Is Lula Unstoppable?
Who would have thought it was possible. To comeback and win the Presidency of Brazil with a margin of barely 2%. Markets are calm. Investors are happy. But how will Lula's new Presidency affect the Brazil Equity and Debt markets?
Despite winning only one out of five regions, with an overall margin of 2%, Luiz Inácio Lula da Silva will become the President of brazil on January 1, 2023. And Interestingly, the first ever to serve three terms (albeit not consecutively).
Replacing the right win Bolsonaro may result in protests and social unrest that could paralyse the country. And reports have today already started emerge. But markets are calm. And investment managers are generally positive on Brazil Equity and Brazil's hard currency and local debt.
Brazil currently has lots of positives. From a governmental and administration perspective, past corruption has resulted in stronger governance. The central bank is independent. Any extreme leftist fiscal policies can be countered by the now right-leaning congress. In fact, inflation is coming down, and the likelihood of rate cuts are more likely in Brazil than in the U.S., Europe, or Asia.
Many initiatives has also been launched on the investment side of the economy. Private Sector Banks are taking more share of the loan book. The all important Petrobras is behaving more like the global listed Oil sector industry - paying large dividends and de-leveraging. And vital infrastructure is receiving the attention is has long needed.
What Happens When Liquidity Dries Up?
As central bankers raise rates across the globe in their fight against inflation, institutional investors are turning their attention to liquidity. In this new chapter of global political economy, a world drained of liquidity is a world where assets are no longer priced on fundamentals.
Being short liquidity means sellers of assets will by necessity take what they can get in order to meet their commitments. Or put differently, being long liquidity facilitates the purchase of quality assets at deep discounts to intrinsic value.
This presents a dichotomy for institutional investors:
An ALM driven investor will be guided by a series of strategic asset allocation benchmarks and associated risk budgets. Which empirically provide a confidence level that their assets will generate enough returns to cover their current and future obligations. So the tendency is to sit out the storm.
But there are hard core investors who see the removal of liquidity from the global economic system, as an opportunity to pounce. Their research inside RFPnetworks is crossing all asset classes. Searching each of the 11 feeds for terms such as "cheap", "intrinsic value", "discount", and "distressed".
We see danger ahead. Markets are still too high, and protection is expensive in an increasingly nervous world; common sense suggests one should invest conservatively, and in safe assets. In a world where people find themselves without the ability to pay commitments as they arise, forced selling drives prices. Among risky assets like equities, one of the counter-intuitive things in a liquidity crisis is that securities perceived as safest and most liquid go down sharply, because investors are forced to sell what they can, not what they want to. We therefore regard plentiful liquidity in the portfolio as overwhelmingly attractive; it allows us to make the most of the opportunities that arise in the aftermath of a crisis. But first we have to get through the storm.
Is Inflation Headed Higher or Are We At Peak?
As the official rhetoric has moved from transitory, to permanent, to all-time-highs, the focus on protecting portfolios from inflation is traversing all asset classes. The search query 'Inflation Protection' brings back hundreds of new research results every week. So whilst this topic is at number 10 in terms of clicks, in terms of sheer volume of impressions it would be firmly at number one.
What is happening is lots of institutional scrolling, and headline reading. Institutions seem to be searching for the ultimate solution to inflation protection. It does not exist. But there is always hope. In the meantime, the novel ideas and in-depth analysis of the conundrum by asset managers, is being well received.
The thought that central bankers can do much to change the broad sweep of inflation is, in my view, far-fetched. Lowering interest rates and keeping them down ensured that, in the aftermath of the 2008 crash, the world escaped a dislocative deflationary recession, and experienced instead a reprieve from deflation. Their actions, however, had an inevitable consequence: the onset of a virulent inflation. This was perfectly predictable at the time, and, indeed, we predicted it.
There was, however, no money to be made from the insight that money had lost stability post-2008 – the car would swerve maybe towards deflation, maybe towards inflation, but the final result would certainly be inflationary, because the authorities’ obsession was (and is) to avoid deflation. The game changer was to be rightly prepared for inflation, and for the last ten years, we have been. To call it too early is, in our book, to call it on time.
What is the ECB Transmission Protection Instrument (TPI) all about?
The main focus of research in our fixed income feed was the ECB's new Transmission Protection Instrument (TPI). Most research was positive on this anti-fragmentation tool and it's clear objective - an unlimited bond buying backstop to facilitate the transmission of monetary policy across the EU. However, details on how it would work in practice with respect to peripheral countries, and particularly Italy, remain less clear.
Related to this theme was the ECB's decision to raise rates last week by 50 basis points. Almost all managers expected 25 basis points based on the forward guidance. As such, many managers are now questioning the credibility of forward guidance in an inflationary world.
Lots of questions remain.
Why Is The ECB Not Raising Interest Rates Faster?
Great question. What is the logic?
The last weeks brought lots of interest rate surprises from Central Banks.
But what does this all mean for Fixed Income Investment Manager Selectors? And Asset Manager Sales, Marketing and RFP teams?
What Are The Biggest Problems of Using Monetary Policy?
Unlike in Japan, the UK, US and now the EU are in all rates lift-off mode. With reluctance, Central Bankers have implicitly admitted their previous policy error of not raising rates sooner. But was this mistake deliberate? Or unpredictable? Last week, Asset allocators were searching for answers to these two questions in our Multi-Asset feed.
Policy Normalisation, Recession & Soft Landings
From the UK to Italy, and beyond, Central Bankers remain divided on the level of pain they are prepared to inflict on the economy as rates are hiked to combat the malicious food and energy driven inflation numbers.
Is there a solution?
Is 5% Growth Possible in China This Year?
In an uncanny way, China has a record of delivering on it's stated growth target. Come what may. But is it possible given the exogenous shocks it faces today?
On the one side, the zero-COVID policy currently imposes some level of restriction on 25-35% of the economy. Even beyond Shanghai. And it is unclear how long this will last.
On the other side, credit and public debt growth are gaining ground. And further policy support in terms of infrastructure spending is the data point many strategists are watching closely.
The Great Debate About The FED Being Behind The Curve
With the FED's official objectives of both price stability and maximum employment, the latest round of macro data has economists questioning FED rhetoric.
On the one side, US March 2022 headline inflation came in at 8.5%, whilst unemployment is projected to reach 3% by year end, a level not seen since the 1950's.
So should the FED be raising rates faster? And if so, why aren't they?
Will The Year Of The Tiger Roar Back?
At the start of this lunar year, investors were expecting the new term of President Xi Jinping to boost the economy's momentum following the COVID induced challenges.
However, with the overhang of the Real Estate sector troubles still causing headaches, and now the delicate political situation given China's relationship with Russia, investors are losing patience. How will the PBOC and the Chinese Government react?
Interest Rates & Quantitative Tightening
As the realisation sinks in that inflation won't be transitory after all, investors have been struck by quantitative tightening, multiple expected consecutive rate rises in 2022, and now an inverted yield curve.
What does this all mean for asset allocation, and how should investors adapt their portfolios?
Are China's Growth Targets Achievable?
With China still targeting 5 to 5.5% year-on-year growth, investors are now questioning whether this is feasible.
The fact remains that the real estate sector continues to struggle, with loans to developers at falling at a faster rate than has been seen in a decade. A drag on economic growth which is compounded by China's zero COVID case lockdown policy.
As things stand today, Asian equites & credit seem to be very challenging headwinds.