Brief Macro: Vietnam Picks up the China Baton and more

In this briefing:

1. Vietnam Picks up the China Baton
2. The Dollar IS the Story; Gold Confounds, A Brexit Rabbit Hole; EUR Punished
3. The Fed Is Increasing Financial System Fragility
4. Fed Policy Credibility: Financial Markets Raise the Heat
5. Japanese Inflation – Much Ado About Nothing

1. Vietnam Picks up the China Baton

The US-China trade dispute simmers on. Regardless of the outcome of talks between the two largest economies on earth, the damage to the existing world manufacturing trading order has already been done. China plus one is no longer a preferential industrial location strategy for multinational companies, it is an imperative. Like Brexit, companies are beginning to relocate out of China even before the dispute is either settled or escalated. Profits can’t wait for governments to behave sensibly.

But where to go? Indonesia and Vietnam are the most obvious potential beneficiaries of the fallout from the ongoing trade dispute between the US and China. There are a number of alternatives but Indonesia and Vietnam both have large, youthful working populations (and really here we are talking about the accessible workforces on Java and in Vietnam) and both are located within easy reach of the existing Asian supply chain. But are both equally ready and equally keen to pick up the China baton? Vietnam is the obvious winner in this contest. Unfortunately, for institutional equity investors the market isn’t included in Asia-Pacific or emerging market benchmarks.

2. The Dollar IS the Story; Gold Confounds, A Brexit Rabbit Hole; EUR Punished

• The dollar IS the story
• EUR punished for negative yields
• Chasing Brexit down a rabbit hole
• Gold confounds
• Bitcoin at an interesting juncture

The fact that the dollar has strengthened despite the dovish turn at the Fed this year and the significant fall in US rates and bond yields has confounded many analysts.

3. The Fed Is Increasing Financial System Fragility

While the Fed and Treasury stabilized and strengthened the financial system following the financial crisis we think recent decisions by the Fed are increasing the risk of future instability.  The Fed’s efforts to manage market volatility are potentially counterproductive and there are risks to addressing liquidity via abundant reserves concentrated at a few large banks.  Researchers within the Federal Reserve systems have raised concerns but policymakers appear to be discounting these warnings.

4. Fed Policy Credibility: Financial Markets Raise the Heat

The Federal Open Market Committee (FOMC) sought to further mitigate the fallout from last December’s rise in the federal funds rate by ignoring its own economic models, and, instead, embracing a more dovish outlook for the policy rate, as well as slowing the planned pace of its balance sheet roll off.

No further interest rate increases are envisaged by the FOMC in 2019, while any required in 2020 will not take policy settings into restrictive territory due to the imminent arrival of sustainable growth.

The persistently low inflation backdrop has permitted the Fed to embrace a dovish approach, but engineering a significant decline in real interest rates could prove problematic if the economy falters at some future point.

Fears about yield curve inversion and recession risks persist, despite the Fed’s dovish tilt, thereby potentially raising concerns about the overall credibility of monetary policy conduct.

US short-term interest rates are being anchored to a “new normal” environment of low inflation and slower economic growth compared to history, and, consequently, the bond market appears to have won its battle of wills with the FOMC by forcing members to reduce their estimate of the neutral federal funds rate.

5. Japanese Inflation – Much Ado About Nothing

Japan’s policymakers continue to fret about the lack of inflation but it is worth remembering the norm globally and historically is for the price of manufactured goods to decline over time. As companies grow, specialise and scale up the cost of production falls and with it final consumer goods prices. Falling retail prices which increase consumer real purchasing power is good news for Japanese households and for discretionary spending. Moreover with labour productivity growth outpacing wages costs by a wide margin, companies can absorb lower prices without sacrificing profitability. Stay overweight Japanese equities.