Summary: It's time to take a step back from developed markets if you want to find positive yields
Take it from someone who—unlike my peers—was originally in the transitory camp of inflation; after all, the tri-factor meta-trends of ever-lower US yields since the 1980s, deflationary forces of technology, and ageing demographics in most western and developed markets were goliath factors that have been running for decades.
Now it’s not so much that these meta-trends have been usurped overnight; it’s more the recognition of the fact that we could well be entering a medium inflationary regime which could run for years.
For context here is a table of recent inflationary prints across the globe (September 16, 2021)*:
*Worth noting that Australia and New Zealand CPIs are quarterly, unlike the default monthly figures for other countries. Sources are Saxo Bank and Bloomberg.
The fascinating thing you can see is that out of the major economies in the world, from both a DM and EM representation, the US is fourth in terms of having the highest inflation rate at 5.3%, but has a central bank rate of 0.0%—way lower than the +4.50% to +6.75% range across Russia, Brazil and Mexico.
If someone had told you in December 2019 that in 2 years’ time the US would be showing higher inflation than places like South Africa, Indonesia and India, alongside a central bank that had not hiked or tapered yet, they would have been laughed out of the room.
The other startling takeaway is the +3.2% to +3.8% range of inflation across the other DMs, with all of them having all-time low central bank rates. What is even more revealing of the inflection point, is when you compare the inflation and central bank rates pre-Covid (December 2019) and today (September 2021).
For instance, pre-Covid Norges bank’s rate was +1.50% with inflation running at +1.40%. Today inflation has more than doubled to +3.40%, while the Norges bank rate as of early September was sitting at 0.00%. It’s not hard to fathom a pathway where Norges bank returns to its +1.50% rate, if not higher, over the next 12 months.
Meanwhile in China, Indonesia and India, inflation has actually been falling from pre-Covid levels to the present. And in the case of China’s PBOC, they never cut rates during the Covid crisis.
Negative real rates seem to be a function of developed markets that have lost the ability to have true price discovery, and are instead influenced by synthetic pricing as a result of extraordinary credit growth. A key inflection point was seen in 1971 when Nixon took the US off the Gold Standard and with it, accountability. Also after the 2008 financial crisis, the predominant response from the US and most of the world was one of monetary policy expansion but fiscal policy restraint. Obama was a Democrat president and Congress was controlled by Republicans who, now being out of the White House, had found faith again in being fiscally conservative.
For additional context on the extent of this synthetic pricing that is prevalent in our markets, the Fed’s BS/GDP ratio grew from around 6% prior to the sub-prime 2008 crisis to a high of 26%, in measures that were supposed to be “temporary”. “Tapering” brought us back to a low of 18%, and then post-Covid we’ve seen that ratio spike to 38%. Now where could this number get to?
When Abenomics kicked off in the back end of 2012, the BoJ BS/GDP was around 28%. Today, less than 20 years later, it’s 133%, with no signs or indications of a reversal of policies to any kind of normalisation. The BoJ own the vast majority of the bond market in Japan and depending on whose data you trust, potentially up to 30% of equities. And this from the third biggest country that, unlike the US, is not even the global reserve currency of the world, with the deepest and most valuable equity, debt, real estate and intellectual property markets.
If we normalise the quarterly growth of the Fed Balance Sheet versus the S&P 500 from the end of 2007 to the end of August 2021, we can see that the Fed’s Balance Sheet grew by +935% versus the S&P 500’s +308%.
Source: Bloomberg and Saxo Group
The net result of all this liquidity in the system is developed markets that cannot reverse course back to a world of positive real rates. The political capital, will and courage is not there. Perhaps most alarming, the zeitgeist and the societal imbalances would just not stand for it. In the DMs we’ve just had the biggest wealth distribution from government balance sheets to its citizens and the vast majority are going to get used to this entitlement. And politicians being politicians, they will respond like monkeys, pushing the same button over and over all because it feels good and leads to their further entrenchment. The flawed incentives, vested interests of the elite, and lack of accountability and transparency from policymakers have DMs stuck in a vicious feedback loop that only compounds the house of cards that has been building since 2008.
EM Asia is host to some of the biggest real rates yielding bond markets in the world. These include Indonesia (+4.5%), China (+2.1%), and Malaysia (+1.1%); contrast this with the negative rates to be found in the USA (-4.0%) and the Eurozone (-3.7%).
Source: Bloomberg and Saxo Group
2024: The wasted year
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.