Economics, Politics, Policy & Markets

1830 words – a 5-minute read.

Today’s Musings come straight from prep notes for this morning’s BTV hit with Katie Greifeld. We covered a lot of bases for a summer Friday including SPY new ATHs, Fed inaction &  Our Age of Investment thesis which morphed into a discussion on Who Will Win the 2nd H of the 2020’s.

Much as our Global Risk Nexus (GRN), which provides the spine for our monthly writeups, runs through the factors noted in the title above, we think it makes sense to order this Musings around those same key building blocks to an investment outlook.

The economics are pretty straightforward and well laid out in our 4 for 24 global macro surprises: lower inflation, sooner than expected (check), better than expected productivity ( check for the US anyway); a return to stability (check - phrasing used by several entities including the World Bank this week) and an early cycle, not late,  global economy (check – if one looks at the semi cycle, Asian export growth, Strong JPM Global Composite Output index, EU recovery, China growth pick up etc. etc.).

It’s the politics that are causing some angst these days, especially in Europe. Who would have thunk it – that EU Parliamentary elections could create this much fuss and furor. These elections have been held for decades (this was the 10th such election though the 1st post Brexit) and are usually the opposite of financial markets movers. Yet in a nod to the policy shift from monetary policy to fiscal policy, ECB rate cuts & the Fed’s dot plot have both been pushed off the front page by European politics.

The far right’s surge in these elections has been headline material all week even though that language vastly overstates the reality as the far right gained only a modest pick up in total seats (less than 20 additional seats out of 720 + total seats) and with less than a quarter of the seats has no shot at displacing the centrist leadership coalition or stopping EC leader Ursula von der Leyen’s shot at a 2nd term.

 In fact, if one looks at where the far right governs or has recently governed (looking at you Hungary & Poland) the far right did very poorly with Victor Orban’s party in Hungary seeing its vote share plummet from the 2019 election cycle. Somehow that doesn’t make the headlines. There is a lesson here, namely that governing is tougher than posturing from the sidelines.

So yes, its in France and Germany, core EU countries with relatively weak Govts & muddled policies, where the far right did BTE but even here none of the angst would have manifested if not for French Pres. Macron’s decision to call a snap election & force a voter decision on the far right. Witness German Chancellor Scholz’s Social Democrat’s poor performance; does one read much about that? No.

We believe Pres. Macron understands the lesson noted above and thinks some cohabitation might dull voter enthusiasm for a far right that will have to defend tough political decisions on budgetary and fiscal matters should it enter Govt. We think he could well be correct.

From this armchair that decision doesn’t look as dim as it is being portrayed in much of the press. The twin forces on both edges – far right and far left - may well enter the Govt on some level but Macron will remain President and lead the governing structure which in turn will likely force the far right to modify much of its program – much as has occurred in Italy under Giorgia Meloni. Cohabitation might just lead to co-opting.

On the policy side several things jump out at us. First is the clear shift in market focus from yesterday’s story – namely inflation, rates and monetary policy dominance to fiscal policy, Government capacity and politicians’ capability. This of course makes for great headlines and breathless news coverage as we in the US have seen for many years.

Second, is how nicely this fits into our recent work on which Tri Polar World (TPW) region: Asia, Europe or the Americas will win the 2nd H of the decade. As we noted last week, the US and thus the Americas has clearly won the 1st H with a go big or go home fiscal approach to the post Covid, climate fight era. The chaser has been an Industrial policy designed to rebuild US manufacturing and assure a supply of both semiconductor chips to run the AI Age as well as EV battery and production platforms to meet the needs for climate mitigation.

We believe the winner of the 2nd H will be determined in the next several years given how fast the rate of change is and will continue to be. We believe governance will be a key distinguishing factor: which countries and regions can best expand its work force (immigration – another US edge believe it or not) while best integrating public (fiscal) and private capital at speed and with scale to fund the enormous investment needs. We note the US prime age labor force participation rate has been growing rapidly since 2020 and is now the highest in over 20 years.

Arguably, its better for Europe to get some of these issues aired and addressed sooner rather than later. Some are suggesting there could be a Liz Truss type moment ahead for the French Govt & bond market.

Marc Chandler makes an important policy point in his recent daily: “The French central bank shaved next year's GDP forecast to 1.2% this week from 1.5% projected in March. This will make it more difficult to comply with EC budget rules. It reinforces the pro-cyclical nature of European fiscal policy. Weaker growth forces fiscal consolidation, which in turns reduces growth. Rinse and repeat.”

We are also interested in thinking thru what it might suggest for the US in the months ahead given the Trump platform of extending budget busting tax cuts, implementing massive tariffs and seeking a weaker USD all of which could reignite inflation and create an ugly environment for vastly over owned US financial assets. One place where such political risk is NOT in the price? US financial assets – esp. the USD.

So, what does this all mean for markets? After all its not just European assets that have taken a bit of a header but also the financial markets in Mexico and India, two major EMs that have been visited by recent political & market upheaval.

We believe it’s worth noting some facts on the ground. The 10 year UST has rallied roughly 25 bps over the past month to 4.2% aided by BTE inflation data which in turn has helped the SPY hit new high after new high. So far so good.

The surprise is that in Europe – scene of all the political uncertainty and angst – the German Bund, the EU’s bellwether bond, has likewise rallied 20 bps thanks in part to the ECB rate cut. France, the epicenter of uncertainty, has seen an 8 bp widening over the past month – 8 bps. Its spread to Bunds has widened to roughly 75 bps, the most in a decade or so. Yet, we note that the French 10 yr. yields 3.1% - 110 bps LESS than the US.

Italy, the usual poster child for EU fiscal worries and bond spread blowouts, has widened 6 bps over the past month – 6 bps. The Italian – Bund bond spread has widened out 30-40 bps to 160 bps; to put this in context when the markets last worried about Italian fiscal profligacy the spread was closer to 300 bps.

What about the Euro? We have heard numerous references over the past few months to King Dollar and the USD wrecking ball – surely the Euro must be cratering? Well, no, actually its well above its lows from just a month ago around 1.06 (now 1.0680). The DXY is up roughly 4% YTD, 2% over the past one year and a whopping .5% over the past month. All this for half a precent move?

True the Mexican Peso has sold off hard, down about 10%, but that’s more reflective of market structure and the fact that that the peso has been one of the world’s favorite carry trades & best performing currencies over the past year. Mexico would probably welcome some FX weakness though perhaps not at this speed. It appears to be stabilizing and has rallied from its weakest point around an $/MXN rate of 19 to 18.47.

So, what are we at TPW Advisory doing during all this? It’s a good question and well timed as we are updating our two model portfolios – our Global Multi Asset (GMA) and our TPW 20 thematic model. We continue to see a global macro blue sky period for the 2023 -2027 period and believe much of the current European political angst will blow over as we move into earnings seasons in just a short few weeks. Perhaps to be replaced by US political angst but that’s a subject for another day! We are making no changes to our Mexican or European positions.

Within our models we are adding to one of our main themes – the fusing of the Digital and Physical realms though the powering of the AI factories – aka data centers. We are also taking a position in the Commercial RE (CRE) space here in the US; with inflation ebbing and rates falling we believe there is plenty of capital to stabilize the CRE and current deals at big discounts are a good thing as they signal the market is open. We note the regional banks bottomed months ago & that the CRE maturity wall falls sharply after this year.

Yields are quite high in CRE vehicles and so we sense that, much as we felt and feel with our 2 tech stack divide thesis and our call to buy China tech some months ago -  the risk reward is pretty good in the CRE space as one is being compensated for the risk via the yield and the  reward should be double digit with some minimal capital appreciation.

In the thematic space we are adding to renewables which have actually been the best performing part of the climate space for the past month or two. Much like we expect to see in the CRE space, this OP has taken place during a time of great woe and gnashing of teeth with story after story about solar overcapacity and plummeting prices etc. etc. It may also connotate market expectations for inflation, rates and the USD as well as growth – this segment wouldn’t be rallying into rising rates and recession. We continue to listen to Stoxx not Vox and the stocks (ETFs) are telling us its all in the price.

Enjoy this clip from Monday’s appearance on Schwab TV – Oliver Renick and I go back & forth on many of the issues discussed above – one can see the evolution of our thinking from Monday to Friday! https://schwabnetwork.com/video/the-gdp-of-g7-countries

TGIF folks!