Geopolitical Context

For a decade before the pandemic and broadly speaking in terms of drivers of investment decisions, we could say that that period was dominated by the capital asset pricing model (CAPM) and efficient frontier portfolio theory and asset allocation, and diversification also played a large role in this process.

During that time, there was relative peace and globalisation spread rapidly. Monetary policy inflation targeting regimes were and still are critical input to these investment decision models and are a dominant market force. Post the pandemic we had the brief period of the “easiest money”, in the dual
form of fiscal stimulus packages, and the return of quantitative easing, as most western and some emerging economies sought to protect business and society, from the economic suppression caused because of pandemic induced shutdowns.

As the pandemic subsided, we were introduced to temporary and transitional inflation, which slowly became more embedded in the global economy as demand and supply imbalances played out. Monetary policy to the fore again, in the shape of higher rates and inverted sloping curves. While not as straight forward as the preceding era of easy money, much of the investment bank trading desk community had not seen a tightening cycle of this magnitude for some time, if ever. There was still some familiarity as it was the other side of the monetary policy coin, as growth and yields swapped in terms of importance. However more recently, two significant themes have emerged to change or challenge the discussion on what are the overarching driving market macro forces. 1 – The strategic competition between U.S. and China with the war in Ukraine as a subplot and 2 – the accelerated pace of transition from brown to green energy economies and the greening of the financial system. Both themes overlap and interlink at times, notably in the strategic areas of energy, raw materials and of course in tech where the level of microchip advancement can determine strategic success.

Patrick’s View

Lower USD arguments come in the shape of 1 – USD has been elevated for some time and overvalued in some measures. The U.S. Federal Reserve has maybe 1 or 2 hikes left before a pause, and if you believe the bond market potentially a rate cutting cycle is in the not-so-distant future. Mean reversion should play out at some point in the currency market, as rate differentials favour non-dollar currencies. 2 – credible desire from the Chinese led non-western community to seek alternative USD trading\settlement solutions. 3 – The raw materials and commodities that will be required to green our economies are significant and the same raw materials can be weaponised in the strategic arm- wrestle between the U.S. and China. While China is and will challenge US hegemony, this is not a call for the USD to be replaced as the global reserve currency, but its dominance is such that even if you move the needle here, then it is a good idea to be on right side of that move.

How you express this view is subjective, but the investment theses is long raw material and mining sector vs short USD.

1. What we know so far through a currency lens is that the USD has remained elevated for some time and is possibly due a correction as interest rate differentials retreat in favour of non-dollar currencies. Driven by a pausing or reversal of Fed policy in the next 6 to 12 months. Timing such an investment is the key to its success. Other central banks certainly don’t always follow the script, and you cannot assume that they will just cease emergency measures, Bank of Japan (BoJ), or are inclined to send
base rates back to pre-pandemic levels, European Central Bank (ECB). The USD dollar has been sought after for a decade. It’s been the settlement currency of the There Is No Alternative (TINA) US equity investment strategy, but also as a haven, as pandemic induced economic jitters took over during a staggered global reopening for business. The dollar benefitted from strong U.S. growth but most economists are forecasting the ASEAN to be the leading global growth engine starting now and later into this decade.

2. The war in Ukraine introduced geo-political risk and the weaponisation of natural resources has brought renewed valuations to key commodities that can fan the flames of inflation. To counteract Western sanctions and confiscation of Russia’s USD reserves, a Chinese and Russian led thought
process on ideologies around an alternative ways to trade without the USD. Alternative USD trade discussions are ongoing between Brazil, Russia, India, China and South Africa (BRICS), the Shanghai Cooperation Organisation (SCO) and even Brazil and Argentina are in early-stage discussions about a currency block for the combined region. Just out is Chinese data and the RMB has for the first time exceeded the USD as the most settled currency over the last year. Even the French head of state last
week has also leant his weight behind a non-dollar trading relationships. This anti-dollar theme is gathering pace, we know that China has developed an e-CNY alternative digital version of the Yuan that can be settled away from the westernised and weaponised Society for Worldwide Interbank Financial Telecommunications (SWIFT) settlement architecture. With the introduction of the CHIPS act in the US, attempting to replicate SWIFT sanctioning ability to the micro chip supply chain as an attempt to stunt Chinese technological development. Protectionist trade policies are likely to cause targeted countries and dependants, seeking safter more reliable avenues for global trade. This bifurcation of a globalised world could also see non-USD trading of solutions of goods and services flourish. Depending on the degree of the trading separations but a retreat of USD is more than likely to be witnessed away from other Western currency block regions as regionalisation and “friend shoring” slowly replaces globalisation.

3. The push from the U.S. Inflation Reduction Act (IRA), E.U.’s recently published Critical Mineral Strategy and Net-Zero Industry Act and China’s economics-of-scale for greener energy, battery solutions, electrification of the grid and economic digitization has seen many precious earths and mining products become front and centre in the race against climate change. Success in these sectors could sway the race for the next leading nation of our world. Weaponization of financial services , natural resources and trade policy to underline the importance of these materials and the surrounding mining sectors should be expected. Lithium, Cobalt, Nickel and rare earths all play an important role in the green transition and digitizing our societies further.

Patrick Flynn

Patrick’s background is in global fixed income G10 currency portfolio management and global macro investing. He has over 12 years’ experience with and is adept at contributing positive risk-adjusted returns, trade idea generation and execution to a currency, alpha generating strategy of USD 10 billion AUM.