Sunday, April 4, 2010

Cyclical bullish or Structural bullish?

The US unemployment was still at 9.7%. Managed to catch Mohamed El-Erian appeared on the Bloomberg right after the number was released. He opined that it's all depends how you look at the issue, are you buying into cyclical or structural story. He thinks it's more difficult to judge the economy at this point of time because of so many temporary factors in the systems - stimulus, easy monetary policies, etc. The inventory cycle is also at the turbo-charged rate now. That's what driving the cyclical part of it. Looking ahead of many quarters ahead, structural side of huge amount of potential deficits from the developed countries will make it difficult to maintain sustainability.

They posted some interesting views on their website recently.

This is their views on the cyclical outlook.

The first issue is the peg between the Chinese yuan and the US dollar, which essentially gives us a one-size-fits-all monetary policy in a very differentiated world. Progress, or lack of progress, on this issue could lead to several outcomes. If China were to let its currency appreciate, it could regain a degree of monetary policy autonomy and a better ability to manage the risk of overheating and asset price inflation. Another outcome, however, is that China refuses to let the yuan appreciate, essentially maintaining too easy of a monetary policy for itself and the developing countries that shadow Chinese policies. This would create bubble risk, particularly for assets such as emerging market (EM) equities and commodities.

The second major uncertainty is what will happen when the Fed completes its mortgage-backed securities (MBS) buying programs. We know that it will have an unfriendly effect on the interest rate markets, but we don’t know the magnitude, because it’s too hard to isolate the supply and demand dynamics between fundamentals and the stimulus programs. The key variables are the “stock” effect, or the lingering price impact of the amount of duration taken out of the marketplace, and the “flow” effect, which is the price impact when the Fed stops buying. They’ll keep the stock, but they’re just not going to be part of the flow any more.

The third uncertainty is any change in the Fed’s pre-commitment language, which is currently committed to keeping the fed funds rate exceptionally low for an “extended period.” We don’t think the Fed is going to tighten any time in 2010, but long before the FOMC (Federal Open Market Committee) actually does the deed, it will have to change its language. That could very well happen in 2010, and there is genuine uncertainty over how quickly and strongly the market will anticipate a tightening process. Our gut feeling is that the moment the Fed changes any one of its words, it’s going to be a very unpleasant experience, because the marketplace has very little patience and a very big imagination. The most important book at the Fed right now is a thesaurus, and it’s probably sitting on top of Paul Samuelson’s Foundations of Economic Analysis.

Bill Gross elaborates the structural headwinds:

That horse, like Billie, however, died in 2008 and we face an uncertain and lower growth environment as a result. The uncertainty comes from a number of structural headwinds in PIMCO’s analysis: deleveraging, reregulation, and the forces of deglobalisation – most evident now in the markets’ distrust of marginal sovereign credits such as Iceland, Ireland, Greece and a supporting cast of over-borrowed lookalikes.

The folks in the Pimco are really smart to position themselves on the cyclical side and also on the long term structural side. Not many people could can hold two conflicting forces in balance, I find their strategies are really brilliant.

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