The Asian Financial Cycle (Part II) … After The Latest Round Of Rate Rises, Could The World Economy Slow?

by Michael J. Howell23. March 2018 16:35

With investor sentiment elevated and markets looking skittish, many fear that these jitters could be a precursor to future economic weakness, particularly if China tightens policy in 2018. Indeed, some have suggested this squeeze is already underway. China plainly matters a lot, but we do not see the PBoC tightening this year. Rather we expect policy to remain accommodative.  This will underpin a rising Asian Liquidity Cycle. Liquidity drives economies: this report argues that investors are still ignoring the huge scope that Asian and EM economies have to ‘catch up’ with the West. Any broad sell-off should be welcomed as an opportunity to buy back into these markets at lower levels.


Using AI and Machine Learning to Predict Future Financial Crises

by Michael J. Howell15. March 2018 10:32

At CBC, we use machine-learning techniques to uncover three intuitive liquidity-based drivers of future financial crises – (1) cross-border capital flows; (2) investors’ risk appetite and (3) Central Bank policy. Adding these factors to a probit model warns of upcoming problems in 2018, largely because of reversing cross-border flows out of the US dollar. Reverse QE by Central Banks is unhelpful in this context, but it is unlikely by itself to trigger a crisis. Liquidity is important, but cross-border flows are the paramount factor to watch.


So Did Chinese Tightening Really Cause the 2008 Global Financial Crisis?

by Michael J. Howell21. February 2018 11:49

Most analysts would agree that US shadow banking, and its associated leverage and inadequate regulation, lay at the heart of the World’s financial problems in 2008 and that distress in the sub-prime mortgage market ultimately triggered the Crash. But we suggest here that there may be another explanation that closely involves China? This is not in any way to suggest that China caused the GFC. Rather it says that we always need to take a broad, global view and to understand the effects of cross-border capital flows on markets.


The Trillion Dollar Bash & The Second Leg Down?

by Michael J. Howell21. February 2018 11:47

The ‘big’ risks centre on US bonds. Bond markets essentially have two moving-parts – policy interest rate expectations and term premia. A strengthening economy and rising inflation pressures are already raising the trajectory of the Fed’s forward guidance. However, this is occurring against a backdrop of very low (negative) Treasury term premia that have been unusually depressed by the Fed’s LSAP and recent flight capital into US dollar assets from Europe and Asia. We are concerned that these benign influences on term premia are likely to unwind sharply as reverse QE engages, at a time when both the Trump fiscal deficit is swelling towards US$1 trillion and capital is exiting the US in search of economic acceleration elsewhere. US 10-year Treasuries will test 3.5% yields and the 10-2 curve will steepen. For equities, this could mean a second leg down. Bonds matter. And, China matters!


Major 2018 Risks (Part 3 of 4) - Prospects For China, Japan and EM in 2018

by Michael J. Howell10. January 2018 15:57

The Asian Liquidity cycle remains in an upswing. Investment prospects in 2018 look bullish because of three factors – persistent Chinese monetary easing, monetized capital inflows from the US dollar and a significant change in Japanese monetary policy from liquidity-management to implicit Yen targeting. We have been Asian bulls throughout 2017, having sensed that the regional liquidity cycle had bottomed in 2016 and was in the early stages of recovery. Two factors to look out for are the growing importance of the Chinese Yuan as a transaction currency (it will ultimately displace the US dollar) and the economic impetus coming from China’s vast geo-political vision – the Belt and Road Initiative – as it stretches into Central Asia. Vietnam and Kazakhstan are consequently economies to watch in 2018.


‘Quantitative Squeezing’: Prospects for Global Liquidity in 2018

by Michael J. Howell8. January 2018 13:11

Nervy investors are looking in the wrong place. It is reversing cross-border flows and not reversing Central Bank QE that poses the major risk for 2018. Overall, this year will see positive gains in both Global Liquidity and Central Bank money, but at much reduced rates when compared to 2017. China, which is entering the New Year with faster liquidity growth and more policy impetus that many recognise, is critical to prospects. On paper, we expect less US dollar weakness this year than last, but the dollar could be the key test for investors. A more rapid exit of US$3 trillion of foreign flows from the US, is easily a bigger threat that the slated more gradual withdrawal of US$1-2 trillion of QE, and paralleling events in 1987, it could trigger a second-half sell-off. Whatever, the alternative currency to watch is the Chinese Yuan, which has the potential to grab a large share of the US dollar reserve currency market. In this light, gold may also be a winner, despite reverse QE policies.


What Could Go Wrong in 2018? Part 1 (of 4) – Global Bonds

by Michael J. Howell6. December 2017 16:07

We remain firmly of the view that long-term yields will rise. The recent flattening of the US yield curve is almost entirely explained by rising short rates rather than falling long rates. Moreover, this flatter curve is unlikely to signal upcoming recession and a scramble for ‘safety’, because the curvature of the term structure remains low and the hump is positioned at a relatively long tenor. In short, a flat or inverted yield curve is a necessary, and not a sufficient, recession condition. Rather, US term premia have been exceptionally depressed over the past three years by massive inflows of cyclical ‘flight’ capital from Europe and EM. A heads-up to the direction of these flows can be taken from the performance of the Chinese economy and our estimates of Chinese term premia, both of which are rising. 2018 should see 3.5% tested on the benchmark US 10-year yield.


Has the Earth Just Moved In Japan?

by Michael J. Howell7. November 2017 11:07

Our 2017 views have centred on two key themes: a stronger China and a weaker US dollar. We predicted the implications would be a higher Euro and strongly rising Asian stock markets, as regional policy-makers monetized the impact of capital inflows. We were ambivalent towards the Yen. Our hunch that things had changed in Japan may be borne out by subsequent events, which unusually have seen the Yen largely unmoved by a skidding US dollar, but Tokyo stocks upbeat. We argue again here that Bank of Japan policy looks to have made a sea-change towards targeting the Yen and no longer targeting the volume of liquidity at a set level. If correct, it provides further bullish ammunition for Japanese equities, but warns of upcoming problems for fixed income markets.


Another Monetary Blast From China

by Michael J. Howell1. November 2017 11:53

China’s People’s Bank (PBoC) continues to ease monetary policy, evidenced by its latest balance sheet expansion. The PBoC is now the World’s biggest Central Bank. It deserves more attention not just for this reason, but because, unlike its Western counterparts, it retains an impressive control over its domestic monetary system. A green light from the PBoC is positive for the Chinese economy, positive for commodity prices and positive for EM equities. But a red light should worry all of us!


The Yen Kowtows

by Michael J. Howell20. October 2017 17:21

Big changes are underway in Asia. Investors may already be seeing this in the recent divergence between the rising Japanese stock market and the sideways-moving Yen. Digging beneath the surface, it seems clear that official BoJ/MoF policy towards the Yen has changed. We have long suggested that a move was imminent, ever since a recent BoJ-led research paper highlighted the changed structure and focus of the Japanese export economy away from supplying final goods to America and Europe, and increasingly towards sending intermediate goods to China. A stable Yen is now important. Put differently, the importance of the Yen/ Yuan cross is fast-rising relative to the Yen/ US dollar cross. It means Japanese liquidity and asset prices become more pro-cyclical. In short, Japan becomes more like another Asian Emerging Market and driven by the Chinese economy.


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