Thoughts through the cycle: W2 June ’20

Share on facebook
Share on twitter
Share on linkedin
  • With ‘WFH’ the new acronym of choice to describe pandemic working arrangements, everything is a little different. It can’t have been easy for Fed Chairman, Jay Powell, to command the room at the 10th June FOMC press conference via a Zoom-style remote link-up. He has a nervous tick which means he coughs when he is struggling. The market sensed the strain. This was another instance of ‘buy the statement, sell the presser’ as US equities faded and long-end bonds rallied during the Q&A session.
  • Central banks have carried the day so far during the crisis, and the performance of the top dog at the post rate-decision press conference is a key determinant for market confidence. The ECB’s Christine Lagarde has taken to reading from notes with ‘no improv’, tetchily repeating the entry from her script for ‘what to say if asked about the German Constitutional Court’ when asked the same question at the June 4th meeting in two different ways. A moment of levity almost arose when a German journalist asked whether Lagarde’s reading from a script was an example of her imposing her style on proceedings.
  • At the FOMC press conference on 10th June, Powell talked nostalgically about how unemployment had been so low before the Covid-19 crisis in the sort of way Adam might have wistfully remembered the garden of Eden before the Fall. To do him justice, Powell was forthright about how the US jobless claims data from the 5th June may have been nearer 16% rather than the 13.3% headline figure presented by the Bureau of Labour Statistics and lionised by President Trump. He also clearly expressed how other measures of unemployment, notably U-3 and U-6, may well mean that the real number of people who need to find work is in the region of 24m. This is a huge figure, and the overwhelming feeling has to be that Powell could no longer disguise the enormity of this task, if indeed that was what he was trying to do.
  • Even with Treasury bond and bill issuance set to rise and with no increase in Fed quantitative easing (QE), bond yields fell sharply as Powell spoke. The graph below show US 5y5y inflation (5yr inflation in 5yrs time). This very much looks to be rolling over. Earlier in the day, US CPI inflation for May came in at 1.2% (vs. 1.3% est. and 1.4% prior). Any inflation in the economy appears at present only to be coming from food prices. Worryingly, core inflation is falling.

Source: Bloomberg, 11th June 2020

  • The Fed is done for now, with QE likely to continue at current rates ($4b per day) for the foreseeable future. Yield-curve control (YCC) was discussed but not acted upon – this seems to be a tool still in the tool-box for now. There was also a hint that more lifting needed to be done through fiscal policy, hence by Congress. Powell awkwardly dodged two questions about frothy stock prices – one senses that he knows there is a bubble. By having to resort to QE rather than rate cuts, Powell has been trapped by the pavlovian response of markets (QE = rip stocks up) meaning that the usual beneficial effect of lower rates isn’t reaching main street, thus a higher rate of QE now would only stoke the bubble further while not helping the real economy at all.
  • The global economic recovery is increasingly looking like a long-haul job. The ECB has revised its projections for Euro area GDP to a fall of 8.7% in 2020 and a rise of 5.2% in 2021 and 3.3% in 2022. Perhaps by 2023, GDP will return to 2019 levels. This would mean countries such as Italy carrying a debt to GDP in excess of 160%, levels which generally severely retard growth of any sort. The severe effect of the lockdown is starting to be revealed – Italy’s industrial production for April was down 42.5% YoY. Auto registrations for May are at 49.61% of prior-year levels, higher than April’s almost inconceivable -97.55% print.
  • There is now a political problem in all countries – the lockdown rightly necessitated governments to step in and provide furloughed workers with money in lieu of wages given the nature of the pandemic and the measures needed to halt its spread. Furloughs have end-dates, and end-dates mean cliffs. The date for the US is currently the end of July. The UK furlough tapers in August then ends in October. Already UK firms are saying they are going to struggle to top-up workers’ wages by the required 20% during the transition period. A sudden increase in unemployment is a political shock which few governments can survive, especially if it is the government’s own decision to actualise the increase by ending the furlough.
  • Unfortunately for many, furlough means a sort of Schrodinger’s cat situation where one can seem both employed and potentially unemployed at the same time. Not only does this put an intolerable strain on individuals in that unfortunate position, but it also means that the extent of overall economic damage cannot be assessed in a meaningful way. This may in part be why the stock market has reacted in the way it has during April and May.
  • In reality, it is politically and probably socially unacceptable to engineer a sudden stop to an economy by ending furloughs ‘just like that’. This reveals the true dilemma for governments across the world, and also therefore for bond markets and capital markets in general. France will serve as an example for this. In an article in the Financial Times, France’s labour minister, Muriel Penicaud, described how the problem would be dealt with (‘France to extend crisis jobs scheme for up to two years’, FT, 08/06/2020):

“We are going to put in place a long-term partial-activity scheme… through which employees could have fewer working hours and be partly supported by the state. [The scheme]  is likely to last a year or two”

  • The scheme is modelled on Germany’s ‘Kurzarbeit’ system which was extremely effective during the global financial crisis as it meant workers stayed in work, keeping their skills (as well as avoiding the psychologically-onerous burden of full unemployment). The current French scheme is operating at 84-100% of net wages for the lower paid. This is not a question of workers being lazy and not wanting to go back because benefits are too ‘cushy’. Many people have genuine fears about the Covid-19 virus, and the event of lockdown has magnified these concerns. The problem comes inevitably from how you pay for it all.
  • In mid-May, the French government said it would likely be running at 2020 deficit of 9% of GDP. The 3%-limit imposed by the Lisbon Treaty has been temporarily lifted by the European Commission. The French furlough plan, if it extends out to the end of 2021 would likely see larger deficits for longer. The ECB has just increased its Pandemic Emergency Purchase Programme (PEPP) by €600b, again with the Germans apparently dissenting. The market logic at present is that governments run deficits to keep things like they were, and central banks just use QE to magic away extra bond issuance. No amount of spending is too much because the pandemic demands it.
  • The political will is there for the print-and-spend pattern to continue. When the Germans are leading the pack in fiscal largesse you know the penny has dropped. Another way of saying this is governments cannot change direction, even if they wanted to. The question then is what the consequences are when everyone is bound into pursuing the same policy simultaneously. This is a twofold question – first, how currencies trade with one another (especially with the dollar), and secondly, how fiat currencies move against ‘hard’ currencies, the last of which is gold.
  • Normally when QE is announced, a currency weakens as the monetary base increases. When the ECB upsized QE on 4th June, the euro actually rallied against the dollar. There are a number of ways of interpreting this. First, it was an assertion of will by the ECB and a statement of continuity that encourages investors back into euro-denominated assets; secondly, that it was reflationary and therefore euro-positive; thirdly, that reflation is under way globally so you just keep selling dollars whatever; fourthly, that US fiscal and monetary policy is the most egregious, hence the weakening dollar; fifthly, that recent rioting in the US has shaken people’s faith in the dollar, and so on. Lots of potential reasons.
  • One thing is for sure. In the absence of capital controls, deficit spending and using QE to absorb issuance and to keep yields low means you are controlling the price but not the quantity of money. This is fine, but it means that you cannot control your currency. Acting aggressively to stimulate domestic demand can lead to devaluation. This is another way of describing a currency war. To win, one’s currency has to lose. This is where the dollar may have a flaw – it is the main reserve currency and the largest currency for trade. People actually want it in a way which no other currency is wanted.
  • The graph below shows the U.S. Dollar Index (DYX) which is at the bottom of its current upward channel, and therefore at a critical juncture. A rise in the dollar from here would signal deflation, and would suggest that the recent market rally was a case of re-leveraging not reflation. The DXY is heavily weighted towards the euro, so issues relating to the forthcoming Euro-area budget or Brexit may start to make themselves felt more as June progresses. A weakening of the euro from here would result in a sharp rise in the DXY.

Source: Bloomberg, 11th June 2020

  • Then there is the wider question of fiat currencies in general. In an era where all countries are printing money at will to accommodate deficit spending, what happens to the only hard currency out there, gold? The graph below shows the price of gold in dollars (yellow) against US M2 money supply in USD trillions (red) from 1960 to the present. It would seem the more they print, the more gold goes up, largely because you can’t print gold. This is the easy bit to show.

Source: Bloomberg, 11th June 2020

  • The next graph is even more interesting, showing the velocity of M2 (blue) against gold in dollars (yellow) between 1960 and 1990. Spikes in the blue line show periods of intense inflation in the dollar, during which the gold price rose sharply (from 1977 to the late-1980 peak it rose from $134.5 to $667, or nearly 500%). The velocity of money is a measure of how quickly money is turned over in the real economy. One reason why QE doesn’t increase the velocity of money is because the money stays trapped in the financial system in stocks and bonds and isn’t actually spent on goods and services – someone probably ought to mention that to central bankers intent on using QE to generate inflation.

Source: Bloomberg, 11th June 2020

  • Studies of periods of intense inflation in the past reveal the following characteristics, the first three of which are necessary, the fourth of which is not obligatory but is more often than not observed; first, a fiat currency rather than a currency attached to a metallic standard; secondly, a central bank lacking independence or a monetary system with insufficient statutory restrictions against government interference; thirdly, large primary fiscal deficits (15%+) over a period of time; finally, a war or war-like situation. Starting to sound familiar?
  • The 1970s was a period of stagflation – low real rates, low GDP growth, high inflation. Debt was much lower relative to now. The current trend is one of deflation due to a large global stock of debt. Should governments overstimulate demand relative to supply while engaging in financial repression (QE to keep real rates low), then stagflation could emerge along with the recovery. Gold will always rise while M2 increases. If the velocity of M2 starts to rise as well, then a repeat of the late 1970s price performance in gold will be likely. If that’s the case, people won’t be talking about heroic robin hood pump-and-dump stories in bankrupted stocks for long.

Unless otherwise stated, all opinions within this document are those of the RWC Diversified Return Investment Team, as at 11th June 2020.

The term “RWC” may include any one or more RWC branded entities including RWC Partners Limited and RWC Asset Management LLP, each of which is authorised and regulated by the UK Financial Conduct Authority and, in the case of RWC Asset Management LLP, the US Securities and Exchange Commission; RWC Asset Advisors (US) LLC, which is registered with the US Securities and Exchange Commission; and RWC Singapore (Pte) Limited, which is licensed as a Licensed Fund Management Company by the Monetary Authority of Singapore.

RWC may act as investment manager or adviser, or otherwise provide services, to more than one product pursuing a similar investment strategy or focus to the product detailed in this document. RWC seeks to minimise any conflicts of interest, and endeavours to act at all times in accordance with its legal and regulatory obligations as well as its own policies and codes of conduct.

This document is directed only at professional, institutional, wholesale or qualified investors. The services provided by RWC are available only to such persons. It is not intended for distribution to and should not be relied on by any person who would qualify as a retail or individual investor in any jurisdiction or for distribution to, or use by, any person or entity in any jurisdiction where such distribution or use would be contrary to local law or regulation.

This document has been prepared for general information purposes only and has not been delivered for registration in any jurisdiction nor has its content been reviewed or approved by any regulatory authority in any jurisdiction. The information contained herein does not constitute: (i) a binding legal agreement; (ii) legal, regulatory, tax, accounting or other advice; (iii) an offer, recommendation or solicitation to buy or sell shares in any fund, security, commodity, financial instrument or derivative linked to, or otherwise included in a portfolio managed or advised by RWC; or (iv) an offer to enter into any other transaction whatsoever (each a “Transaction”). No representations and/or warranties are made that the information contained herein is either up to date and/or accurate and is not intended to be used or relied upon by any counterparty, investor or any other third party.

RWC uses information from third party vendors, such as statistical and other data, that it believes to be reliable. However, the accuracy of this data, which may be used to calculate results or otherwise compile data that finds its way over time into RWC research data stored on its systems, is not guaranteed. If such information is not accurate, some of the conclusions reached or statements made may be adversely affected. RWC bears no responsibility for your investment research and/or investment decisions and you should consult your own lawyer, accountant, tax adviser or other professional adviser before entering into any Transaction. Any opinion expressed herein, which may be subjective in nature, may not be shared by all directors, officers, employees, or representatives of RWC and may be subject to change without notice. RWC is not liable for any decisions made or actions or inactions taken by you or others based on the contents of this document and neither RWC nor any of its directors, officers, employees, or representatives (including affiliates) accepts any liability whatsoever for any errors and/or omissions or for any direct, indirect, special, incidental, or consequential loss, damages, or expenses of any kind howsoever arising from the use of, or reliance on, any information contained herein.

Information contained in this document should not be viewed as indicative of future results. Past performance of any Transaction is not indicative of future results. The value of investments can go down as well as up. Certain assumptions and forward looking statements may have been made either for modelling purposes, to simplify the presentation and/or calculation of any projections or estimates contained herein and RWC does not represent that that any such assumptions or statements will reflect actual future events or that all assumptions have been considered or stated. Forward-looking statements are inherently uncertain, and changing factors such as those affecting the markets generally, or those affecting particular industries or issuers, may cause results to differ from those discussed. Accordingly, there can be no assurance that estimated returns or projections will be realised or that actual returns or performance results will not materially differ from those estimated herein. Some of the information contained in this document may be aggregated data of Transactions executed by RWC that has been compiled so as not to identify the underlying Transactions of any particular customer.

The information transmitted is intended only for the person or entity to which it has been given and may contain confidential and/or privileged material. In accepting receipt of the information transmitted you agree that you and/or your affiliates, partners, directors, officers and employees, as applicable, will keep all information strictly confidential. Any review, retransmission, dissemination or other use of, or taking of any action in reliance upon, this information is prohibited. The information contained herein is confidential and is intended for the exclusive use of the intended recipient(s) to which this document has been provided. Any distribution or reproduction of this document is not authorised and is prohibited without the express written consent of RWC or any of its affiliates.

Changes in rates of exchange may cause the value of such investments to fluctuate. An investor may not be able to get back the amount invested and the loss on realisation may be very high and could result in a substantial or complete loss of the investment. In addition, an investor who realises their investment in a RWC-managed fund after a short period may not realise the amount originally invested as a result of charges made on the issue and/or redemption of such investment. The value of such interests for the purposes of purchases may differ from their value for the purpose of redemptions. No representations or warranties of any kind are intended or should be inferred with respect to the economic return from, or the tax consequences of, an investment in a RWC-managed fund. Current tax levels and reliefs may change. Depending on individual circumstances, this may affect investment returns. Nothing in this document constitutes advice on the merits of buying or selling a particular investment. This document expresses no views as to the suitability or appropriateness of the fund or any other investments described herein to the individual circumstances of any recipient.

AIFMD and Distribution in the European Economic Area (“EEA”)

The Alternative Fund Managers Directive (Directive 2011/61/EU) (“AIFMD”) is a regulatory regime which came into full effect in the EEA on 22 July 2014. RWC Asset Management LLP is an Alternative Investment Fund Manager (an “AIFM”) to certain funds managed by it (each an “AIF”). The AIFM is required to make available to investors certain prescribed information prior to their investment in an AIF. The majority of the prescribed information is contained in the latest Offering Document of the AIF. The remainder of the prescribed information is contained in the relevant AIF’s annual report and accounts. All of the information is provided in accordance with the AIFMD.

In relation to each member state of the EEA (each a “Member State”), this document may only be distributed and shares in a RWC fund (“Shares”) may only be offered and placed to the extent that (a) the relevant RWC fund is permitted to be marketed to professional investors in accordance with the AIFMD (as implemented into the local law/regulation of the relevant Member State); or (b) this document may otherwise be lawfully distributed and the Shares may lawfully offered or placed in that Member State (including at the initiative of the investor).

Information Required for Distribution of Foreign Collective Investment Schemes to Qualified Investors in Switzerland

The representative and paying agent of the RWC-managed funds in Switzerland (the “Representative in Switzerland”) is Société Générale, Paris, Zurich Branch, Talacker 50,

P.O. Box 5070, CH-8021 Zurich. In respect of the units of the RWC-managed funds distributed in Switzerland, the place of performance and jurisdiction is at the registered office of the Representative in Switzerland.

Explore more


Please confirm your investor type



By clicking Submit, you agree that you have read and accepted the terms and conditions detailed in the DISCLAIMER

This website uses cookies. A cookie is a small data file placed on your computer which captures information about your choices which allows us to improve your experience of the website, for example, by remembering your country of residence. By continuing to access this website, you agree to be bound by our Cookie Policy. You can accept and/or block at any time by changing your browser settings.


Where are you located?



Rest of world

By clicking Submit, you agree that you have read and accepted the terms and conditions detailed in the DISCLAIMER


What type of investor are you?



By clicking Submit, you agree that you have read and accepted the terms and conditions detailed in the DISCLAIMER