Summary
- Everyone has become a (secular) inflationist.
- Why an inflationist? Rising energy prices despite lockdown is a prelude, of sorts, to rising inflation since transformation of energy underpins all economic activity.
- Shortage of energy and also semiconductors, for example, sets us up for higher prices.
- Negative real rates due to central bank actions has prompted investors to shift from cash and bonds to equities and commodities.
- Where are bond yields headed? It will depend chiefly on central bank policies. Will they fully embrace yield curve control to keep the cost of government borrowing in check and in the process destroy the value of their currency? Or will they let the bond yields go towards more natural levels? The Fed is likely to go with the first option.
- US treasuries have come to be regarded as “anti-fragile”: they are understood to perform well when the rest of the components of an investor’s portfolio do badly. However, the current macro setup does not support this view, and these bonds can come crashing down when the market wakes up to this truth.
- Of late, equities and bonds have tanked simultaneously, undermining the 60/40 rule. In the backdrop of falling equity prices due to Covid-19, bonds have contributed to increasing rather than containing the volatility of one’s portfolio. The reason bonds cannot do their job of reducing volatility any longer is in large part due to their negative real returns.
- The failure of bonds to deliver in this respect has necessitated diversifying into other asset classes to reduce portfolio volatility.
- We must deploy capital in places where the currencies are not being debased. With the debasement of Western currencies because of unprecedented fiscal and monetary stimulus, the internationalization of Renminbi, de-dollarization of international trade, there is case to be made for owning Asian currency bonds, where the size of monetary and fiscal stimulus in response to coronavirus has at best been modest. These may be the new anti-fragile assets.
- The growth components of an investor’s portfolio are shifting from “growth from volume” (i.e. technology) to “growth from prices” (i.e. energy, material industries etc.). It makes sense in light of the upcoming inflation.
- Gold is a Mercurial player: it can do badly but also shine on an occasion and save the day when all other assets are faring badly. Given that real rates are going to fall because inflation is anticipated to rise faster than nominal yields, gold can be expected to perform well, very well, in fact, but only for a short span of time, after which it will consolidate (like always). Even though equities and other commodities (copper, energy) are doing well, should they tank in the future, we can turn to gold to work up its magic.
- Coming to energy, oil has a potential to rise higher still for one simple reason: demand from reopening will arrive sooner than the turnaround in production.
- Copper prices have soared already, but supply continues to remain constrained. In future, greater demand from electric car production etc. could spell a further rise in its price.
- China has taken over Hong Kong to help in internationalization of the Renminbi. And even though Hong Kong has remained mired in political tensions, it will continue to be a major financial center. Singapore has tons of finance business too, but it cannot replace Hong Kong any time soon.
- Because China has taken over Hong Kong, it is not in China’s interest if Hong Kong capital markets perform poorly. Indeed, they are thriving at present. China is now the guarantor of Hong Kong’s financial stability.
- Money printing is a dangerous way to fight the ongoing downturn: it can lead to exploding prices of commodities (for example, food). Add this to the pervasive confinement policies put in place to fight the virus, and you will have angered people a lot. There could be riots, too.
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