If Europe’s sovereign debt crisis weren’t enough to ruffle bond traders, escalating tensions between the US and China regarding the Middle Kingdom’s currency policies are also straining nerves. The US government’s ever-expanding deficit is also on traders’ minds. This month David Rolley, part of the management team of Managers Global Bond (MGGBX), gives us his take on US-Sino relations and the simmering European crisis.
Let’s start out on a positive note. Are there any regions with attractive bond markets right now?
A number of regions offer attractive opportunities, and we remain upbeat about the direction of the global economy. We expect a global recovery this year and would be surprised if US gross domestic product (GDP) doesn’t grow 3 percent this year. China’s economy remains robust, and non-China, non-Japan Asia should also post impressive growth numbers. Even Japan’s economy is in recovery mode and will grow between 1.5 and 2 percent this year.
Our portfolio holdings reflect this outlook; we own quite a number of Asian names. We have exposure to the Chinese renminbi, as well as positions in the Indian rupee, the Indonesian rupiah, the Singaporean dollar and the Malaysian ringgit. Our biggest position is in the South Korean won.
We believe this exposure to non-Japan Asian currencies will pay off, as the US and Chinese governments are working out a grand bargain as we speak--an outcome that will be reflected in the markets over the coming weeks.
Again, our three major themes are the global recovery, the Asian recovery and the outperformance of Asian currencies.
German government bonds should avoid a selloff this year. There’s a flight to quality underway from Europe’s periphery--particularly the Mediterranean nations--back to northern Europe, so we expect the German bund to perform reasonably well. That doesn’t mean we expect the euro itself to do well; we’re underweight the currency relative to our benchmark.
We also own some issues that will fare better in a US economic expansion than Treasuries. Mexico and Canada will do well if the US economy picks up as expected. Both nations count the US as their most important trading partner and supply the US with natural resources, as well as a variety of manufactured goods and sub-components to US companies. Both countries are integral parts of many US multinationals’ supply chains. Accordingly, we own both Canadian dollars and Mexican pesos and believe these holdings will generate equity-like returns if the US economy surprises to the upside.
You mentioned a grand bargain between the US and China on trade issues. Some people argue that China can afford not to worry about its relations with the US. What’s your take?
China’s relationship with the US is too important for the Chinese government to back away, and frankly, it’s in their interest to remain on good terms. China has managed its currency in such a way that the country was able to become a global export powerhouse. The Chinese authorities did that quite deliberately, following the example of Japan and Korea. But China’s economy is much larger and involves far more people--there’s a great deal at stake here.
If China were to sell or even stop buying US Treasuries, there would be an immediate impact on the renminbi. The Chinese authorities maintain the renminbi’s peg to the dollar by accumulating reserves.
A Chinese company comes over here, sells a bunch of stuff to Wal-Mart Stores (NYSE: WMT) and ends up with a bunch of US dollars. But the Chinese firm isn’t allowed to keep those dollars offshore--it’s required to exchange them for renminbi. Now the Chinese government has a bunch of dollars. The only way to keep the renminbi from moving around is to accumulate US dollars. If the Chinese sell their position in US Treasuries, they would have US dollars; that would be even cheaper for the US government because in some ways it would then be financing its deficits with a zero-yield USD100 bill instead of something on which it has to pay interest. Selling Treasuries is clearly not in China’s interest.
And if the Chinese did sell Treasuries, what would they buy with US dollars? The Japanese yen is a lower-yielding currency, and Japan’s fiscal problems are still worse than those of the US. The euro isn’t anyone’s favorite flavor this week because of the crisis in Greece--in fact, a large competitor of ours on the West Coast recently likened Greece to the Titanic. Speaking of our friends out West, we’ll have to wait and see if anyone comes up with a great disaster metaphor for California.
But to return to the subject at hand, what would China pour its US dollars into if it sold Treasuries, and how would it maintain the renminbi in its chosen band? China could quit buying Treasuries, but its currency would go vertical--though in some ways that’s exactly what the US is asking the Chinese to do.
The Obama administration recently delayed the release of a Treasury report that was expected to accuse China of currency manipulation. Will that report ever come out?
I don’t think the US is going to explicitly label China a currency manipulator because it would offend the leadership and the Chinese take these things very seriously. Someone recently likened the affair to a classic good cop-bad cop situation in which the Treasury plays the good cop and Senator Charles Schumer (D-NY) [the driving force behind recently proposed legislation that would require the US Treasury to impose stiff import tariffs on goods produced in countries designated as currency manipulators] plays the bad cop. But we do want some flexibility here.
It’s clear the US needs to grow exports because that’s how it will create jobs. Retail sales numbers are coming in okay, but that’s going to provide only limited support to the US recovery.
There’s no question that the US consumer needs to rebuild some savings and recover wealth by spending less; it’s hard to contemplate another consumer-driven boom in the next two or three years.
If you want decent job growth--a must with the unemployment rate at 9.7 percent--net trade is the obvious solution. Two things need to occur for that to happen: The US dollar can’t get too much stronger, and the rest of the world needs economic growth. US policy discussions with the G-20 will focus on how to engineer a sustainable global expansion. The Chinese have an important role to play in supporting the global economy’s growth, including what they’ve already done in terms of their domestic fiscal stimulus--for example, raising minimum wages for Chinese workers--and developing healthy trade relationships without confrontation.
The worst-case scenario would be a US-China confrontation that leads to reciprocal import tariffs and a trade war. In the latter event, US Treasuries would do extraordinarily well because equities would suffer dramatically. Then the concern would be how far equities fall because that would terrify the global investor base. I don’t think we’re headed down that path, but a Sino-US trade war wouldn’t add to world GDP growth.
What risk does the situation in Greece pose?
It raises broader questions about solvency and sustainability and explains why the euro has moved against the dollar. The crisis has already had a material impact on the entire European currency market and has implications for how investors perceive the solvency risks of Spain, Portugal and even Italy. If the Greek situation isn’t resolved properly, concerns about policy risk will increase volatility. If policy is less predictable, investors will look for a premium that would seep into equity markets in the form of a higher VIX [a measure of volatility for the S&P 500]. Fixed-income markets would face steeper yield curves, as investors would demand a term premium for lending to governments for longer periods.
Is this a test of the EU’s credibility?
Many investors perceive it that way, though they’re drawing different conclusions. It’s a genuine test of whether the EU’s constituents can pull together and sort the situation out.
The prevailing view in Germany is that EU solidarity is all well and good, but German voters are hostile to the country playing the role of paymaster. Similar resistance is building in other nations--I think that’s a very important development.
What’s your best piece of advice for investors over the next year?
Given the uncertainty about the economy and policy in the US and abroad and the inherent unpredictability of politics, investors need to have a diversified portfolio if they are to be comfortable about capital preservation. We believe US equities and fixed-income securities have an important role to play in investors’ portfolios, as do for foreign equities and fixed-income investments. Funds offering deep diversification are an excellent way to get broad exposure to assets that aren’t dollar-denominated.
Disclosure: No positions
No comments:
Post a Comment