The two big decisions for fiduciary investors this year concern interest rates and currencies. But those decisions are relatively easy. What is a lot more difficult is: how do you go about implementing these big-picture decisions at the hands-on level?
The consensus on the duration bet for interest rates in the US and Europe is that they have only one way to go – up. However, investors can lose a lot of money waiting for that to occur.
Similarly, the consensus for the US dollar is that it will weaken again, at least against the Asian nations and perhaps against the euro. The recent strength of the Japanese yen, currently at record levels against the greenback, may not reflect the cyclical trend but it certainly does not contradict it.
The interest rate question is, as always, linked to the inflation question. Inflation fears are now much more common than deflation fears. But that may well be a short-term phenomenon.
How long it takes for the Chinese authorities to rein-in inflation – and whether or not China has a soft or hard landing – will have possibly the biggest impact on world inflation. However, the US is also showing signs of an uptick. Higher import prices, due largely to Chinese and other emerging nation export prices, are infecting all OECD country supply chains and will probably hit consumers by mid-year.
With respect to currencies, also of course linked to interest rates and inflation, there has already been a rebalancing between the developed and developing worlds in the latter part of last year. Some developed nations which have been big beneficiaries of the developing nation growth, such as Germany for its manufacturing and Australia and Canada for their resources, have seen their currencies realigned also.
According to UK independent economist and former fund manager Andrew Hunt, the Japanese tsunami will cost that economy about 15 per cent of its GDP and lead to a doubling in Japanese bond yields to just over 2 per cent.
India, Thailand and Brazil have already suffered higher nominal exchange rates or higher domestic inflation, or a combination of both, whereas the US and UK have suffered neither. While Japan may have suffered a strong nominal exchange rate, even before the disaster, but it had been able to regain and sustain its competitiveness via its ongoing deflation.
Hunt says that unless China depreciates the RMB – which is highly unlikely – there will be another three to six months of rising export price inflation impacting in the west.
The good news is he believes that inflation is unlikely to be a sustained problem. If and when China does succeed in tightening, then global inflationary pressures should dissipate as quickly as they appeared.
The bad news is we could flip-flop back, say this time next year, to a new round of real deflationary fears.
With volatility at such a macro level, the actions of fiduciary investors, especially with asset allocation, become both more crucial and more difficult.
