Regional views

Brexit and the prime minister of the UK, reflections on Memorial Day, and more weekly insights from around the globe.

Emerging Markets

21 May 2019 Markets and political curve balls

In emerging market politics, figures from the past tend to find interesting ways to rear their heads back in the present. When they make a loud enough noise to cause a national stir, it's enough to cause concern among the people and investors looking to move on to the future. This happened last week in Argentina, when former President Cristina Kirchner announced she will participate in the August primary elections, running as vice president to a presidential candidate she handpicked.

Investors in Latin America remember the Kirchner surname for many things. Perhaps foremost of these: Cristina succeeded her late husband Nestor in 2007, and the policies they espoused during their combined 12-year rule, until 2015, rendered the Argentine economy vulnerable to a crisis that helped precipitate a recession and ultimately resulted in a sizable rescue package from the IMF in mid-2018. It is therefore no surprise for observers to wonder if Kirchnerism could come back.

We don't think Kirchner's surprise candidacy will garner much traction with the electorate. How many marginal voters, who would not tolerate her as a presidential candidate, would do so as a running-mate of a relative unknown, considering it is obvious she is running the show? For the first time in Argentine political history, a vice presidential candidate is naming the flag-bearer, sending a clear signal about who will be in power if they are elected in office.

It may be inevitable that Kirchner's announcement will rejig the competing coalitions in a relatively crowded field. By sharing the ticket with a moderate and a former critic of her own administration, Kirchner is likely trying to broaden her popular base and attract influential Peronist politicians into her coalition. Will they join her? Many have distanced themselves from her, so it's unlikely, save for a mere few. Let's not forget that the ruling Cambiemos may also lure non-Kirchner Peronists into its own umbrella.

With five months to go, the presidential race remains wide open, and we believe the most likely outcome is one of continuity of the policies put in place by incumbent President Mauricio Macri. We think the next Argentine leader will continue to pursue fiscal consolidation efforts toward a primary surplus, tight monetary policy to rein in inflation, and a cooperative relationship with the IMF, as well as demonstrate "willingness" to remain current on debt obligations.

Kirchner's ticket does not represent continuity, in our view. We see her odds as around 35% given that she is facing severe corruption allegations; the future of the Argentine economy is looking less dire; the global macro and political backdrop is supportive, with key partners the US, Brazil, and Chile all backing policy continuity; and the fact that incumbent presidents in Latin America have historically had a distinct advantage in winning reelections.

Interestingly, the impact of Kirchner's announcement on asset prices may be muted. While some investors might believe her electoral chances have increased, others may interpret the announcement as a signal that her government would be a more moderate one, diminishing the country's "willingness to pay" risk at the margin.

In our view, current Argentine asset prices overestimate the likelihood of a return to populism in the upcoming elections. We maintain our favorable view of a number of Argentine US dollar-denominated bonds, though we warn against making too large of an allocation to the country. Our favorable view on its electoral outlook is far from guaranteed, and Argentina's still-large twin deficits leave its assets vulnerable to sharp changes in the external financial environment in the near term. Longer term, the country will continue to face economic and political challenges.

Author: Alejo Czerwonko, Emerging Markets Strategist Americas


20 May 2019 Low Eurozone interest rates are here to stay

Most economists would agree that high government debt doesn’t necessarily lead to an economic downturn – the sharp rise in Eurozone government debt in 2008–15 was a consequence, rather than the cause, of the Great Financial Crisis (GFC). But excessive credit tends to be a drag on economic growth and can be a constraint on fiscal policy.

According to a research paper by Carmen Reinhart and Kenneth Rogoff, over the past two centuries government debt in excess of 90% of GDP in advanced economies has typically been associated with economic growth, on average, of 1.7%. This compares with 3.0%–3.7% growth, on average, when debt is below 90% of GDP.

In the Eurozone the government debt/GDP ratio rose, on average, from 65% in 2007 (i.e. before the GFC) to 85% in 2018. But there are big divergences between, for example, Germany on the one hand (60% and shrinking) and Italy, France and Spain on the other (close to, or above, 100% of GDP).

So, what can be done to bring down these high debt levels?

There are four ways to reduce a country’s government debt-to-GDP ratio; two by lowering the numerator and two by raising the denominator. Unfortunately, all four have their drawbacks.

First, a country can reduce its outstanding debt (i.e. lower the numerator) through fiscal austerity. The problem with this is that it can be pro-cyclical in the short term (i.e. belt-tightening when economic growth is slowing), while the efficacy is subject to considerable debate, especially in Europe (think of the Maastricht Treaty’s contentious debt and budget deficit limits).

Second, a country can simply decide not to pay off its debt, i.e. to default. But as Greece showed in 2011-12, this is easier said than done, especially in a currency union, not least because it involves known unknowns such as risky feedback loops between sovereigns and banks.

Third, governments can stimulate real GDP growth (i.e. raise the denominator) through structural economic reforms. This is effective in the long run, but economically painful and politically difficult in the short run. The ‘gilets jaunes’ movement against French President Emmanuel Macron’s reforms springs to mind here.

Fourth, a country can try and boost nominal GDP growth by raising inflation. This is what the ECB has been trying to do, desperately, by means of asset purchases, also known as quantitative easing (QE). This policy has boosted nominal growth over the past few years, although the impact has been modest compared to what it has done to asset price inflation. Eurozone core consumer price inflation is still well below the ECB’s targeted 2%.

Although the fourth option – exceedingly loose monetary policy – comes with unintended consequences, such as rising inequality, misallocation of capital, asset bubbles and moral hazard, it looks like the least painful way to lower the government debt/GDP ratio.

As a consequence, low interest rates in the Eurozone are here to stay for as long as inflation stays low, which is likely to be a long time, in my view. Will the ECB’s exceedingly easy monetary policy continue to support equity markets to the same extent as it has in the past ten years? I have my doubts, but that is a story for another day.

Author: Bert Jansen, Strategist

United Kingdom

24 May 2019 No end in sight

By the time you read this Theresa May might, or might not, be prime minister of the UK. Her political fate is not really a point I want to dwell on though, for it seems that May has been in office, though not in power, for some time. Her premiership is over, as is any hope of parliament passing the Withdrawal Agreement and the UK embarking on a smooth separation from the EU.

What comes next? Little is certain, but I would venture that the UK first needs to find a new prime minister. This does not mean a general election (yet). The oddities of the UK electoral system mean that this decision lies in the hands of just over 300 Conservative Party MPs and other members of the party, rumored to be less than 100,000 voters. No one else (including your author) gets a say in the process. It is what it is.

Market attention has already turned to who is likely to emerge as the next Conservative leader and what this means for the Brexit process. The fall of the pound, some 4% against the US dollar and a little less against the euro from its peak earlier this month, suggests that investors are taking a more cautious, some may say dim, view on the outlook for Brexit.

As I write, this doesn’t seem unfair. We (I) don’t know who will win the contest to be PM; if history is a guide the frontrunner in these affairs rarely ends up winning, which doesn’t bode well for former Foreign Secretary Boris Johnson's ambitions. But we live in strange times – politically that is. So making concrete predictions seems futile.

However, I will be bold enough to assume one thing – the contest will be dominated by talk of "standing up for Britain's interests," which you can read as adopting a very hard stance toward Brexit. Investors understandably will be nervous so the pressure on sterling is unlikely to fade anytime soon.

Whoever walks into No. 10 Downing Street as the victor a few weeks hence will not find the job of "getting Brexit done" any easier than May did, despite what he, or she, claimed on the campaign trail. The parliamentary arithmetic is the same; MPs will not accept no-deal even if a boisterous PM wanted to go down this route. Moreover, they can’t agree on alternative options. And then there is the EU itself, which isn’t likely to consent to renegotiate the Withdrawal Agreement. Conclusion: the stalemate continues.

As the October 31 deadline approaches it appears that the new prime minister will have no other option than, or may even be forced by parliament, to request another Article 50 extension. Our best guess is that this will be granted, but it may not be for as long as previously assumed. And this extension will carry with it something to cause investors even more concern – a general election. What such a vote will solve is a topic for another day.

Author: Dean Turner, Economist, UBS AG

United States

23 May 2019 Reflections on Memorial Day

With the approach of the Memorial Day holiday, many are turning their thoughts to the summer. The longer days and warmer nights open up a host of activities that we're typically precluded from enjoying during the winter months in colder climates. These range from day trips to the beach, to rambling evening strolls, to long-neglected yard work, to rigorous sports activities, to various parties and festivals…and even to just lounging around in casual conversation on the front porch (or front stoop, for those of us who grew up in Queens).

But of course, Memorial Day means so much more than that.

The origin of Memorial Day in the US is actually a bit controversial. While some argue that it started as remembrance day ceremonies during the Revolution, most trace the formal beginnings of what we now know as Memorial Day to the post-Civil War period. Regardless of when it began, Memorial Day is now a nationally recognized holiday that honors all those who have given their lives defending our country. According to estimates from the Department of Defense, 1,196,656 military servicemen and servicewomen have died fighting our country's wars over a period spanning the American Revolution through to today's Global War on Terror.

These are, of course, only estimates and therefore likely undercount the number who were actually lost in combat. What's more, these totals don't include those who died many years removed from the battlefield as a result of the wounds, illnesses, and traumas sustained during their active service. Yet I believe that those lives must be added to the tally as well if our nation is to have a true accounting of the sacrifices made in service to our freedoms.

While that toll may seem staggering at first, let's keep in mind that 550 million souls have called the United States home since the founding of this Republic. This means that we owe our liberty, our safety, and our prosperity to the ultimate sacrifice borne by just 0.22% of our fellow countrymen. So each year on this weekend, I try to go to Long Island National Cemetery in Pinelawn, New York in order to pay my respects and to reflect upon what they sacrificed on our behalf.

But it's not just about what they were willing to sacrifice that awes me; it's also why they were willing to sacrifice.

When we look around today, we see a nation that appears deeply divided. But that's nothing new. From the very moment of conception, this country has been locked in conflict and disagreement. Most have forgotten that nearly 40% of the original colonial population were considered "loyalists" who opposed independence from Great Britain. The Civil War almost tore the country apart as we endured our moment of reckoning over the "original sin" of slavery. The Vietnam War sparked a culture clash that continues to rage to this very day.

But the ability to disagree—sometimes heatedly—is one of the great strengths of a pluralistic society and a functioning democracy. So to focus solely upon the burdens of what divides us is to completely miss the blessings of what unites us. The United States was founded upon a collection of principles and has been guided ever since by a set of ideals. These include the notion that all political power emanates from the people; the belief that every individual was created equal; and the insistence that everyone is free to express their opinions and preferences without consent. These principles and ideals not only represent the standard by which every form of governance the world over is now measured, but also serve to sanctify the ultimate sacrifice made by 1,196,656 of our countrymen.

So that is both the "what" and the "why" that I will reflect upon this Memorial Day.

Author: Michael Ryan, CFA, Chief Investment Officer Americas

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