Tampering Or Tapering?

by Michael J. Howell8. July 2013 22:09
Two conclusions emerge from recent US and European Central Bank policy comments: (1) the Fed seeks to clearly distinguish (a) 'forward guidance' on Fed Funds from (b) QE, which determines the risk premium on bonds. Thus taken together forward guidance and QE determine bond yields. However, contrary to popular belief we believe that QE raises and does not reduce bond yields. Rather it reduces all other risk premia. The Fed by seeking to taper QE is trying we believe to stop the hunt for yield and likely wants to fatten 'too low' risk spreads on instruments such as junk debt, (2) the decision by the ECB and BoE to include 'forward guidance' is an interesting step. The ECB is admittedly using more 'words ' and according to our earlier points cannot control risk premia without QE. Nonetheless, the important thing here is that a European 'forward guidance' clearly opens the way for monetary policies in the US and Europe to formally diverge significantly. This could be key in 2014.

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EM Head For The Entrance!

by Michael J. Howell25. June 2013 17:57

When everyone else yells 'sell', start to think differently. EM are not yet in a sweet spot but this could come early in Q3. We figure that 'cyclical economic recovery' is the message from skidding bond markets. This is entirely consistent with our data showing rising liquidity. On top, we expect EM currencies to weaken as local policy-makers begin to ease. This may worry EM bonds, but EM equities will benefit. Third, the main historic driver of the Asian business cycle is the Yen. This plunged in Q1 and Q2, but should now stabilise. A flatter Yen is a great base for EM to build upon. What could go wrong? Our main worry concerns a too strong US dollar, but if our hunch that we are in a 'normal' economic recovery proves correct, the US dollar may soften over coming quarters as the US current account deficit again starts to swell.

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Watch Bonds

by Michael J. Howell21. June 2013 08:19
Bond markets nearly always give more sober assessments than equities. The movements in global fixed income markets in the past two months have it right again. QE or simply more liquidity drive up the risk premia on long-dated bonds (the low risk asset) and drive down the risk premia elsewhere. This is Liquidity Theory 101. If policy-makers anchor the short-end (they do) this beomes a bear steepening. The Central Banks pumping in most liquidity, the Japanese and the US, see the greatest yield curve steepening and those pumping least,the ECB, suffer the least (Bunds). On top, think about real interest rates. These are rising in anticipation of better economic growth in the second half 2013 and, if we are correct, stronger capex. The rise is connected to the end of the Great China Cost Shock we have written much about. This will push up marginal returns on capital and cause real rates to rise. 4-5% bond yields are again on the horizon. This is bullish for everyone else!

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Risk Assets ...Time to Exit?

by Michael J. Howell21. June 2013 08:06
The mid-June FOMC spooked markets with Bernanke's exit talk. Actually, we learned nothing new here and in fact if anything the long-tail exit should be reassuring. In our view, this liquidity cycle should last until 2015, and we still rate 2016/17 the mst likely time for the next banking crisis. So what now? The big stories for 2013 are not about the Fed, but three other things (1) strong growth in US private sector cash flows; (2) Bank of Japan QE and (3) lack of any QE in Eurozone and China. In short, liquidity may be high globally but it is skewed first towards the US and Japan and second skewed towards private sectors. Central banks overall including the Fed are not as easy as many assume. Strong private sector liquidity is a sign to us that economies will pick up strongly in the second half 2013. This tension is worrying bond markets. Money now has two directions to go it: real activity and financial assets. This must heighten volatility. The next 18 months should still see rising risk asset markets, but it will be a much bumpier ride.

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Emerging Markets??

by Michael J. Howell21. June 2013 07:48
Emerging Marets are in the eye of the storm. This not a surprise but it is important to understand why, not least because investors currently have relatively low exposure. Our long standing mantra is that every EM crisis is first-and-foremost a currency crisis. EM have suffered this year from a lack of capital inflow. Tensions have been worsened by a tight Chinese monetary stance that shows few signs of abating, and the collapse in the Yen. Traditionally (pre-mid 1990s) the Yen was the key driven of the Asian business cycle. This troubling backdrop has forced EM policy-makers to tighten their own policies to protect currencies, but in the process they are causing significant domestic economic slowdowns, that in turn add further downward pressure on currencies. Viz Turkey and Brazil. Liquidity levels on our indexes are very low, circa 35 index level (0-100 'normal' range). They need to jump before we recommend returning. This probable influx of Central Bank cash will further weaken EM currencies and trouble EM bonds, and the sell-off in EM credits may spread out into Eurozone credit markets which also look highly exposed. The second half year 2013 looks a better time to re-enter EM assuming currencies have adjusted, since by then there should be strong signs of cyclical rebound in the US and Japan.

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Global Liquidity Index (GLI) Latest

by Michael J. Howell17. June 2013 15:10

Latest Global Liquidity Index (GLI) data from CrossBorder Capital show the headline GLI hitting 73.8 (normal range 0-100). The distribution od World liquidity is dangerously skewed. Moreover, levels of liquidity above 70 on our index are associated with average VIX levels above 28.1%. For more information please contact us.

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Japan's Sell-Off

by Michael J. Howell30. May 2013 19:58

A 15% drop in just a few days focuses the mind. Is Tokyo's rally bust already? Not a chance, in our view. Nerves have been twanged by the sharp jump in JGB yields and associated steepening of the Japanese yield curve. But a steep yield curve is exactly what QE and liquidity policies should deliver. America since 2008 is a clear case in point, but the evidence is overwhelming and true throughout history and across geographies. In fact, this is how bond markets work. Forget all the talk that Central Banks push down yields by buying bonds. In a micro sense they do, but economics and finance are more about macro events. A steeper yield curve reflects fatter risk premia and fatter risk premia on bonds are the very reverse of slimmer risk premia on stocks, or should be if the monetary stimulus works. In short, bonds always sell off and enjoy these fatter risk premia when investors expect a return to 'better times'. Therefore, a steep yield in Japan, as in the US and Europe, signals coming economic recovery. Sell bonds, buy stocks. This is an unexpected opportunity for equities.

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Global Liquidity Climbs A Peak

by Michael J. Howell17. May 2013 11:01

 

Global Liquidity rose again in April 2013 to a GLI reading of 65.2 ('normal range' 0-100), or the highest since October 2009. Of more interest, is the fact that without the drag from a tight Eurozone and sluggish EM, the Global Liquidity Index (GLI) would probably be over 75.

 

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Gold: There is No Conspiracy!

by Michael J. Howell19. April 2013 14:02

The recent plunge in the US dollar gold price is unsettling but it reflects no dark forces and no sinister conspiracy by Central Bankers. The reason is the strong US dollar, and this strength maybe unusual for this stage of the business cycle, but it is driven by underlying liquidity forces. Specifically, when our PSL index exceeds the Fed CBL index the dollar soars. This is true now, with a strong Fed outpaced by even stronger private sector flows underscored by corporate revenues, household recovery, renewed shadow bank lending and shale oil cash. In short, its economics not politics that is the problem for gold.

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Latest GLI March 2013

by Michael J. Howell19. April 2013 13:57

Our Global Liquidity Index (GLI) jumped to 64.5 in March 2013 (normal range 0-100). A large increase in Japan Central Bank liquidity and continued gains in US private sector liquidity more than offset another slide in Eurozone liquidity. EM liquidity remained low, although cross-border inflows into EM picked up a tad. Our data story still supports a strong US$. It also warns of Eurozone Crisis.

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