. Hedge ratios should be diverse across countries, as correlation with currency weakness is a function of industry structure. Emerging market equities have historically not always correlated negatively with currencies due to the prevalence of crisis events.
Credit Suisse’s Dong Tao and Weishen Deng nicely summarize causes, size, and systemic risks arising from China’s rapidly growing shadown banking sector. Low regulated bank interest rates and rationed supply of credit have created ample incentives to by-pass the regular banking channels. By end-2012 the shadow banking sector has soared to about 44% of GDP and continues expanding at a torrid pace. Meanwhile, poor transparency and lack of risk management and regulation bode ill for credit and liquidity risks, and even a state bailout could involve a drastic deterioration of credit conditions.
Paul de Grauwe and Yuemei Ji have produced disarmingly simple charts that show why the euro area’s 2010-12 crisis response is being discredited. Essentially they illustrate that (i) market conditions rather than fundamentals have driven large absolute changes of credit spreads, (ii) fiscal tightening has been a mechanical response to credit spreads, and (iii) austerity has largely been self-defeating. Such evidence of failed excessive austerity dovetails anti-euro populism, underpinning euro area policy change towards more accommodation.
Macrosynergy is a London based macroeconomic research and technology company whose founders have developed and employed macro quantamental investment strategies in liquid, tradable asset classes, across many markets and for a variety of different factors to generate competitive, uncorrelated investment returns for institutional investors for two decades. Our quantitative-fundamental (quantamental) computing system tracks a broad range of real-time macroeconomic trends in developed and emerging countries, transforming them into macro systematic quantamental investment strategies. In June 2020 Macrosynergy and J.P. Morgan started a collaboration to scale the quantamental system and to popularize tradable economics across financial markets.
