A stronger dollar could cause a 'massive global deflationary wave'
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Though most investors are worried that the failure of Japan’s Abenomics could drive the yen much higher and hence are fleeing Japanese equities, Macquarie analysts believe we might be close to an inflection point. In their April 13 research note titled “Rights, Wrongs & Returns,” Viktor Shvets and colleagues point to the Fed’s recent “dovish tilt” as recognition that it is essentially a global central bank, and hence, it must avoid adding fuel to the fire by minimizing policy divergences.
Global TFP growth rates turned negative
Shvets and team point out that whether one uses traditionally-defined labor productivity growth rates or a much more meaningful Total Factor Productivity (TFP), it is clear that the U.S. productivity growth rates have been on a declining curve for quite some time. They note that TFP growth rates started to decelerate in late 1970s and that, apart from a short-lived IT-driven pick-up in the late 1990s to early 2000s, TFP growth rates have been hugging the zero levels for more than three decades, with the average TFP clip dropping from ~140bps achieved in 1950-80 to ~25bps in the 1980-2015 period:
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The Macquarie analysts point out that the same trend of declining productivity growth rates is becoming evident across most emerging markets, with the only exceptions being some of the lowest income and least developed economies (such as the Philippines or India).
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The Macquarie analysts point out that the same trend of declining productivity growth rates is becoming evident across most emerging markets, with the only exceptions being some of the lowest income and least developed economies (such as the Philippines or India).
USD appreciation could cause massive global deflationary wave
The analysts note that ultimately, declining TFP prevents companies from improving their competitiveness and profitability and threatens the ability of countries to maintain or better their citizens’ standards. The Macquarie analysts argue that in the absence of productivity, there can be no deleveraging. They point out that the onset of GFC was the period of significant acceleration in EM debt levels, with China being the primary driver. Also, unlike many DMs, non-financial corporates were the key leveraging sector within the emerging market universe.
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Shvets and colleagues argue that if the private sector refuses to spend and multiply money, it would be only a matter of time before consensus (both investment and policymakers) swings towards much more proactive public sector activism.
Japan, Eurozone and China: countries in the deepest liquidity trap
The Macquarie analysts believe a sharp depreciation of the yen and euro and sharp appreciation of the U.S. dollar would prompt an uncontrolled depreciation of RMB and would cause a massive global deflationary wave. The analysts envisage two alternative courses that decision makers are likely to embark on over the next 12 months. As a first alternative, they see the Fed joining other central banks in much more robust monetary policies (such as QE4), while the second alternative involves the public sector embarking on active nationalization of capital markets and gross capital formation. The analysts believe the countries in the deepest liquidity trap (i.e. Japan, the Eurozone and China) would be the first to embark on these policies, with Japan as the most likely candidate for this policy alternative, while China, the U.S. and the Eurozone would eventually join Japan.
As an investment strategy, the Macquarie analysts believe the change in policy settings towards significantly more proactive public policy in directly driving investment would force investors to at least temporarily relocate funds towards reflating economies and sectors that are likely to be direct beneficiaries of Government largesse. Shvets and team believe “Quality-Sustainable Growth” should remain the basis for any equity portfolio. The following captures the analysts’ key recommendations and portfolios:
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