Abe-cadabra: Japan Is Changing

by Michael J. Howell7. January 2013 17:17

Latest weekly BoJ net liquidity injections jump to Y50.4 trillion, or up from Y42 trillion at end-November. This looks more than just year-end window-dressing. Abe is working his magic!

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by Michael J. Howell7. January 2013 17:06

Market sentiment has been hit by the latest FOMC minutes which indicated that several meeting participants urged the Fed to halt QE in 2013. At first sight this seemingly reverses Bernanke's recent statements and flies in the face of Fed insistance that there is no timeline, rather than policy remains conditional on economic outcomes. On reading the minutes, the offending concern is plain. But whoops, we had inadvertently picked up the Dec 2011 minutes not the 2012 ones! Therefore, a minority of the FOMC ALWAYS seems to demand an end to QE. So Dec 2012 was no different. In short, market sentiment should rebound, perhaps spurred by latest SOMA data indicating that the Fed balance sheet in early January may be close to a new peak. Implied monetary base growth is ahead by an annualised 16.5% over 3 months. QE continues Phew!


US Dollar Yield Curve...Moving On Up

by Michael J. Howell3. January 2013 09:53

A recap of our recent fixed income market views: (1) QE policies steepen and do not flatten yield curves as the consensus apparently believes;(2) QE and Liquidity must be judged from the entire US Dollar Area; (3) the Fed has clearly changed policy from attacking inflation to attacking the jobless numbers. This is the most significant policy change since Volcker's in 1979. Yet the Fed's balance sheet has grown too slowly of late because of the long settlement times involved in MBS buying, but fact is it is buying. On the other hand, US Dollar Area liquidity is already rising because of China and EM expansionary policies. Conclusion: expect the US yield curve to steepen more and the 10-year bond to sell-off. The yield curve has already steepened from a July 2012 low of 85bp between 10 and 5 year Treasuries, to 108bp in early January 2013. On top, the 10 year yield is testing it's 1.9% break-out level. So far so bad for fixed income, but this is what QE does to 'low risk' assets. 2013 should be 'Risk On'.

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How to Understand 2013: Think 'M'

by Michael J. Howell2. January 2013 02:14

If like us you believe in the power and efficacy of Liquidity, then you should think about how liquidity moves? We maintain that it flows in a regular pattern that roughly traces out an M-shape over a decade long cycle. Liquidity leads by around year, but troughs are associated with banking crises and peaks with asset booms. The 'v' of the 'M' is typically shallow, giving approximately two asset booms per banking crisis. Banking crises occurred in 1966, 1974, 1982, 1990, 1998, 2007-08. The next is slated for sometime around 2016/17. Near enough to register, but too distant to worry about. Before then the next Liquidity peak is likely to be 2014, with 2013 a likely year (or should be) of rising liquidity. The last Liquidity peak was in 2010, and the recent 'v' lasted on cue from mid-2011 to late-2012, with liquidity drifting around its mid-levels. Thus, if we and our more prescient assistant history are correct, 2013 should see the monetary spigots open; yield curves steepen, paper currencies weaken, commodities jump and risk asset prices rise. This is our roadmap for 2013.

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The Big Event of 2013: 2012

by Michael J. Howell2. January 2013 01:51

We remain upbeat for this year, convinced the seeds for success were sown in 2012. Three 'liquidity' events proved critical: (1) Draghi at the ECB backstopped Eurozone risk with promises of extra cash; (2) Fed policy switched from attacking inflation to promoting employment. This message resonated among several other key Central Banks, so making it the most significant global policy change since Volcker took over the Fed in 1979, and (3) China's PBoC stepped up the pace of its liquidity injections from mid-year 2012. This halted domestic economic weakness; reversed the whopping outflow of foreign capital and promoted outperformance of EM equities from Q3. More of the same should be expected in 2013: paper currencies, notably the Yen, will remain fragile; commodity prices will pick-up; yield curves should steepen and rates start to rise, against the backdrop of still sluggish but better than expected economic activity. Above all EM equities will outperform: they are typically pro-cyclical and currently are out-of-favour with skeptical global investors, whose exposure remains a whopping two standard deviations below average.

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Bernanke Draghi Svensson Carney Iwata = CB Revolution

by Michael J. Howell21. December 2012 12:20

We celebrated just more than a year ago the appointment of Draghi at the ECB to continue  the good works of Bernanke at the Fed and Svensson at the Swedish Riksbank. Now Carney is slated to take-over the helm of the Bank of England, and rumours suggest that new Japanese PM Abe will turn to Iwata to lead the BoJ in 2013. These pro-employment CB changes are as significant as the selection of anti-inflation Volcker to head the 1978 Fed. The effect on the equity markets in 2012/13 may not be as dramatic as the impact Volcker had on the bond markets thirty years ago, but the positive effect will be felt.

This revolution attacks MV, i.e. money times velocity. Get M up via QE injections and raise V by creating inflation expectations via 'forward guidance', the Evans Rule (e.g. keeping rates low until unemployment drops below say 6,5%) or by weakening the US$. Taken together the latter are like having a nominal GDP target, or much as Carney as recently mooted for Britain.

All-in-all, given the well-known correlation between nominal GDP growth and nominal bond yields, this is poor news for global bonds. We expect yield curves to steepen. Normally this is bullish for other risk assets. The key to this puzzle may be Japan's JGB market. Investors must watch this bellwether in 2013 for confirmation that the new Central Bank Revolution is working its magic.

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More Money For EM...Again

by Michael J. Howell19. December 2012 23:40
Turkey, Thailand, India, Hong Kong and Russia top list of net financial inflows for month of November 2012. Money coming back into Emerging Markets again. Pace of outflows from Brazil slowing significantly.

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2013: Big Questions For The Big Consensus

by Michael J. Howell19. December 2012 15:41

The first flush of November liquidity data allows us to reassess 2013 prospects. Hard evidence of extra cash inflows are thin. Latest data show the aggregate GLI (Global Liquidity Index) slipping back to 46.5 from a value of 57.0 in October, 2012 ('normal' range 0-100). The bulk of this setback came from lower Central Bank Liquidity in both the Eurozone and Japan in November. BoJ liquidity injections measured at an index value of 27.9 are proving remarkably weak in the face of persistent criticism of its policy and expectations that its hand will be 'forced' towards greater ease after the early December Election. Given that latest capital flow data highlight a sharp net outflow of money from Japan, this fact by itself would normally (and may be currently does) signal a domestic monetary tightening in response. Therefore, talk of a further flood of Yen from re-starting the printing presses could prove significant and highly disturbing for the forex and JGB markets in 2013. The long-threatened sell-off in JGBs could prove the key event for global bonds because if Japan can escape from deflation, so can the other economies.

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Global Liquidity Update

Asset Allocation: Growth and Equities?

by Michael J. Howell12. December 2012 20:44
A recent FT blog contained academic wranglings concerning the 'fact' that faster economic growth is associated with lower equity returns! The professors are striving to find a paradox when really there is not one. Bonds (taking due account of inflation) correlate negatively with GDP growth and commodity prices (taking due account of resource sector productivity) correlate positively with GDP growth. These two asset markets seem to do what theory says. However, when equities are introduced, sometimes they correlate negatively with bonds and sometimes positively. It looks like equities are at fault. But we know that eps growth is strongly positively correlated to GDP growth, so the true culprit is equity valuation. Since P/Es cannot disappear to zero, this tells us that different valuation regimes must exist that include periods when valuations move oppositely to eps growth. Thus, sometimes equity valuations are pro-cyclical, e.g. right now, and sometimes they are anti-cyclical, e.g. 1980s and 1990s: two periods when they saw their highest correlation to bonds. What explains these regimes is a combination of inflation, the credit cycle and the starting valuation level. Moderate inflations, with strong credit growth, are typically when equity valuations are at their highest. The bottom line is that when economic activity picks up: equities will outperform. See latest research note: 'The Return of TAA'


EM Another Bullish Sign?

by Michael J. Howell12. December 2012 20:29

EM markets have out-performed on cue since the announcement of QE3. We maintain our view that 2013 will prove another good year, underpinned by the latest Fed announcement and by the visible pick-up in our indicators of EM Central Bank Liquidity. EM Central Banks remain 'tight' on our measures, but these indexes are definitively turning higher. Chinese PBoC liquidity injections have risen moderately but consistently every month since May 2012, and our index of EM Central Bank Liquidity stands at its highest level for a year and more than double its low point value. This is consistent with the monetization of renewed capital inflows: a feature consistent with QE3. Bottom line is that EM equities are highly pro-cyclical. With the Workd economy near a turning point in 2013 and policy-makers focussed on getting more growth not less inflation, EM will outperform.

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