BofA says 'Great Debasement' will drive move to global stocks over U.S.

Published Fri, Jul 24 202011:43 AM EDTUpdated Fri, Jul 24 202012:14 PM EDT

(This story is only for CNBC PRO subscribers.) A torrent of fiscal and monetary stimulus to fight the effects of the coronavirus, combined with already-low interest rates, will contribute to a "Great Debasement" of the U.S. dollar in the years ahead, according to Bank of America Merrill Lynch. That, in turn, will make investments in commodities and emerging markets more appealing as investors look for reliable inflation hedges and savvy ways to play a weaker greenback, BofA chief investment strategist Michael Hartnett wrote. "Interest rate repression means investors can't hedge the inflationary risk of $11tn of fiscal stimulus via 'short bonds' … so investors [are] crowding into 'short US dollar', 'long gold' hedges," Hartnett wrote. U.S. dollar depreciation is "well underway as the default narrative for [a] US economy with excess debt, insufficient growth, and maxed-out monetary & fiscal stimulus," he added. Central to Hartnett's thesis is a belief in an uptick in U.S. inflation, a rise in prices and a decline in the purchasing power of each dollar. Inflation can happen in a developed economy for a variety of reasons and, in moderation and around 2%, is considered healthy by the Federal Reserve. Inflation has been low for years and has dipped even more during the pandemic, falling to 1.2% in May as measured by the Fed's preferred gauge. Central bank officials say inflation is likely to stay low as the economy struggles. But many high-profile investors including Ray Dalio have in recent months warned that a deluge of U.S. debt will drive a more serious devaluation of the U.S. dollar as the pandemic continues to sap economic growth. Early signs of a long-term slide in the value of the greenback are already present. The U.S. Dollar Index , which tracks the value of the American dollar vs. a basket of foreign currencies, hit a low of 94.569 Friday morning, its weakest reading since September 2018 and down from highs above 102 as recently as March. "Cash is trash," Dalio said from the World Economic Forum in Davos earlier this year, adding that investors should consider buying a bit more gold. "We're going to have larger deficits which we're going to print money for. ... At a point in the future, we still are going to think about what's a store holder of wealth." As Dalio recommended in January, Hartnett says investors should consider investments in commodities as an inflation hedge, especially with exposure to gold. The recent popularity of precious metals is hard to overstate. A long bet on gold futures is up more than 22% year to date versus the S & P 500's 0.5% decline. Gold for August delivery topped $1,900 per ounce on Friday morning for the first time since 2011. Silver futures are up even more since January, gaining 28% year to date. Those robust returns haven't slowed weekly inflows to gold and silver either, Hartnett added, noting that the "gold rush" continues to see more cash pile into precious metals each week. Mark Haefele, chief investment officer at UBS Global Wealth Management, put it bluntly. "While we think gold will continue to be supported by rising geopolitical tensions, in our view the primary drivers of the gold price are its negative correlation to real interest rates and the dollar," he said in a note Friday. "This combination of low nominal interest rates and anchored or even higher inflation expectations will result in real rates likely remaining negative this year." Others, such as longtime hedge fund manager Paul Tudor Jones , have said they've actually invested a small amount of their assets in bitcoin as an inflation hedge. Jones said the cryptocurrency could serve as a safe place to park purchasing power if rising prices start to erode the value of each U.S. dollar. Jones told CNBC in May that he had somewhere between 1% and 2% of his assets in bitcoin . We're witnessing the historic "birthing of a store of value," Jones told CNBC at the time. "Every day that goes by that bitcoin survives, the trust in it will go up." But other than betting against the U.S. dollar and buying up gold, Hartnett said investors who fear inflation may be well served with exposure to global equity markets. Especially in emerging markets with a significant amount of U.S. dollar-denominated debt, a weaker greenback can allow governments to take advantage of low-cost dollars to pay down deficits and otherwise shore up financing. Exchange-traded funds operated by iShares that track the performance of Brazilian , Mexican and Turkish equities are up 45%, 21% and 18% over the last three months. The S & P 500 has gained 13.5% over the same period; the Vanguard FTSE All-World ex-US ETF , which tracks a basket of global stocks minus those from the U.S., is up 17%. — CNBC's Michael Bloom contributed reporting.

An employee of a bank counts US dollar notes.

Kham | Reuters

(This story is only for CNBC PRO subscribers.)

A torrent of fiscal and monetary stimulus to fight the effects of the coronavirus, combined with already-low interest rates, will contribute to a "Great Debasement" of the U.S. dollar in the years ahead, according to Bank of America Merrill Lynch.

That, in turn, will make investments in commodities and emerging markets more appealing as investors look for reliable inflation hedges and savvy ways to play a weaker greenback, BofA chief investment strategist Michael Hartnett wrote.

"Interest rate repression means investors can't hedge the inflationary risk of $11tn of fiscal stimulus via 'short bonds' … so investors [are] crowding into 'short US dollar', 'long gold' hedges," Hartnett wrote.

U.S. dollar depreciation is "well underway as the default narrative for [a] US economy with excess debt, insufficient growth, and maxed-out monetary & fiscal stimulus," he added.