Ilan Solot shares his thoughts on three key developments this week:
1) How would an optimist (or contrarian) try to make a case for buying Brazil today?
2) Between expectations, actions, and guidance, there are a lot of moving parts on the global board game of central banks.
3) A few words about classes, globally.
1/ How would an optimist (or contrarian) try to make a case for buying Brazil today? There are at least four sources of hope, however remote. (A) There is a cabinet reshuffle on the way, so there is room for a deal (between the PT and the PMDB) that could give the government some breathing room on its fiscal consolidation plans and the impeachment process. (B) Congress could vote on the government’s side regarding the positive fiscal measures, such as upholding the vetoes on spending. (C) The Treasury and the central bank are stepping up their interventions, with spot FX sales probably the next move, and they have plenty of ammunition. (D) A lot of the bad news must already be reflected in the price, and we are possibly well into overshoot territory. Is this enough to make up for interminable list of negative factors? Probably not, at least not just yet. But some assets – especially local rates and CDS – seem to be well into overshoot territory and will eventually be good targets for tactical contrarian trades. Markets (including ourselves) will remain unconvinced that we have reached the inflexion point, but as yesterday’s sharp moves show, it’s at least worth keeping an open mind. We maintain our view that while things are extremely dire in Brazil, the end game is not a repeat of a classic currency crisis resulting in sovereign default.
2/ Between expectations, actions, and guidance, there are a lot of moving parts on the global board game of central banks. On one side of the spectrum, Latin American central banks stand out as cluster of hawkishness, and at the margin, the ECB and the BOJ have recently been relatively less dovish compared with what some had expected. Draghi didn’t sound too sanguine on extending the ECB’s QE program, and neither did Nowotny. In Japan, many observers have been frustrated by the lack of signal for further easing. In LatAm, implied rates are pricing in a series of hikes in Brazil (though much is risk premium), Mexico could follow the Fed higher whenever it moves, Chile signalled a tightening bias, Peru could eventually follow up with more tightening, and Colombia’s central bank meets today and some expect hike. On the other side of spectrum, we have seen a dovish resolution to the dilemmas of many other central banks. The Fed refrained from an early hi ke, though a move this year still seems likely. Norway cut rates to a record low of 0.75% and Taiwan cut rates to 1.750%, both surprising the majority forecasters. Israel’s central bank kept rates on hold but said it’s open to unconventional measures. India seems likely to cut this month. Hungary’s central bank stated that it will keep rates low for longer than previously expected. Nigeria cut reserve requirements by 600 bp. In addition, there is still risk of more easing in a host of countries, including Sweden, Switzerland, Australia, New Zealand, and South Korea, while expectations for a BOE hike has been pushed to mid-2016.
3/ A few words about classes. “There is a very big difference between the psychological self-definition of class and anything approaching a useful economic definition of class,” according to Richard Reeves from the Brookings Institution. There has been a lot of interesting discussions on the topic of classes, maybe inspired by the popularity of Piketty’s work on income inequality. Let me highlight three recent ones: (A) Pew Research published a fascinating study on the global middle class. Here is a calculator where you can enter your annual income in 2014, the country you live in, and you can see where you fit in the global and national income scale. And here you can see the distribution globally, by country, and how it changed from 2001 to 2011 (see the first graph below). (B) The World Bank is set to increase the poverty line from $1.25 to $1.90, the biggest move in 25 years, which could nominally place an extra 150 million people (mostly in Asia) below the poverty line. (C) The St. Louis Fed published a paper in April (The Middle Class May be Under More Pressure than You Think) in which it takes ethnicity, education, age, income and wealth into account, then tries to break down the usual class taxonomy in America as such: thrivers, middle class, and stragglers. (See the second and third graphs below).