Summary

Andrew showed us how the world is moving into two distinct blocks. Conditions within the Pacific area, including the US, are diverging with those seen in Northwest Europe and the Atlantic region. The pandemic shocked supply as well as demand. US money supply is up 25-30% larger with an economy producing 98-99% of its pre pandemic levels. We have therefore seen an increase in underlying inflationary pressures which have been building much faster than expected. These unprecedented transfers from public to private sector entail an entirely different situation to what we saw in the wake of the GFC. In 2009 funds transferred through QE were used predominantly to repay debt in a financial system that was seeing austerity, de-leveraging and shrinking of bank balance sheets. This destruction and absorption of money was the principal reason for low inflation. Today, it’s the opposite: huge transfers to a re-leveraging private sector. In June 2020, the financial sector created $800 billion of new credit in a single month! US households have become substantially wealthier, with disposable income growth in 2020 significantly higher than previous years. Moreover, it is anticipated that the Treasury will soon add a further $1 trillion added to retail bank deposits, which will likely soon be recycled into a significant increase in financial sector leverage and therefore fund flows into the US domestic market and abroad. The end of the pandemic means US coordinated growth and therefore the likely return of a Phillips Curve - we can already see signs of wage inflation. The US also needs to be wary of external sources of inflation. 1/5th of the US CPI is made up imported or import sensitive goods. Asia’s export price deflation historically reduced US CPI by 50-100 basis points per annum but onshoring and higher inflation in Asia is only going to result in global inflation. It is a perfect inflationary storm, perhaps taking hold from late Q3 to Q4. The Fed will react to inflation if it hurts the poorest members of American society, moving cautiously to a positively sloped yield curve by the year end. The disaster scenario for markets would be a correlated bond and equity sell off. In Asia, we are seeing domestic demand growth and a focus on profit maximisation for corporates so overall a very attractive outlook for local markets. Central banks are intervening to hold their currencies down against a weak dollar, by expanding their balance sheets and enabling record credit growth. Following Japan’s model, employment and output maximisation no longer outweighing profit outcomes and economic shocks have driven profit motives, for example in Korea. In dollar terms Korea’s had 11% export growth in 12 months, over 50% coming from price increases, not output. This necessitates Asian currency revaluations, that will raise US import prices. A more profit focused approach, appreciating currencies, and a domestic credit boom invariably means rising Asian export prices. It’s very difficult to see any sort of European momentum this year. It is at fiscal limits, far from herd immunity and with declining real incomes the recovery looks lacklustre, and unable to sustain growth. Stagflation may be too extreme a scenario; but imported inflation and limited income growth provides a poor European outlook near-term. For UK, everything depends on Sterling. Growth must come from the provinces, outside London (where fundamentals look poor), which will require an appropriately valued Sterling. At current levels it’s expensive relative to value added in the provinces and a weak Sterling is unlikely to be found in a global economic system flush with dollar liquidity. The UK grows perhaps but extremely modestly. Meanwhile Japan will look to sit and watch from the side-lines, trying to insulate themselves from any global inflation with a slightly stronger currency and geopolitically trying to form alliances.

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