Last Sunday, when a Trump victory still seemed improbable, One River Asset Management CIO, Eric Peters issued a note that in retrospect, was surprisingly prophetic: in it he predicted that after years of failure to kindle economic animal spirits, the "magic formula" to boost inflation involved a victory by none other than Donald Trump. To wit:
With central bankers desperate to boost inflation both in their country, and around the globe, yet failing to do so for years (especially as measured by the long end of the yield curve) leading to serious economists and pundits going so far as proposing the pinnacle of monetary lunacy, such as helicopter money, one person may have stumbled upon the "magic formula" for how to create inflation in the new normal: 'A populist uprising, compromised free trade, immigration restrictions, a 15% currency devaluation, 0.50% interest rates combined with aggressive QE is today’s magic formula for modestly exceeding a 2% inflation target 2yrs hence."
In other words, all that is needed for inflation expectations to spike, is a victory by the Donald Trump "populist uprising." Sure enough, hours after the presidential election result, inflation expectations soared, bond sold off, and stocks surged on expectations that Trump would... unleash inflation.
Judging by the market's reaction, Peters was 100% spot on.
Which is why we paid especially close attention to his latest note released earlier this morning, in which in his trademark "anecdotal" way, the CIO warned that while the US economy may appear to be benefiting from Trump's policies - if only for the time being - the rest of the world is set to suffer. Below are the key excerpts from his latest weekly note to clients:
“What’s good for the US in this case, is not good for emerging markets,” said the CIO.
“Emerging markets benefit from a weaker dollar, and you’re not going to get that,” he continued.
“Emerging markets benefit from global capital flows moving in their direction and that’s not happening either.” Back in February, emerging markets were in sharp decline, driven by (1) a strong dollar, (2) rising US interest rates, and (3) slowing Chinese growth. Then China spurred a massive credit stimulus, the Fed became wildly dovish, and the dollar declined sharply.
Interest rates collapsed throughout the year. As the growing pool of dollar, euro and yen liquidity searched for a decent return, it headed to emerging markets. “Trump has reignited the dollar rally, and his fiscal stimulus will force interest rates higher. This reversed everything. So emerging market investor’s last hope is that Chinese growth remains strong.”
And to be sure, the Beijing boys don’t want to see material weakness ahead of next autumn’s Party Congress.
But we’re currently near peak impulse from China’s Q1 stimulus. “To be bullish on emerging markets at this stage is to disregard the adverse dollar and interest rate environment, and build your investment thesis on the expectation that China will sustain the largest credit expansion in modern economic history.”
Most investors viscerally understand this, particularly within China, where capital outflows just hit new highs for the year - weakening the renminbi. “Historically, emerging markets have done well when global growth has been robust. But the world is changing.”
From 1945-2000 the US was the largest trading partner for emerging markets. Now China dominates their trade flows.
They’ve leveraged their economies to Chinese growth.
“Investors now have the choice of whether to chase dollar assets higher or buy emerging markets - it’s really not a choice.”
Peters' thesis in a nutshell: for Trump's policies to succeed, the biggest hurdle may be not the US Congress (earlier today in an FT op-ed, Trump economic advisor Anthony Scaramucci took aim at conservative budgetary restraints in a push to unleash much more US debt) but rather China, which will not only need to agree to "let Trump make America great again" by sending the dollar soaring, but to be willing to continue its unprecedented debt issuance flood.
It remains very much unclear if China - and thus the entire emerging market world - will agree to either of these two necessary (if not sufficient) conditions.