Emerging Markets

Meanwhile, the emerging market currencies look quite cheap vs. the USD. The U.S. economy needs a lower Dollar, which is one reason we think the Fed will not unwind their balance sheet this year and if GDP numbers start to decline, the Fed may even have to back off on 2 more rate hikes in 2017. To engineer a lower Dollar, the other side of the USD – the Euro and EM currencies, need to appreciate. In the case of EM currencies, they are low and capital flows are returning to key countries such as Brazil, Mexico and Indonesia. Shamrock would not be at all surprised to find Chinese investment flowing into Brazil and even Venezuela.  Mexico is another destination for EM capital as we do not view NAFTA reform as harmful to Mexican interests, in fact it could be beneficial. Whether the U.S.-Mexico-Canada re-align themselves into more of an internal market to compete with China, or U.S. growth is boosted by the U.S. authorities turning their attention to developing the domestic energy/technology/infrastructure industries, Mexico can benefit.

EM currencies are low compared to where they have traded since the 2008 financial crisis and EM bond markets carry meaningful yield advantages to U.S. Treasuries. The commodity related EM currencies may be at timely points as we think the Chinese economy will turn up in 2nd half of the year. If China turns up, commodities turn up and countries which supply commodities will outperform. We must also not forget India, which is growing strongly and is seeing inflows of capital.

Inflation vs. Deflation

The Fed was focused on core inflation early in 2008, but their principal objective now is reflation.  A long period of above normal inflation, which inflates away America’s debt, is quite possibly the desired outcome of the Fed’s monetary policy.  A period of higher inflation is not impossible once deflationary forces abate, economies accelerate and the velocity of money picks up.  Is inflation the outcome the Fed wants?  The answer seems to be “yes”.  Will the Fed ever again be able to raise interest rates quickly or too high enough levels to fight inflation (if it appears) or will they choose to let inflation run, given the debt overhang which exists in the consumer/government/ financial sectors and the interest expense increase involved?  Letting the economy “run hot” seems to be the course the Fed is on.  One of the most powerful disinflationary forces is the ongoing reduction of headcount in some economic sectors, which still has a long ways to go.  As the robot/technology revolution unfolds, other parts of the economy will experience job losses, and additional deflationary impacts.  M2 is at +6.3% annually, while M1 is at +8.8%.  Plenty of money is available in the banking system thanks to quantitative easing, but the velocity of money remains low and will remain low until loan demand from the real economy picks up dramatically.  It appears the Fed is still fighting deflationary forces.