Why Latest Chinese Data Spell ‘Sell’ For Global Bonds

by Michael J. Howell29. March 2017 16:12

This report argues that World government bond markets are risky because of Chinese reflation and the progressive recovery of the Eurozone economies. Curiously, this threat is only partially explained by rising inflation pressures. The bigger risk comes from a prospective ‘re-normalisation’ of bond term premia. This is largely a capital flow story. Some US$3 trillion poured out of the Chinese and Eurozone economies into ‘safe’ (largely US) government bonds between 2012-15 – it now seems to be heading back. US 10-year governments could test 4% yields and the US dollar could fall 10% over the next 12 months.

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Two Critical Prices Are Dangerously Wrong

by Michael J. Howell15. March 2017 16:16

The two most important prices in World financial markets are wrong. The US 10-year Treasury yield and the US dollar, each representing the price of the dominant economy’s debt, are too high and distorted by capital flows. Whatever the future risk outlook, the World’s two primary ‘safe’ assets are mispriced. In large part, they have been distorted by the extraordinary liquidity injections made by World Central Banks since the financial crisis: in short, policy-makers gave us ‘cheap’ money but we chose to buy ‘safety’ with it. The unwinding of these distortions will cause some jitters over the coming two years, but they will essentially mean a 5-10% weaker US dollar and higher, near-4% US Treasury yields.

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The Chinese Sleeping Giant Awakens – Capital Flows, Global Bonds and 1987 Redux?

by Michael J. Howell9. March 2017 16:14

As the Chinese and Eurozone economies gain traction, inflation pressures are building. Global bonds must come under further pressure. Yet, inflation is only half the story. Most of the collapse in bond yields in recent years was driven by capital flows: a hefty US$4 trillion-plus poured into US Treasuries, the US dollar and other ‘safe’ assets from ‘offshore’. Central Bank QE policies may have contributed, but they cannot explain the size of the flows. We argue that these flows are economically-related, highly cyclical and already reversing. In February, China actually saw net capital inflows again. They threaten much higher bond yields ahead by forcing depressed bond term premia back up . Capital flows appear to explain most of the 400bp swing in bond yields, more than fluctuating inflation. A reversal could stretch equity valuations like in 1987 and lead to a broader sell-off in ‘safe’ assets. It is predominantly these ‘safe’ assets whose prices look out-of-line. In short, risk may come from where you least expect it. It is critical to understand this capital flow story.

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The Return of Gold?

by Michael J. Howell1. March 2017 11:57

We have long-held a bullish view of the gold bullion price, setting a long-term target of US$3,200/oz. (see Global View “Rising Oil and Rising Gold” March 2011). This figure represents the value required to keep the monetary value of the gold stock in line with the vast accumulation of paper debt. The target was never likely to be a straight-line prediction, but the monetary rollercoaster witnessed over recent years is testimony to the uncertainties of Central Bank policies and the associated fragility in credit markets. This report argues two things: first that the two monetary drivers of the gold price are now much better aligned to support a further near-term rally and second that the future trend towards higher gold prices will be set by the monetary consequences of key geo-political change involving the US and China. We reiterate our view that gold and commodities will be star performers in 2017.

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Strong Emerging Market Capital Inflows Signal Another Good Year

by Michael J. Howell20. January 2017 16:56

Emerging Markets rely heavily on foreign capital inflows for their performance. This is true even for China. Cross-border capital both directly fuels asset purchases and indirectly leads to greater domestic liquidity as foreign inflows are often monetised by the financial system. 2016 was a year of strong recovery in Emerging Market capital flows. These helped push domestic asset markets higher, but more importantly they have re-ignited a rising EM liquidity cycle. This expansion should continue into 2017. We reiterate our view that Asia is leading global markets under the sway of Chinese economic recovery and, thus far, is undented by fears of further US dollar strength. We also show in this report that EM capital flows follow three trends that feature: (1) China & Emerging Asia; (2) Brazil, India; and (3) South Africa, Russia and, possibly, Turkey. Momentum is currently shifting from the first to the second group, which are seeing a ‘catch-up’.

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What Is Driving Down Bonds?

by Michael J. Howell21. December 2016 11:53

Global bond markets, led by US Treasuries, are finally selling off. The excuses of rising inflation expectations and President-elect Trump are not convincing. Chinese reflation and reversing term premia look to be better answers, but they are more worrying ones since they suggest that government yields could jump by far more. These term premia are determined by liquidity and volatility. Rising Chinese liquidity warns that US Treasury 10-year yields may be still at least 100bp too low.

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The Double-Whammy – Central Banks, G4 Fixed Income and How China Still Sets World Interest Rates

by Michael J. Howell16. November 2016 10:21

Bonds are turning down. Neither the Fed nor Trump are the problem: it’s the economy – the Chinese economy. Reversals in Chinese cost deflation and Chinese flight capital are currently having bigger impacts on G4 government bond markets than either Central Bank policy actions or expectations about President-elect Trump’s new fiscal policy. Bond yields were rising prior to Trump’s Election and the major Central Banks still talk as though they can control bond yields through QE policies. Yet, China matters far more through the People’s Bank, via the ebb and flow of flight capital to the West and from domestic cost pressures. In this report, we argue that these China trends point towards rising bond yields and steeper yield curves. This has been hard to see because Asia, and unusually not the US, is leading the global credit cycle.

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The Financial Silk Road – Assessing Future Chinese Monetary Policy and Capital Flows

by Michael J. Howell16. November 2016 09:52

China is again under attack from the doomsters. Too much debt; a housing bubble; too much reliance on unproductive credit for GDP growth; rising wages; a collapsing Yuan; accelerating ‘flight capital’ …. The list goes on. In this report, we reiterate our views that, although we can foresee future challenges, the near-term investment outlook looks surprisingly good. And the slated US$4 trillion OBOR (One Belt, One Road) programme will be central to addressing China’s medium- and long-term challenges and delivering sustainable GDP growth.

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The Bank of Japan Makes A Second Big Error

by Michael J. Howell22. September 2016 16:41

The reported September ‘major rethinking’ of Japanese monetary policy is an error that will add risk to markets. That is not to say that the previous BoJ move to push policy rates into negative territory was any better. Fundamentally, the BoJ’s recent actions confirm that policy-makers do not understand the yield curve. The end result will be higher Japanese bond yields, a steeper yield curve and a stronger Yen.

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China’s QE4 or QE3.5?

by Michael J. Howell27. July 2016 17:03

While markets ponder the Fed’s next move, swinging agitatedly between the probabilities of a rate rise and no change, China’s PBoC (People’s Bank) is quietly getting on with its job of reviving the Chinese economy. China is hugely important because her liquidity pool now matches America’s in size and the People’s Bank (PBoC) is one-fifth bigger than the US Fed. Call its actions a ‘QE4’ or something similar? But after last year’s tightening, latest analysis of the PBoC points to a renewed stimulus coinciding with greater stability in Chinese capital flows. The six months to June 2016 saw an annualised jump of 21.7% in the size of the PBoC balance sheet. This compares to an annualised drop of 17.7% in the six months to December 2015. No wonder commodity prices and EM are firm?

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