Three Thoughts From London – Deval, Labour Party, Turkish Outperformance

1) The reaction in certain segments of financial markets shows just how much investors may be buying into the idea that China is engaging in competitive devaluation.
2) The UK’s political landscape could be about to change.
3) Turkey was the clear outperformer yesterday, and it continues to do well today.

1) The reaction in certain segments of financial markets shows just how much investors may be buying into the idea that China is engaging in competitive devaluation. For example, look at the Automobile and Parts subcomponent of the European Stoxx 600 index. The auto component was down 4% yesterday and is down 2.8% today, underperforming the full index by a large margin (first graph). We are not on the currency war side of this argument. While some yuan depreciation is surely welcome and likely in the short-term now that market forces will play a greater role, we don’t believe a sustained trend is their policy choice. And even if it were to be, it’s unlikely that the CNY would weaken enough to make a difference for European exporters. EURCNY has been on a multi-year downtrend since its high in 2008, falling 40% peak to trough in nominal terms (second graph), and far more in real terms. The associated risks to the Chinese financial system of trying to catch up via nominal depreciation (outflows, corporate foreign debt cost, etc) seem far too high to make this a strategy worth pursuing.

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IMAGE 2Here are a couple of notable items that may have gone under the radar yesterday:

2) The UK’s political landscape could be about to change. The Labour party maybe set for a big shake-up. Hard left self-styled socialist Jeremy Corbyn was a 100-1 shot outsider when he just scraped on the ballot a few weeks back, but now polls put him as “heading for 53% landslide first round victory,” according to YouGov. That said, recall that polls in the UK were well off the mark in the last elections. After the English electorate wholesomely rejected centre left Ed Miliband at the last election, appointing Corbyn as leader of the party could be interpreted as a protest vote. Either way, it will be a major change if he wins. On one hand, it could reinvigorate the UK left by creating a real difference between the views of the two parties. On the other, it could weaken the party further, since several MPs have already stated that they will refuse to work with Corbyn. The result comes out on September 12.

3) Turkey was the clear outperformer yesterday, and it continues to do well today. Markets are getting excited about the prospects of a coalition between the main opposition party CHP and the ruling AKP. The rally seems optimistic. First, an agreement is not yet at hand with negotiations continuing on tomorrow. And even if they agree, it will be a very fragile government. Second, the most important politician in the AKP, Erdogan, is reportedly not keen on a deal, preferring to roll the tavla dice on new elections. Third, the government has openly waged war on the Kurds, a minority that could compose around 20% of the country’s population, depending on how you count it. Yesterday, Erdogan called the elected Kurdish party, the HDP, the political extension of a terrorist organization. Meanwhile, F-16 planes bombed PKK targets in the Southeast of Turkey. It’s hard to grasp how this would be a net positive development for the country’s assets.