Markets Weekly podcast - 18 January 2021

Welcome to this week’s Markets Weekly podcast. This week our host Henk Potts, Market Strategist for EMEA, is joined by Gerald Moser, Chief Market Strategist, both from Barclays Private Bank.

Moser tackles the cryptocurrency question and dissects whether it makes a good alternative investment. He cautions that the threat of regulation makes it risky. Potts looks at what investors can expect from Biden’s administration, with a particular focus on the recently announced stimulus package.  He also explores China’s resilient export and growth figures, along with the US inflation outlook and its impact on monetary policy.

Henk Potts (HP): Hello it’s Monday the 18th of January and welcome to 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 Henk Potts, 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 15 minutes, and 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 will 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 that our special guest is Gerald Moser, Chief Market Strategist for Barclays Private Bank.

We will discuss the outlook for cryptocurrencies and their place within portfolios. And finally I'll conclude by previewing the major events and data releases that are likely to shape the week ahead.

But let's start by reviewing last week’s action. Investors spent much of last week assessing the prospects for the new administration in the United States as opposed to considering the implications of an historic second impeachment for the outgoing President.

In some ways it felt equities struggled for direction against the backdrop of stocks near record highs, elevated valuations, and the imposition of ever tighter restrictions to contain new highly contagious variants of the coronavirus.

However, expectations that governments will continue to support activity fuels optimism that recovery will indeed be robust once virus disruption starts to abate and corporate profit growth will help to justify the rally.

In terms of market performance on Wall Street stocks eased back from record highs. The S&P 500 was down 1.5%, its biggest weekly decline since the end of October. In Europe, equities registered its first weekly drop in five, stocks retreated from 11-month highs early in the week.

Cyclical stocks coming under pressure, STOXX 600 was down 0.8%. US bond yields eased back from recent highs due to strong demand at a sale on Wednesday, but it was really Fed officials pushing back on fears that the central bank is getting ready to taper purchases that filtered through to market expectations.

This week investors, I think, will focus on the transfer of power from Trump to Biden. Wednesday's inauguration will encourage investors to consider the administration's policy objectives.

With the Democrat victories in the Senate run-off elections, the moderate blue wave is likely to have a significant impact on domestic policy and international relations.

On Thursday last week the President-elect laid out his ambitious $1.9tr relief plan. In terms of size it's close to March’s CARES Act, that’s on top of the $900bn December relief package.

Its aim is to control the virus, boost consumption, and provide support for low paid workers, small businesses, and state services. Key measures include, well for the virus $20bn to create a national vaccination distribution programme, $50bn to improve testing capability.

In terms of the economy and workers well another round of direct cheques to individuals, perhaps as much as $2000, increasing a weekly federal unemployment benefit to $400, extending it through September, help for state and local government to meet the shortfall from low tax take and higher spending, another $170bn dollars to support the reopening of schools, increasing loans and grants for small businesses and a proposal to increase the minimum wage to $15 an hour.

In terms of the impact, well, of course there's still a real question over the implementation. Certain provisions, as we know, can be achieved using the budget reconciliation process if required.

But legislation that affects spending, revenue and the debt ceiling requires a 60 vote majority in the Senate and therefore could be significantly watered down. We do know the measures will help to stabilise economic conditions and bridge the gap between the pandemic and the vaccine and will, as we know, of course result in substantially larger fiscal deficit.

Beyond the current announcement, analysts are also expecting an infrastructure spending package, with elements of climate and energy policy, to come in the second half of the year.

A more active regulatory agenda looking at trade, foreign policy and international cooperation. We think you’re likely to see a pivot towards multilateralism, significantly lower risk to US and EU trade.

If you look at US-China policy, it may not actually differ greatly in substance from the outgoing administration. The tariffs are likely to remain but will differ I think in tone and consistency.

In healthcare the Biden administration are expected to significantly strengthen the Affordable Care Act but political commentators assign a much lower probability to a higher corporate and individual tax rate as possible revenue raisers.

On the data front investors focused on the US inflation figures along with trade and GDP numbers coming through from China. US headline CPI rose 0.4% in December, it's very much driven by that volatile food and energy component.

If you look at underlying price pressures as measured by core inflation, they actually weakened in December - that was due to reduced momentum in labour markets, subdued demand, and waning rent prices in large urban areas.

Core consumer price index increased just 0.1% from the prior month. Compared with the year earlier, core CPI rose 1.6%. In fact, if you look back through 2020 CPI increased just 1.4%, that's the smallest gain since 2015. Core inflation rose 1.6%, that's the smallest rise since 2014.

Moving on to the outlook, US inflation is expected to remain subdued throughout the course of this year with shelter and medical services inflation significant headwinds, with the exception I think perhaps in the second quarter when base effects could temporarily push CPI above the 2% mark.

We look beyond that into 2022. If activity in labour markets recover further, aided of course by another large stimulus package and vaccination roll out, it should enable mobility and economies to return to much more normal levels.

As a result, inflation momentum should pick up as we look through next year. We have core inflation at 2.3% at the end of 2022.

What does that mean in terms of Fed policy? Well, the Fed will want to guarantee the recovery before considering tightening rates. Its new inflation target, to remind you, allows for periods when PCE inflation can moderately overshoot the 2% target. Policymakers, as we know, have vowed to keep rates close to zero through 2023 but tapering of its asset purchases could start in early 2022.

Moving on to China. Chinese exports surged at the end of last year. Exports were up 18% in December, the second best year on year gain in 2020. Fourth quarter monthly export growth averaged 16.9%, that's markedly stronger from the 8.9% in the third quarter.

The surge in exports led to the trade surplus to widen to another record high, coming at $78bn dollars for December. A breakdown of the numbers point to strong growth in both COVID and non-COVID related exports.

The fourth quarter strength in exports is expected to continue through the first half, supported by policy stimulus in Europe and the United States, ongoing COVID-related demand until of course population immunity is achieved, and China's control of COVID as we know is helping it to take market share from manufacturers in pandemic hit regions.

In terms of the growth figures that we've seen, China's economy grew at a fast and expected 6.5% in the fourth quarter. It is expected to be the only major region to register growth in 2020. Full year growth was 2.3%, although we should remind ourselves that’s still the weakest that we've seen in four decades.

Look at the breakdown: industrial production rose 7.3%, it’s up 2.8% in 2020, retail sales rose 4.6% in December but that's actually a slight deceleration from the 5% that we saw in November, fixed investment was up 2.9% compared to what we saw in 2019.

The Chinese economy certainly looks in pretty good shape as you look through this year. Strong export demand, robust factory output, rising domestic retail sales, steady fixed asset investment provides a growth rate close to 8.4% for the course of this year.

So that's where markets finished off. Let's move on to our focus section on cryptocurrencies.

For some they’re a revolutionary asset class which offer tremendous opportunities for investors, for others it's a dangerous game of pass the parcel.

Gerald, good to have you with us today.

Let's start with the fundamentals. How different are Bitcoin and other cryptocurrencies from traditional currencies?

Gerald Moser (GM): Good morning Henk. Well, a currency is used to store value but also as a means of exchange, so if you think about it you really trust whichever entity is behind the currency if you want to use that currency.

So, for example, if you use the dollar you think that the US government or the Fed will be good on the value of the dollar you’re holding.

So you see that in the FX market on a very regular basis when it's risk-on it's usually the currencies of the weaker countries that do well, but when its risk-off you have the safe havens like the Japanese yen, the Swiss franc, or the dollar that outperform.

So in a normal currency you have a backer and usually it's a state which means that it has a lot of economic power, also legal means, it can decide if a currency can be used to pay on its territory whereas for Bitcoin and cryptocurrencies those currencies are not backed by any issuer, they are decentralised.

That's one positive when you listen to people that are enthusiastic about Bitcoin because that means they can't be manipulated, you can't have the central banks printing money like we've seen during the different quantitative easing phases but also at the same time that means it's a bit like gold.

The value of those cryptocurrencies are only equal to our collective thinking of what the value should be - it's very theoretical in a way and you can't really link it to economic power like you can do with normal currencies.

And I think this is also bit of an issue because if you think of Bitcoin and cryptocurrency as currency i.e. you would store value, it doesn't work very well right now because of the volatility. You wouldn't want your value that you store in Bitcoin to fluctuate as much as it's done recently. I think that's one of the drawback of cryptocurrency and Bitcoin in particular.

HP: Okay let's think about cryptocurrencies from an investment perspective. Does it make sense to add Bitcoin in an investment portfolio?

GM: Well there's been a lot of hype about Bitcoin because of the very strong performance we've seen since I would say October. But let's take a step back and think about why you would add an asset to a portfolio.

You really have to have an analysis in terms of risk return profile - is this asset improving your return or/and is it improving your diversification.

As I said before, it's extremely difficult to know what would be the fair value of Bitcoin because again it's not really backed by anything.

So let's just assume for a moment that the return would be equal to what you would get for gold, I mean after all a lot of people call it digital gold, I'm not saying that that should be the case but for the sake of the argument let's assume that we expect to be doing like gold for example.

Then if you had Bitcoin you would hope that it would diversify your portfolio. It's not really the case if you look at the data.

I mean first of all we said before the standard deviation of moves in Bitcoin is multiples of what you see in even the most risky assets like equities, but then on top of that when those risky assets are selling off and if you look at the last few years when you had a selloff in equities, usually Bitcoin fared even worse than equities so it didn't help the portfolio, it actually compounded the loss that you would see during a market downturn.

And in that sense it also an indication that it's clearly quite a bit of a speculative asset, it does extremely well towards the end of a bull market or before a correction because people get very optimistic and then when the correction happens you see that, the pullback is even worse which is really because you had a lot of retail participation.

Now you've seen some institutional, financial institutions coming in and saying we want to start looking at bitcoins, but still I think it's very much a retail driven market and that's why also it's quite unstable.

So, to answer your question, I think it's very difficult to make the case for Bitcoin as an asset to add to a portfolio as it doesn't really improve the return profile and it certainly doesn't improve the risk profile.

HP: Well I think as you quite rightly mention it's certainly been a violent few weeks of volatility for Bitcoin. Where do you see it going from here?

GM: As I said it's extremely difficult to build a model that would allow you to know what is the fair value for Bitcoin, it will probably continue to be something that investors use for short term bet on upside.

However, I also think that it's very much at risk of any regulation. We've heard from Christine Lagarde last week that she would like to add regulation to Bitcoin, we've heard similar statements in the US, so that I think is a big risk when you think of cryptocurrency and Bitcoin, the regulation that any state can put on Bitcoin.

And bear in mind there are already quite a few countries where you can't use Bitcoin as a means of payment which probably reduces its value close to zero. If you can't use it, what's the point of it?

So I just think that Bitcoin from here, we have to follow very closely what the new Biden administration will decide in terms of regulation and there will be a new SEC chair very soon.

We have to see what central banks will do and I think the next ECB meeting will be interesting from that prospect. Clearly it has been overstretched recently if you look at the technical, so I wouldn't say that it's necessarily a good time to buy Bitcoin.

And then finally a side note, but Bitcoin is also very negative when you think of the carbon footprint of your investment or your portfolio.

Mining Bitcoin requires energy similar to what a small country would need for a year of electricity production. So clearly it's not very sustainable and that's only going to get worse because the energy you need to mine Bitcoin goes up every day.

So that's something to keep in mind really when thinking about the future of Bitcoin.

HP: Well Gerald thank you very much for your insights today. I'm sure the volatility in cryptocurrencies will continue. As always time will tell if cryptocurrencies are indeed that huge bubble or indeed the start of a financial revolution, but there's no doubt buyers need to be extremely careful. Any investment should very much be seen as highly speculative.

This week the focus will very much be on the European central bank's meeting on Thursday where the weak growth profile for the eurozone along with subdued inflation expectations certainly keeping pressure on the central bank.

However, interest rates are already in negative territory leaving the European central bank with very little room to manoeuvre. We expect the deposit rate to remain at minus 0.5% at this week's meeting and for the next two years and the bank continuing to focus on liquidity support.

In terms of data, January flash manufacturing and service purchasing managers’ indexes in the Eurozone, UK and the US will help to gauge the continuing effect of the pandemic on economic activity.

Manufacturing output in all three regions printed strongly, as we know, in December suggesting demand remained robust despite rising virus cases. However, services fell into contraction in both the UK and the eurozone, pushing the eurozone composite into contractionary territory.

Services in the US remained strong in December. The flash readings will help to indicate whether the further lockdowns introduced in the UK and Europe post-Christmas have continued to suppress services activity and if the strong resurgence in virus cases in the United States has negatively impacted this strong demand.

Against a backdrop of suppressed economic activity inflation rates generally subdued as we've been talking about. Wednesday's UK December consumer price index will be likely to confirm rates at disinflationary levels after a November reading of 0.3%.

With that I'd like to thank you once again for joining us. We hope that you found this podcast interesting, informative, and it provided you with a suitable warning over cryptocurrencies.

We will of course be back next week with our next instalment but for now may I wish you every success for the trading week ahead.