Macro Digest: The new dynamic duo

Macro 9 minutes to read

Steen Jakobsen

Chief Economist & CIO

Summary:  The twin circumstances of an incoming recession and a massive, trade war-related breakdown in the global supply chain have joined forces to lean heavily on risk sentiment.

Our macro view

A new, negative double-whammy is impacting markets and risk. First we have the dawning realisation that the breakdown in US-China trade talks already points to a a massive disruption of the global supply chain and a halt in “technology transfer”. Second, and due only partly to the trade war, the world is heading full-tilt into 'recession-light', if not a full-blown recession.

Why it matters

The Federal Reserve and its global peers are increasingly behind the curve and will move to do what they can (non-NIRP banks, at least) to aggressively cut policy rates.  We see the Fed cutting by at least 50 basis points by October.

Taking action

Remain long overweight US fixed income and unhedged (i.e. accepting currency risk), and add to overweight at a break of 129.50 in the TLT (US Long Treasury ETF) as measured by the daily close. Remain defensive in stocks and position for a shift from monetary to fiscal policy by Q4 2019 (infrastructure spending and early inflation).

Concerning credit

After the initial risk-on impact that followed the Global Policy Panic, we moved to our False Stabilisation theme in April, arguing that lowering both guidance and the future price of money wouldn’t be enough when the real issue is that credit facilitation is still falling.

Using our dependable credit impulse metric, we feel justified in insisting that the trough in economic activity lies ahead of us, not behind. The chart below plots Chinese manufacturing PMI against credit impulse and suggests a low in the August/September timeframe.
China manufacturing PMI v. credit impulse
Source: Bloomberg
If the credit impulse correctly predicts the timing of this low, the next policy action is likely to arrive around the same time: still-lower global policy rates led mainly by China and the US.

It’s important to realise that we don’t really have a business cycle any more, only a credit cycle – and credit leads and predicts nearly everything. The barrier for a cut appears high at the moment as the Fed seems to be engaged in a misinformation campaign. I asked my Bloomberg terminal for the top Fed news headlines in recent days to get a feel for where the US central bank stands.

This was the result:
Bloomberg and the Fed
Source: Bloomberg
Two things are surprising there, and the first is how neutral/hawkish the Fed still sounds. Second, and probably more relevant, is the question of why two top people – one a real contender for New York Fed President and both with over 25 years at the Fed – are leaving on such short notice? But let’s get back to the point: the Fed is either clueless or faking it to avoid a new, destabilising melt-up in equities, as both domestic and global economic data point to a steep deceleration.

Here is the Chicago Fed National Activity Index, the broadest measure of US economic activity. It has moved into negative territory (forget the chart headline – the data are updated, but not the headline).
US growth
Furthermore, the market is not only calling the Fed’s bluff but it's even raising the stakes and betting that the Fed will not only cut once, but at least twice this year.

Look at the state of play in the bond market versus the likelihood of a Fed cut on the chart below:
TLT v. Fed near-term spread
Source: Bloomberg
The chart shows that although TLT is returning to strength, it needs to break 129.50 to start the final climb to its 2016 high of 143.60 (which I expect it could eventually exceed). 

Finally, we at Saxo Bank have always said that the world-leading gauge of economic activity is Australia, and AUDJPY in the currency space. That exchange rate is making new lows at 75.50 and looks as if it will soon test the 72.50 low of 2016. What's more interesting, though, is that the Reserve Banks of Australia and New Zealand have always been at the forefront of cutting rates as global growth comes under pressure.

This was notably true in 2008 (we are excluding the Fed here, and looking at non-US central banks) as illustrated by this morning's excellent piece from Bloomberg's David Flickling.

The RBA, by the way is expected to cut rates next Tuesday for the first time since 2016.
Aussie and NZ rate cuts
Note that the 10-year Australian government yield is really Down Under as well, having collapsed to an all-time low below 1.50% over the course of last week, and below the RBA’s current short policy rate before next week’s cut!
10-year government debt
This new double-whammy for markets – an already recessionary tilt that is only being aggravated by trade war – has yet to be fully priced in. I continue to receive research hailing the resilient US economy, but the reality is that both the Fed and Wall Street are behind in terms of adjusting to a global scenario where the engines of credit growth – lower rates, cheap energy and globalisation – can either no longer prevail (globalisation and arguably energy) or have reached the point of diminishing returns (low rates).

Next up is an attempt to trot out the same old policy recipe: a lowering of policy rates, resulting (if we are lucky) in a brief “sugar high” in asset markets. But ultimately this just extends the False Stabilisation narrative until around October, which coincides with the US federal budget season.

The next policy pivot, which looks likely to dawn on the market around that time despite plenty of chatter over the last few quarters, will be massive fiscal spending built on a modern monetary theory framework. This means overt stimulus not sterilised by the issuance of US Treasuries.

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