Weekly View – Don’t cry for me Argentina

The CIO's view of the week ahead.

The global economy is a bag of mixed signals. Last week, US retail sales for July came out stronger than expected, proving the US consumer remains in good shape. Hopefully, this will buoy the US economy, as it suffers elsewhere, including manufacturing and business investment. Meanwhile, data out of China and Germany, the world’s second and fourth largest economies, proved more worrying, underlining concerns about global industry as trade tensions continue to take a toll. The good news is that while the German economy shrank in Q2, the broader euro area economy appears relatively healthy, driven by the consumer. The Chinese economy, on the other hand, is suffering from both weakening industrial production and retail sales.

This position of relative economic strength has bolstered President Donald Trump, whose more aggressive trade rhetoric is backfiring, as China may still retaliate despite his backpedalling. This raises the risk of weak global growth turning into recession, as suggested by the inversion of the two-year to 10-year yield curve, historically one of the best recession predictors up to 17 months out, which is also not necessarily bad for equities in the short term. The key difference to past instances is that the current inversion is being driven by the fall of the 10-year, rather than the rise of the two-year yield, as had been the case in previous inversion episodes. 1998 was the only exception to this, when the fall at the long end drove the curve’s inversion, against the backdrop of the Long-Term Capital Management fund and Russian financial crises. To stop yields from falling, the Federal Reserve should position itself ahead of the curve by cutting rates more aggressively than markets expect. This may prove difficult, however, given the ongoing strength of US economic data. As bonds continue to rally, we are neutral US Treasuries as a safe-haven asset. 

South of the equator in Argentina, President Macri’s unexpected defeat in last week’s primary elections sparked investor fears that the Peronist opposition candidate, Alberto Fernandez, could win the general elections in October. Fernandez’s victory would raise the risk of Argentina defaulting on its debt, which has sent Argentina’s local currency sovereign yield to over 47%. We now live in a world of binary outcomes and traditional investment processes are broken, with fatter, longer tails, allowing unexpected events to drive big moves in risk assets. The next binary outcome will be with Brexit, and playing volatility could prove the most sensible investment action. 

César Pérez Ruiz, Head of Investments & CIO, Pictet Wealth Management

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