Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Steen's Chronicle: What's up and what's down?
Steen Jakobsen
Chief Investment Officer
Summary: Q4 will be more risk-off, with a US Dollar Index peak coming in December (along with a "dovish Fed hike") and China finally bringing some major stimulus online.
I have just returned from a busy travel schedule that only confirmed that our main macro scenario, "The Four Horsemen", is indeed working its way through the global economy.
• Quantity of money: collapsing
• Price of money: rising fast
• Globalisation: collapsing
• Price of energy: rising (and acting as a tax on consumers)
The price of energy has corrected since we initiated the Four Horsemen, but the full impact of the past rise in prices is clearly being felt in global consumption, along with a “credit cake” that is its smallest in decades and a Federal Reserve that is more aggressive than any since the Volcker Fed of the '80s.
How do we get on from here? More downside? More risk-off? I think the timing is becoming clear:
Q4 will be more risk-off; we see a US Dollar Index peak coming in December (along with a "dovish Fed hike") and China finally bringing some major stimulus online.
The China of 2018 has largely been on pause while local business people and bureaucrats awaited the next phase in the country's industrial revolution. What we often fail to appreciate in the West is how Chinese sees its recent history as 30 years of struggle during the reign of Mao Zedong followed by 40 years of "reforms and opening" led by Deng Xiaoping’s 1989 decision.
In other words, China’s past 70 years has seen the country follow two paths: one of hardship and one of changes. Now, the “third way” or the phase between now and the PRC's 100-year anniversary in 2049 needs to be decided.
While I was in China last, two major catalysts were triggered:
First, President Xi reached out the private sector in a near-180 degree turnaround from earlier policy. This is clear sign that the private sector needs to play a role in the third period, which will most likely be called something like "opening up with Chinese characteristics". The big question that remains is whether the country's wary private sector will be calmed by the Party's recent endorsement, including tax cuts and substantial policy support.
Second, the party's endorsement of Chinese business was a public acknowledgment that the 40th anniversary of Deng’s policy would be celebrated. This was seen as critical in confirming that Beijing would embrace “opening up and reforms”.
In my view, much of the bad data seen in 2018 came from this “indecision” – the lack of clear signs on Beijing's commitment to reforms saw companies and bureaucrats holding back. This should now clear the air, as the following recent release from XinhuaNet illustrates:
"Xi Jinping, general secretary of the Central Committee of the Communist Party of China (CPC), presided over the fifth meeting of the central committee for deepening overall reform Wednesday. Xi, also Chinese president, chairman of the Central Military Commission, and head of the central committee for deepening overall reform, called for "holding high the banner of reform and opening-up and achieving the overall goal in improving and developing the system of socialism with Chinese characteristics and modernizing China's system and capacity for governance. He also urged more efforts to keep advancing the reform and opening-up in the new era.
To celebrate the 40th anniversary, concrete actions are needed in facilitating reform implementation," said the document, adding that local authorities should take tough action against the practice of 'formalities for formalities' sake' and bureaucratic."
These two changes leave me relatively confident that China will follow our predicted pick-up from Q1'19.
• Quantity of money: collapsing
• Price of money: rising fast
• Globalisation: collapsing
• Price of energy: rising (and acting as a tax on consumers)
The price of energy has corrected since we initiated the Four Horsemen, but the full impact of the past rise in prices is clearly being felt in global consumption, along with a “credit cake” that is its smallest in decades and a Federal Reserve that is more aggressive than any since the Volcker Fed of the '80s.
How do we get on from here? More downside? More risk-off? I think the timing is becoming clear:
Q4 will be more risk-off; we see a US Dollar Index peak coming in December (along with a "dovish Fed hike") and China finally bringing some major stimulus online.
The China of 2018 has largely been on pause while local business people and bureaucrats awaited the next phase in the country's industrial revolution. What we often fail to appreciate in the West is how Chinese sees its recent history as 30 years of struggle during the reign of Mao Zedong followed by 40 years of "reforms and opening" led by Deng Xiaoping’s 1989 decision.
In other words, China’s past 70 years has seen the country follow two paths: one of hardship and one of changes. Now, the “third way” or the phase between now and the PRC's 100-year anniversary in 2049 needs to be decided.
While I was in China last, two major catalysts were triggered:
First, President Xi reached out the private sector in a near-180 degree turnaround from earlier policy. This is clear sign that the private sector needs to play a role in the third period, which will most likely be called something like "opening up with Chinese characteristics". The big question that remains is whether the country's wary private sector will be calmed by the Party's recent endorsement, including tax cuts and substantial policy support.
Second, the party's endorsement of Chinese business was a public acknowledgment that the 40th anniversary of Deng’s policy would be celebrated. This was seen as critical in confirming that Beijing would embrace “opening up and reforms”.
In my view, much of the bad data seen in 2018 came from this “indecision” – the lack of clear signs on Beijing's commitment to reforms saw companies and bureaucrats holding back. This should now clear the air, as the following recent release from XinhuaNet illustrates:
"Xi Jinping, general secretary of the Central Committee of the Communist Party of China (CPC), presided over the fifth meeting of the central committee for deepening overall reform Wednesday. Xi, also Chinese president, chairman of the Central Military Commission, and head of the central committee for deepening overall reform, called for "holding high the banner of reform and opening-up and achieving the overall goal in improving and developing the system of socialism with Chinese characteristics and modernizing China's system and capacity for governance. He also urged more efforts to keep advancing the reform and opening-up in the new era.
To celebrate the 40th anniversary, concrete actions are needed in facilitating reform implementation," said the document, adding that local authorities should take tough action against the practice of 'formalities for formalities' sake' and bureaucratic."
These two changes leave me relatively confident that China will follow our predicted pick-up from Q1'19.
We have often said that China was worse off than the numbers showed, and that the most likely result would be another boost to the credit impulse.
Have a look at the sheer size of the move down in China’s credit impulse, from +5% of GDP to -5%!
This all the work of deleveraging and fighting corruption/pollution, combined with 2018's aforementioned indecision on new investment and projects. The road is now clear, in our opinion, but we proceed from a low actual level of activity so the recovery will be slower than normal. This makes Q1 a brave call, but nevertheless one we feel confident about.
Have a look at the sheer size of the move down in China’s credit impulse, from +5% of GDP to -5%!
This all the work of deleveraging and fighting corruption/pollution, combined with 2018's aforementioned indecision on new investment and projects. The road is now clear, in our opinion, but we proceed from a low actual level of activity so the recovery will be slower than normal. This makes Q1 a brave call, but nevertheless one we feel confident about.
We remain committed to our reallocation out of the US stock market and into emerging markets and China, but in terms of overall risk, Saxo Bank Head of Forex Strategy's John Hardy’s risk monitor is screaming "alert! alert!" so this market could still have further to fall.
From a tactical point of view we think the recent low in SPX and NASDAQ, minus 5-10%, is the inflection point to stop the Fed.
The year-to-date low in the Nasdaq is 6,317, so a 5% drop would see 6,000 and a 10% drop would see 5,685; 6,059 is also roughly the 61,8% Fibonacci retracement and 5,544 is the 50%
The key to this timing remains the dollar. Here we borrow an excellent graph from the Nordea Economics Department depicting correlation between excess US liquidity and DXY.
(Note: end of year in the Nordea model coincides with year-end.)
The year-to-date low in the Nasdaq is 6,317, so a 5% drop would see 6,000 and a 10% drop would see 5,685; 6,059 is also roughly the 61,8% Fibonacci retracement and 5,544 is the 50%
The key to this timing remains the dollar. Here we borrow an excellent graph from the Nordea Economics Department depicting correlation between excess US liquidity and DXY.
(Note: end of year in the Nordea model coincides with year-end.)
Finally, over the last few days our “primitive” model has drawn close to buying USZ8–10 US Treasury.
I will write a "deeper" note on China over the next few days, as well as have Saxo Bank Head of Macro Strategy Christopher Dembik update our credit impulse work. Right now, however, I see things as follows:
December will continue to be volatile, but China is outperforming despite the most negative sentiment I have ever seen in action on the ground. The market is developing a sense of the big shift I mentioned in the beginning of this piece.
In the meantime, have a look at a different approach: The Bradley Siderograph... it matches our outlook.
December will continue to be volatile, but China is outperforming despite the most negative sentiment I have ever seen in action on the ground. The market is developing a sense of the big shift I mentioned in the beginning of this piece.
In the meantime, have a look at a different approach: The Bradley Siderograph... it matches our outlook.
Be careful out there.
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