Saturday, 24 September 2016

Trump Bleeds Mexican Peso: a ´Peso Problem´ or Prediction?

According to Deutsche Bank, the Mexican Peso (MXN) is now the world´s cheapest currency on three fundamental valuation metrics: MXN purchasing power beats others; effective exchange rates are at historical lows; and the fundamental equilibrium exchange (external and internal balance) has dropped into the sink. [i] The question is: does the cheap Mexican Peso reflect a “peso problem” or a rising probability of a Trump presidency?
The term “peso problem” is often attributed to Milton Friedman in comments he made about the Mexican peso market of the early 1970s when the interest rate on Mexican bank deposits exceeded the interest rate on comparable U.S. bank deposits, despite a hard peg of the peso to the US dollar since 1954. Peso problems can arise when the possibility that some infrequent or unprecedented event may occur affects asset prices. The event must be difficult, perhaps even impossible, to accurately predict.

The event now is a Trump presidency that hopefully will never materialise. The markets have tended to assume that Hillary Clinton would win the election but the polls have narrowed and some have Donald Trump ahead. No doubt, a Trump victory would be a disaster for emerging market assets. Countries that run a heavy bilateral trade surplus with the United States would suffer from isolationist and protectionist U.S. policies. Countries that rely on financial markets to fund their current account deficits would suffer from a rise in US interest rates as a result of loose fiscal/tight money policy mix under a Trump presidency. Société Générale has found that Treasury bond yields tend to rise when Mr Trump gains in the polls while emerging market currencies (and the Mexican peso in particular) tend to fall. Citicorp economists recommended this summer to short the MXN as a “Trump trade”.[ii]

A Trump victory would be negative for the entire emerging market asset class – with perhaps the notable exception of the Russian market as Western sanctions would likely be withdrawn. So far, however, MXN has priced in substantial Trump risk premia.  MXN has underperformed emerging market currencies (EM FX) since May (use of MXN as a hedge for EM risk), but this underperformance has accelerated recently. According to Deutsche Bank, MXN has decoupled from external factors such as the oil price or the S&P500, being increasingly driven by Trump risk premia.

Scary prospects if the MXN is a reliable predictor of the outcome of U.S. elections to be held in November! By contrast, the MXN risk premia would unwind with a Trump election loss, implying scope for substantial MXN appreciation. Consequently, there is significant room for MXN appreciation (round 20%) if Trump loses the election. So if you like neither candidate – like so many – you can still sweeten the outcome with your personal MXN bet.

[i] Gautam Kalani and Guiherme Marone, “MXN´s Trump Card”, Deutsche Bank Research, 19th September 2016.
[ii] Dimitra DeFotis, „4 Trump Trades For Emerging Market Uncertainty”, Barron´s, 2nd August 2016.

Thursday, 1 September 2016

Reflections on the G20 Hangzhou Summit

Yawn, we are approaching another G 20 summit. Yawn because these summits have a history of proclaiming self-evident truths that subsequently aren´t implemented. Their promises are as quickly forgotten as their stiff photo snapshots with 30 or so ´world leaders´.  The 2016 G20 Hangzhou summit, planned to be held on 4–5 September 2016, will be the eleventh G20 meeting. China’s slogan for this summit is “Towards an innovative, invigorated, interconnected, and inclusive world economy.” Who could object?
What are the macroeconomic stakes?  First, to stimulate growth, fiscal expansion in G20 surplus countries is urgently required. Second, G20 structural policy should focus on rolling back the protectionist measures taken since 2008 in the G20. Third, monetary policy is largely exhausted. At the  G 20 Brisbane summit held in 2014, G20 leaders set the goal of lifting GDP by at least 2 percent by 2018. Yet, despite unprecedented monetary stimulus much of the G20, GDP growth  projected for 2016 remains well below target growth in the Euro area (1.6%) and in Japan (0.3%), according to the IMF (WEO Update, July 2016). Don´t blame the host, China: In 2015, China contributed roughly 30 percent to global economic growth-even with its growth slowing to 6.9%, the increment of GDP that it added to the world was around $760 billion.
The policy package required for achieving the Brisbane goal – monetary, fiscal, structural – seems to have relied excessively on the central banks to do a growth job for which they aren´t assigned.

·         Monetary policy: The collateral damage of monetary easing has been the danger of competitive devaluations, notably of the Japanese Yen.  G20 policymakers have repeatedly pledged to refrain from competitive devaluations and not to target exchange rates for competitive purposes.  China hopes to constrain Japan on FX intervention and to limit further downside for the EUR and GBP (CICC, Daily Briefing, 24 August 2016) with the help of the Hangzhou summit. According to Deutsche Bank´s August 2016 FX valuation snapshot, the Chinese Yuan ranks with the Swiss Franc as the most overvalued currency on all metrics used (DB effective rates; FEER; PPP). From China´s perspective then, there is little room for monetary easing elsewhere but in Beijing. It would be disingenuous to ask Beijing for more appreciation, also from a global growth perspective.
Graph: The Yuan - the most expensive G20 currency

Source: Deutsche Bank Research, FX Valuation Snapshot, 31. August 2016

·         Fiscal policy: In contrast to monetary policy, there is ample room in G20 surplus countries for fiscal expansion. G20 surplus countries beggar their neighbors by crowding in foreign demand via their savings-investment surplus. Within the G20, China, Japan, South Korea, Russia, and the Eurozone ran a balance of payments surplus last year of over $1 trillion, on average 4 percent of their GDP. In the case of Germany, the surplus is currently over 8 per cent.  The G20 needs to blame Drs. Schäuble and Merkel directly and forcefully to drop their pathological fixation on the “black zero”, the balanced fiscal budget with no red ink. Raising public spending and lowering income taxes in the G20 surplus countries are the most direct way to stimulate world demand and growth in times of zero interest rates.

·       Structural policy: Priority action for the G20 should be a standstill and rollback of trade protectionism. While global trade stagnates, FDI into G20 nations has yet to break out of a narrow range witnessed since 2009. According to the latest report by – a pre-G20 summit briefing on investment and protectionism - the sustained violation of the G20’s pledge on protectionism has resulted in nearly 4,000 trade barriers and distortionary incentives. Seven G20 members have implemented more protectionist measures this year compared to their crisis-era annual average: Australia, the US, UK, Saudi Arabia, Italy, France and Germany. The five BRICS countries, by contrast show a better trade policy performance, but only in comparison.

Graph: Ranking G20 Member Protectionism

Source: FDI Recovers? The 20th GTA Report, CEPR Press 2016.

Name and shame specific G20 countries (as outlined here) that are first and foremost responsible for global lackluster growth: this is the noble task that G20 leaders, especially US President Obama, will face this weekend. On Tuesday, 6th September, the world will hold G20 leaders accountable.