Markets Weekly podcast- 15 February 2021

Gerald Moser (GM): Hello its Monday the 15th of February, and welcome to the Barclays Private Bank Markets Weekly podcast, the recording that will guide you through the turmoil of the global economy and financial markets.

My name is Gerald Moser, Chief Market Strategist with Barclays Private Bank, and each week I'll be joined by guests to discuss both risks and opportunities for investors.

This recording will last around 30 minutes and will be broken down into three component parts. Firstly, I'll analyse the events that moved the markets and grabbed the headlines over the course of the past week.

I’ll then move on to our focus section where we’ll spend a few minutes discussing a specific investment theme. This week I'm pleased to say our special guest is Marvin Barth, Head of FX Strategy at Barclays Investment Bank.

With him we will discuss the latest developments in FX markets and the outlook for each major currency. And finally, I'll conclude by previewing the major events and data releases that are likely to shape the week ahead.

Let's start with markets from last week. Government bonds rallied on Thursday after Jay Powell, the Fed chairman, stressed there would be no rapid changes to monetary policy in the US.

He emphasised the importance of “patiently accommodative” monetary policy to boost the strained US labour market. The US first time jobless claims on Thursday confirmed the dire state of the US employment market with almost 800,000 new people claiming benefits 11 months after the initial economic shock.

The yield on the two year US Treasury bond briefly slipped below 0.1% for the first time on Thursday before steadying at the slightly higher level of 0.11%. Here, Jay Powell signalled that despite market fears of rising inflation, the Fed intend to keep policy the same until unemployment recovers to pre-crisis levels.

Talking about inflation, January readings for the US showed headline CPI below expectations with 1.4% year on year growth. Core CPI was also flat on the month, with growth coming down from 1.6% year on year in December to 1.4% year on year for January.

Core goods inflation did improve from the prior month, and its annual rate of 1.7% is elevated relative to historical norms.

However, we think that the upside from core goods will likely be offset by the downside from core services, leaving annual core CPI on the moderate side for 2021.

We maintain our view that inflation momentum in the US will remain subdued through 2021, with the exception of Q2 where positive base effects could push core CPI as high as 2.5% but that would be only temporarily in our view.

A strong positive base effect on that side is coming from oil. Oil prices rallied 18% year to date and it is currently trading at levels close to $60 per barrel, up more than 200% since the bottom in Q2 last year when it traded below $20 per barrel.

But in a report on Thursday, the OPEC, again downgraded their oil demand view for 2021, stating that demand will rebound more slowly than previously thought. OPEC expects demand to rise by 5.8 million barrels per day this year to 96.05 million barrels per day, a cut in the growth forecast of 110,000.

They stated that all demand is currently lagging the global economy recovery, but expect a pick up in the second half of the year. OPEC also trimmed its non-OPEC supply growth forecast to 670,000 barrels per day this year, from 850,000 barrels per day previously, showing supply from rivals is also underperforming.

The gloomier outlook for oil demand was also confirmed in the latest International Energy Agency report where oil demand forecasts for 2021 was cut for four months in a row. Concern about oil demand could put a halt to the oil rally we've seen so far this year.

Talking about rally, Bitcoin hit another record high above $48,300 on Thursday before falling back below 48,000. This was supported by Tesla's $1.5 billion investment earlier in the week and interest from MasterCard and Twitter.

MasterCard announced plans to allow cardholders to transact in certain cryptocurrencies on its network during 2021, and Twitter's finance chief said the company have thought about how it might pay employees or vendors using the cryptocurrency.

Elon Musk also announced plans for Tesla to begin accepting payments in Bitcoin. The digital currency is up more than 40% so far this year buoyed by institutional buying and its appeal as a hedge against potential inflation.

However, as a largely speculative asset it seems only a matter of time before the bubble once again bursts.

Looking at equity markets, they were almost unchanged last week. While macro drivers such as interest rates, stimulus discussion, and vaccine roll out continue to influence equity markets, it is important to keep an eye on the ongoing Q4 2020 earnings release.

Two-thirds of US companies have reported their earnings, while in Europe we are now past the halfway mark. Earnings have continued to come in better than expected. In the US +17% average surprise and that leaves the S&P 500 earnings year on year growth at +3% - a remarkable achievement as a year ago COVID-19 did not exist.

In Europe earnings have contracted substantially when compared to last year’s fourth quarter -15% year on year, but here too this is much better than feared with average surprise coming in at +25%.

Expectations for the full year now appear well anchored thanks to the combination of strong Q4 2020 numbers and likely normalisation in the second half of the year as vaccination campaigns gather pace.

While a lot rides on accommodative monetary and fiscal policy as well as successful vaccine roll out, micro-economic fundamentals should provide a strong support to markets.

Interestingly a few companies in the earnings call have indicated that they see a risk to higher costs in the near future. I expect that inflation will continue to be a key talking point in our discussions with clients in the next few weeks.

So we talked about government bonds, commodities, and equities. Now let's turn to FX, an asset class we don't talk enough about.

And for this I would like to welcome our guest on the show this week, Marvin Barth. Marvin is a managing director and the head of FX and EM macro strategy at Barclays Investment Bank.

Marvin, thank you very much for joining us today.

Marvin Barth (MB): Thank you Gerald, I'm very pleased to be here.

GM: Well as I said, we are pleased to have your expertise on FX with us today. So let me start with a question on the dollar.

There is a widespread belief that we've seen the end of the dollar dominance but I think you don't subscribe to that view. Could you please share with us your thoughts on the dollar?

MB: Yeah, I'm told that we're actually the only major bank on the street that is not forecasting the dollar going weaker in the year to come and you know, just to be very clear here, we're not talking about a lot of dollar strength either, we're just talking about in trade weighted terms we expect the dollar to be roughly flat a small appreciation in trade weighted terms.

That's going to be different by different currencies, some currencies are going to outperform the dollar so for instance we have the Canadian dollar is actually our top performing currency this year, and some currencies are going to weaken versus the dollar.

Several EM currencies do quite poorly but within the G10 the euro is actually our weakest currency versus the dollar.

GM: So, and why do you have this view that the dollar is going to be faring better than what most of the street expect?

MB: So I think this comes from our perspective which is much more asset allocation in orientation. So a lot of the street, I think, focuses too much on interest rate differentials and that's not to say that interest rate differentials aren't important they are, you know that is an important investment category it also clearly affects hedging decisions.

But ultimately, we have many other investments that take place across borders: private equity, public equity, real estate, real assets, all different types of corporate investments, types of foreign direct investment across economic borders.

And those tend to be driven much more by the underlying returns to capital in the economy so even if the interest rates go to zero, and in fact indeed if the central bank is actually being successful in stimulating the economy they are much more likely to raise the returns on capital.

And that's really where this comes from, we expect higher returns to capital across the board for the US given its superior growth path so far in COVID and our expectations for it to continue to outperform most other economies. That means that you're going to get more out of return from other asset classes.

But there's another important aspect of this which is people’s attitudes towards risk. And it's important to recognise that we've just been through the largest global economic shock in at least 70 years.

By our calculations it's one of the three or four largest global economic shocks of the last two centuries and it's not just an economic shock obviously as people know: it's a massive health shock, it's a psychological shock, it’s a political shock and it's even manifesting itself as a geopolitical shock.

All of those things are changing people’s risk preferences quite markedly in a way that I don't think anyone alive in markets today has seen before.

But if you go back and look in the first half of the last century you could see that traumatic events like World War One, the Great Depression, World War Two sustainably changed the way people thought about risk.

Equity went down as a share of people’s portfolios, bonds went up, people put a greater emphasis on safety. And one of the things that we saw last March quite clearly was that when people were in full panic mode there was exactly one asset in the world that outperformed every other asset - it was the dollar.

It went up versus every other currency, US treasuries went up versus German bunds, versus Japanese government bonds, versus gold. The dollar was King there and we're seeing that continuously in activity today when we do have markets start to become concerned about global growth or concerned about the uncertainties around us, the dollar tends to appreciate.

GM: That's quite interesting so you would almost say that the dollar could be a good hedge in your portfolio, which is something that there's a lot of talk at the moment of FX being used as a new asset class in a portfolio, now that the 60/40 portfolio - the one where you just do 60% in equities, 40% in government bonds and it's a good balanced portfolio - there's a lot of talk about that not working anymore considering the level of interest rates.

So you think that the dollar could be actually a good hedge in a portfolio?

MB: Yes, Gerald I do think that FX can be used as an effective hedge here and I think markets are using FX in that way and there have been some really interesting changes. So typically dollar/yen has been a great hedge i.e. owning the yen, being short dollar/yen and yet this time that didn't work out as well.

It's not that the yen has lost its safe status, if you look at euro/yen or Aussie/yen or Brazil/yen, any of those crosses, actually the yen did exactly what it was supposed to do throughout the entire COVID affair.

It's the dollar that has gained primacy in terms of its safe haven status, even out shining the yen here.

GM: That's interesting let's stay on that topic then and let's talk about the Swiss franc which is another widely perceived safe haven currency.

If I listen to you I would think that you are positive on the Swiss franc, but at the same time there's of course the fact that, it has been labelled as, or the Swiss government has been labelled as currency manipulators by the US administration.

So what's your, between those two factors, what's your view on the Swiss franc?

MB: Yeah so, I think you're absolutely right that the Swiss franc is definitely considered by most people a safe haven, I think it still is. The issue with the US is less of a concern, I'll come back to that in a moment.

I think it's much more about the Swiss national bank's policy that is actually the concern in terms of owning the Swiss as a safe haven asset right now. Which is that the SNB is trying to prevent further appreciation of the Swiss franc from levels that they consider considerably over valued and so they've been intervening heavily in euro/Swiss whenever it goes down towards 105.

And, so what that means is that in a risk-off event effectively the Swiss franc behaves just like owning euros and so you're losing that safe haven effect in the least in terms of its performance vis-a-vis other currencies.

Now the US actions. First of all, President Trump is no longer the President. Second of all, while it is the case that Switzerland meets all three of the Treasury Department’s criteria here this really ultimately ends up being a political decision.

We do think that the Biden administration will take a different path here and even if they continued to describe Switzerland as a currency manipulator, you know, the US Treasury over the years has gone to great lengths to denude the, you know, consequences of that.

Effectively the main consequence of that is that they would have to enter into negotiations with Switzerland over that and report back to Congress after a year.

So, given the change in administration I just don't think that this is a serious issue from the US side.

GM: OK, I mean talking about negotiation and just going back to something you said before about the impact of geopolitics when it comes to FX there's of course one currency that has been tremendously impacted in the last few years by geopolitics, and that is the British pound.

Now that Brexit is behind us, does that mean that there is only upside for the GBP?

MB: Well, you know, you have to be careful here because you never want to say anything is a sure thing, right. That said, especially in FX right, you know foreign exchange is a really interesting asset class in the sense that, you know, it is symmetric.

It should have equal upside and downside and it doesn't pay a dividend or anything like that, it's just a relative price.

However, we do know that over long periods of time purchasing power parity, the idea that goods and services should cost roughly the same across different currencies, really do hold in the long run and the further you get away from that, the more likely it is to reverse the direction of the currency.

So that is, if a currency becomes super, super cheap in purchasing power parity terms then it's very difficult for it to depreciate further and it's obviously a lot easier for it to appreciate and in fact it has a natural tendency to appreciate.

And that really is the case with Sterling. Sterling for the last few years because of Brexit has been trading near 60 year lows in real effective exchange rate terms and the behaviour of Sterling last year I thought was just incredibly interesting and really supported this idea that there does seem to be a floor there.

It didn't matter how bad the news was in the UK about, you know COVID cases, whether it was about Brexit negotiations, or what, Sterling just really could not depreciate, it continued to hang in there.

And so yes exactly to your point, you remove Brexit uncertainty now, people can go back to some sense of normality and ultimately that purchasing power parity effect does start to have some sort of effect and that should mean in that certainly in our forecasts that this should lead to persistent appreciation, particularly over a multi-year horizon, but even in our expectations over the course of the next year.

GM: OK,  fascinating discussion around the pound which I think is something that we get a lot of questions about so it's great to have your view on that.

Now let's turn to the last major currency we haven't really discussed in detail which is the euro. Do you think that the recovery funds solve the euro area problem, or do you think that the concern around slow vaccination roll out is too much for the euro to appreciate from here?

MB: Well, I think the euro area has a number of different problems and let's start with growth.

If we go back to the pre-COVID in world, and I know at this point it’s kind of hard to remember what the world was like before COVID, but if we think way back, in the way back machine, the euro area was really struggling to growth throughout 2018 and 2019.

Indeed, Germany and France were actually in technical recessions before COVID started. And then COVID hits and despite the fact that the euro area could claim to have lower per capita case rates across the whole of the euro area, and generally in most countries as well by the way, versus say the United States you saw that the economic outcomes in Europe were far worse.

GDP fell much much further in the lockdowns in the second quarter of last year and it recovered much more slowly than in the US and most other economies. And you look at the fact that the euro area was already in a situation where the ECB was ultra-dovish before COVID started, their ability to really sort of press the envelope here has been kind of constrained by their unwillingness to go further into negative rates, and so we should expect that their recovery is going to be weaker anyway.

But then yes, you add to this the fact, as you pointed out, that actually their vaccine deployment has been slower than most other major economies, that's going to delay things even further.

And so yes, there was an important uplift to the euro last year from the European recovery fund which I think is important to note it was often cast in, I heard the term, it's a Hamiltonian moment.

It wasn't a Hamiltonian moment. Hamilton guaranteed the debt of all the states, that didn't happen here.

You created a precedent for that to happen in the future and that's a really important step that we need to acknowledge and did show up in the value of the euro, but they have a long path from here and I think unfortunately the mood music in the background is kind of changing.

If you thought about the second half of last year, it was all good news about the recovery fund and how they were marching towards this, and this was really giving people greater hope about European fiscal union which is a multi-year process that ultimately is needed here.

But this year a lot of that momentum has stalled and it's in part because of the shift in politics here and the fact that several countries are going to have significant elections this year.

We're going to lose one of the key leaders in Europe in Angela Merkel when she steps down as Chancellor later this year, Germany is going to go to elections. We have the leader of the ‘frugal four’ the Netherlands going to elections next month, that's going to be a really tight election by the way.

And then we have, as we have already seen so far this year, Italy’s government is fragile and potentially may have to go to early elections. Spain also has a relatively weak minority government that could have to fall to early elections at some point this year.

All of those things mean that just the political mood music is going to be quite different this year and put all that together and that's kind of why we see the euro underperforming the rest of the G10 right now.

GM: OK now, that makes sense. There's always the political issue in Europe, it seems we never get a break from that.

To close the discussion let me ask you a broader question. What kind of behaviour have you seen from long term investment community and also the fast money community so far in the FX market this year?

MB: Well I think there's genuinely been a lot of confusion right because, to the first question that you asked me, there has been an incredibly strong consensus around this dollar weaker view.

And I've actually, because we had this out of consensus view, and the dollar hasn't weakened in fact it's been relatively strong so far this year, everyone and their mother seems to want to talk to me now and so I've been talking to a lot of different clients and the really interesting thing that I notice here, is who seems to be shifting to our view and agreeing with it.

It tends to be those that manage multiple assets i.e. are more in the asset allocation game, rather than specific specialised investment sleeves, those who have a longer term horizon and those who tend to be more experienced in markets.

And all of those types of clients that I speak to do really seem to be agreeing with this view that the asset allocation, picture does not suggest moving away from the US at this point, despite the decline in interest rates.

The shorter term, more specialised, focused investors are a bit more resistant to our view still, but the interesting thing about them is they seem to have completely lost conviction in their own views.

You know, market events have made them really start to rethink things. So, all of this in my mind really, reaffirms my conviction and confidence that we're on the right track here and we are thinking about these issues in the right way.

GM: Well Marvin, thanks again for joining us this week to share your thoughts on FX, it was very fascinating.

MB: It’s my pleasure and I'm happy to join whenever you'd like.

GM: We will welcome you again on this show for sure.

Looking into the next few days, February flash manufacturing and services purchasing managers’ indexes in the eurozone, UK and US will help to gauge the continuing effect of the pandemic on economic activity.

Manufacturing output in all three regions printed strongly in January, suggesting demand remained strong despite elevated virus cases. However, services continued the December contraction in both the UK and eurozone, worsened by the renewed lockdown measures introduced in January.

US services however strengthened in January, showing strong demand despite the worrying health outlook. The flash readings this week will help to indicate whether this divergence between Europe and the US has continued into February, and whether the reduction in cases and progress with vaccinations has improved the demand outlook.

We mentioned before the importance of inflation at the moment. Against the backdrop of suppressed economy activity, inflation rates remained generally subdued.

Wednesday’s UK January Consumer Price Index will likely confirm rates at disinflationary levels after the December reading of 0.6% year on year. We expect UK inflation to be low during Q1, before rising into Q2.

In Europe, we will also keep an eye on the latest inflation figure. In an interview on Friday, Jens Weidmann, President of the Bundesbank, predicted that inflation in Germany will surge to more than 3% later this year.

The head of Germany’s central bank also warned that if inflation rates rise in the euro area there will be a need for discussion around the direction of monetary policy.

While we are far from levels triggering any type of discussion around tighter monetary policy, it will be interesting to see if the euro area harmonised index of consumer prices final reading confirms the drop of 0.9% in January flash reading.

After five months of year on year deflation, it would be the highest rate since February 2020.

This is it for today. I hope you enjoyed listening to this podcast and we look forward to discussing latest markets development with you again next week.