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.


Gold or Paper Money? Capital is Quitting the US but it is Heading into Euros not Gold

by Michael J. Howell27. September 2017 15:09

The price of gold bullion closely tracks liquidity and capital flows. Latest data point to broad stability in the bullion price and possibly a small future percentage rise. Further upward impetus would require either a collapse in confidence in the US dollar, triggering larger-scale capital outflows, and/ or still stronger QE injection by Central Banks. Looking ahead, we foresee neither. Even after the German Election result, we retain our view that the Euro is more likely to be the main net beneficiary as capital progressively quits the US and Central Banks reverse their QE policies.


Are Central Banks triggering a bear market?

by Michael J. Howell25. September 2017 14:51

Is a 2018 Bear Market Coming? Are the G4 Central Banks About to Make Another Major Error by Reversing QE? Watch Capital Flows to Find Out

This report analyses latest Central Bank QE actions against the background of global capital flows – or a potential clash between Tyrannosaurus and Godzilla? We argue that, although policy-makers have vowed to tread slowly in reversing QE, the facts that often dominant cross-border flows already appear to have peaked and that Central Banks are starting out from a much less accommodative position than widely acknowledged, must heighten systematic risks. Feeding these facts into a statistical probit model that has been informed by machine-learning techniques warns that the consequence may be a bear market in World risk assets starting in 2018. This is not yet certain, but watching the upcoming direction of cross-border flows will tell us a lot more.


Has China made Japan an Emerging Market?

by Michael J. Howell21. September 2017 13:56

As a global supplier of consumer goods, Japan has for decades enjoyed a strong Yen, high street deflation and a surging bond market. Now, re-constituted as predominantly an Asian regional supplier of intermediate goods, Japan faces different challenges and consequently deserves new policy and currency regimes. It may in future behave increasingly like a typical emerging market, choosing a more stable currency against a pan-Asian basket, but at the cost of more volatile domestic liquidity flows, particularly, when Chinese and pan-Asian liquidity are also expanding as now. These increased flows may be channelled initially into Japanese equities and latterly into outward capital flows. On top, upward pressure on Japanese interest rates from higher domestic liquidity will build, so forcing JGB yields higher and likely spilling over negatively into international bond markets. There is a growing risk to the 10-year JGB, which could suffer an upward yield spike from zero to around 30bp.


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