Helicopter Money: A Semi-Hostile Q&A

The latest Global Investment Strategy Weekly Report entitled “Helicopter Money: A Semi-Hostile Q&A” examines this very topical issue and concludes the following points:

  • Helicopter money is coming, and once deployed, will prove to be much more successful than most people imagine.
  • Investors should stay long Japanese and German inflation swaps.
  • USD/JPY and EUR/USD are ultimately likely to reach 140 and 0.9, respectively, over the next two years.
  • The U.S. economy will remain resilient enough to make helicopter money unnecessary but a strengthening dollar will greatly curtail the ability of the Fed to raise rates.
  • Investors should overweight Treasurys relative to bunds and JGBs.
  • Helicopter money will benefit gold as well as the beleaguered European and Japanese stock markets.

To access the report entitled Helicopter Money: A Semi-Hostile Q&A, please click here.

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Hiatus In The Dollar Bull Market

The latest Global Investment Strategy report is entitled “Hiatus In The Dollar Bull Market”, and examines why the greenback has sold off this year and what the path forward is. The Weekly Report also discusses the Fed and the U.S. economy, the BoJ, and China, namely arguing the following points:

  • The FOMC statement underscored the Fed’s willingness to take a ‘go slow’ approach to raising rates. While a June rate hike looks increasingly unlikely, a September and December hike remain in play.
  • The lagged effects from the easing in U.S. financial conditions over the past few months should boost growth in the second half of the year. Diminished labor market slack is also likely to put upward pressure on wages.
  • The BoJ’s reluctance to admit that NIRP has been a flop so soon after it was launched helps explain why it failed to provide more monetary support at this week’s meeting. We expect a new round of easing measures this summer.
  • Chinese stimulus efforts should last a few more months, after which time commodity prices will resume their structural downward trend.
  • As such, while the greenback could weaken over the next few months, this will simply be a hiatus in the dollar bull market.
  • Investors should remain tactically bullish risk assets for now, but be prepared to shift to a more cautious stance in the second half of the year.

To access the report entitled “Hiatus In The Dollar Bull Market”, please click here.

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Escape From The Land Of The Rising Yen

Our Global Investment Strategy service published a report entitled “Escape From The Land Of The Rising Yen”, which discusses the following points:

  • Hopes that Abenomics would lift Japan out of its deflationary quagmire are being crushed by the weight of a stronger currency.
  • The BoJ’s experiment with negative interest rate policy has failed. While direct currency intervention remains an option, it is one that is unlikely to be exercised until after Japan hosts the G7 Summit in May.
  • There is a high probability that the planned April 2017 sales tax hike will be postponed, perhaps indefinitely.
  • Combining a major stimulus package with “helicopter drops” of money and an increase in the inflation target to 4% may be the only way to permanently overcome deflation. Policymakers are not at the point where they are ready to do this, but they are getting there.
  • The yen is likely to strengthen some more in the near term. However, the long-term path for the currency is to the downside. This makes Japanese stocks a long-term buy as well.

To access the report entitled “Escape From The Land Of The Rising Yen”, please click here.

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Strategy Outlook: Ten Predictions For The Rest Of The Year

Our Global Investment Strategy service recently published their Q2 Strategy Outlook, which highlights ten predictions expected to drive global financial markets throughout the rest of the year.

The quarterly report discusses topics such as:

– How the global macroeconomic backdrop justifies a neutral stance on risk assets.
– How the ECB and BOJ will have to ramp up their monetary policies, using much more unconventional measures, while the Fed dials up its hawkish rhetoric.
– The outlook for the dollar, as well as Treasurys, given the continued divergence in monetary policies between the U.S. and the rest of the world.
– The outlook for U.S. equities given expensive valuations. Does it still make sense to overweight European, Japanese and Chinese stocks relative to the U.S.?
– Does the jump in commodity prices have staying power?

In addition, the report touches on themes such as the current situation in the U.S. high-yield market, and the elevated political risks engulfing the world today (namely the U.S. elections and BREXIT).

To access the full report entitled “Strategy Outlook: Ten Predictions For The Rest Of The Year”, please click here.

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Low Potential?

One of the raging debates among economists and investors these days concerns the size of output gaps in the major developed economies. If output gaps are smaller than widely believed, central banks will need to tighten monetary policy earlier than expected, which could trigger a selloff in equity and bond markets.

The IMF estimates that the output gap will reach 2.2% of potential GDP in advanced economies in 2014, down from a high of 4.9% in 2009.

What is often overlooked is that output gaps would be much larger today had it not been for a significant decline in potential GDP growth. Chart 1 shows the growth of real potential GDP in a variety of countries and regions since 2008. Each panel contains two series: one drawn from the IMF’s April 2008 World Economic Outlook database; the other from the most recent projections released in April 2014. (The IMF did not make output gap projections back in 2008, so I assumed that whatever output gap the IMF estimated for 2008 would eventually converge to zero in 2014; this allowed me to back out projected potential GDP growth).

Low Potential? - Chart 1

The numbers are striking. For advanced economies as a whole, the IMF estimates that real potential GDP will be 7% lower in 2014 than what it projected in 2008. For some countries, the drop in potential GDP growth is immense: for example, the IMF estimates that real potential GDP in Spain will be 21% lower in 2014 than what it had projected in 2008. In the case of the U.K., potential GDP is likely to be 10% lower.

Are these estimates correct? To be sure, potential growth must have slowed over the past six years relative to what the IMF had expected before the crisis. The Great Recession led to a steep drop in capital spending, which sapped productivity. It also undoubtedly caused many people to flee the labor market, some of whom are unlikely to return.

Yet, the sheer magnitude of the downward revisions to potential GDP strikes me as excessive. The weakness in capital spending has likely pushed up the rate of return on capital (this is one reason why profit margins are so high), which should give a nice cyclical boost to capital spending going forward. In addition, a large share of youth who dropped out of the labor market will eventually return (quite a few decided to stay in college, which is not necessarily a bad thing). And perhaps most importantly, many workers who remained in the labor force have ended up in substandard jobs that do not fully utilize their skillsets. Stronger labor demand over the next few years should allow them to transition to jobs where they are more productive, helping to boost potential GDP.

Back in the 1930s, many commentators argued that the economy had suffered a permanent loss of capacity. Yet, as Chart 2 shows, real per capita GDP eventually returned to its pre-Great Depression trend by the 1950s. If this happens again, it would imply that today’s estimates of potential GDP are too low, which is another way of saying that the output gap may be bigger than widely estimated. In that case, tightening too early because of a fear of diminished spare capacity would be a huge mistake (just as it was in 1937).

Low Potential? - Chart 2

I suspect that Janet Yellen is quite sympathetic to this line of thinking, and as such, she will want to see a meaningful burst of inflation before she starts to hike rates. But if the output gap is bigger than commonly believed, as I think is the case, that burst of inflation may not occur for several more years at least. This calls into question the widely-shared view that the Fed will start raising rates next year.