Morgan Stanley has an excellent note today that summarises the entire business cycle ahead for mine:
Reason 1 to stay long USD: Peak bearishness on US growth? Our US economists have revised down their 3QGDP estimates for the US to 2.9%Q SAAR compared to 6.5% previously. The impact of the Delta variant has been clear in recent indicators of US consumer confidence and data more broadly in 3Q, taking the Atlanta Fed’sNowcast measure of current quarter GDP growth down to 3.7%.
However, this hit to 3Q growth and the most recent labour market indicators will probably just be temporary. For starters, our US biotech team believes that the COVID-19 case count in the US is starting to plateau and now expect a “slow bumpy path down”. Our economists see 4QUSGDP reaccelerating back to 6.7% QSAAR.
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I see US growth in a continued slowdown over the next few quarters as it rolls off the fiscal cliff. But that is temporary. Ahead is a stronger cycle of fiscally-led stronger growth than elsewhere leading to higher inflation and yields. MS goes on:
Reason 2 to stay long USD: China growth concerns to stay with us, keeping pressure on EM economic surprise indices: While US growth is likely to re-accelerate into the end of the year, we see a similar rebound from China as being less likely. Given concerns about excess leverage, large stimulus is less likely, while regulatory uncertainty and the zero COVID strategy should keep investment and consumers sentiment more subdued. While the credit cycle could stabilise at the end of the year, we see a risk of growth staying weak for a few more months,.
That is the absolute best case. The base case is China keeps slowing deep into 2022. The rising risk case is that policymakers do not react to this much at all and Chinese growth shunts lower to DM growth rates permanently. Whatever the slowdown, it will drag down Europe as well as EMs, leaving the US the only game in town. MS goes on:
Reason 3 to stay long USD: Options markets show that USD positioning has switched back to short: Our positioning tracker shows that USD positioning is short across both the options and futures markets. This is mostly reflected against G10 currencies rather than EM currencies but nonetheless the net short positioning is the most short it has been since the middle of the year.
These arguments are short-term. But they also represent the major reasons for why the entire developing cycle is one in which to be wary of EMs despite the cheap valuations that a bull trap drawing in the likes of Jeremy Grantham.
They also mean be wary of Australian equities as commodities are trounced and the income shock denudes the local economy of profits. The only exception is non-commosity USD earners.
Any and all strength in the AUD should be used to weight assets offshore.