Q2 Outlook: You can't fight gravity
Summary: The global policy panic seen in Q1 saw the world unable to escape its QE dependence, with central banks pivoting to a degree of support that will remain in place until structural failure. The “QE for life” era, though, holds some implications of its own, and we see China’s gravitational pull as perhaps the key factor.
Fed chair Jerome Powell’s Fed now seems to belong to vice-chair Richard Clarida (who, it should be noted, was previously at one of the biggest bond shops on the planet). The Fed hiking cycle, meanwhile, is down for good with a wooden stake through its heart – we went from expecting two hikes in 2019 (after a December 2018 downgrade) to no hikes. Additionally, there is already an end in sight for the balance sheet unwind, despite its having barely got through 10% so far.
Mario Draghi’s ECB has also moved firmly back into stimulus mode in a year that was supposed to see it look to raise rates. The “hawkish Fed” and the “hawkish ECB” must now be classified alongside the unicorn and all the other mythical beasts.
No one should be surprised that we couldn’t escape this QE world, particularly given debt levels that are now north of $250 trillion as compared to $175 trillion before the financial crisis. The speed with which we have been pulled back in, however, was surprising. The implication is now that, until a “great debt reset” (read: haircuts, restructuring and a debt jubilee) that could still be five to 10 years away, it’s back to QE for life.
Does the level of debt and excessive money printing in the system matter? No and yes... or rather, it doesn’t matter until it does. It’s just like any bad habit: at first, it’s just a taste here and there, then it becomes a regular occurrence and some time after that, there is notable structural change. We will need a global recession before we see the great debt reset but until then, the QE-for-life theme has quite a few implications.
For one, it will continue to extend this business cycle even further, despite the fact that we are presently in the tail-end. The 2020 US elections, Tokyo 2020 and the Chinese Communist Party’s centenary in 2021 – not to mention a likely forced fiscal spend in the Eurozone at some point – will carry overall global growth.
Taking the world back to looser monetary policy and lower yields will be bullish for bonds and equities. Expect new cyclical lows in bond yields (for example, and as we have long mentioned, Australian 10-years are already taking out the 1.81% lows). Structurally speaking, I also expect a much weaker USD over the course of the year. The world needs a weaker USD to flourish and what the world needs, it tends to eventually get.
Lower yields mean less financing and a lower cost of capital for global companies and emerging market corporates. A structurally weaker USD will remove years of headwinds for EM assets. It should also be a tailwind for higher commodities, which are generally supportive of EM as whole.
For China, there are a lot of moving parts. The market is still anticipating some form of resolution on the US trade deal, although repeated delays of the long-awaited Trump/Xi summit could be bearish in the short term. It’s also worth bearing in mind that the market is acting like there will almost certainly be a deal. As such, a no-deal scenario would be a disaster for equities – we could see a retest of the December lows – and a boon for higher bond prices and a stronger USD.
There is another gravity effect in China over the long term and that’s the multi-generational move from a positive current account economy (outwardly driven) to a negative current account economy (inwardly driven). This is all part of Beijing’s plan to be more reliant on domestic consumption than on exports to the rest of the world. That’s over around $1 trillion of Chinabound inflow over the next three to five years; to put that in context, it’s over +7% of China’s 2018 GDP of $13.5 trillion.
Saxo Chief Economist and CIO Steen Jakobsen made a very contrarian call towards the end of last year that Chinese equities were likely close to the bottom and that they would outperform in 2019. The 30%-plus gains from the lows in the Shanghai Composite show that he was precisely correct – not just on direction, but more importantly on timing.
It’s also worth noting that while we are not far from all-time highs in US equity indices (we have already seen new all-time highs in certain stocks), Shanghai at around 3,100 is still around 40% lower than its 2015 high of 5,180. We also have huge China equity inclusions in the MSCI EM index coming that will take us from 5% to 20% (in +5% increments slated for May, August and November. The bounce in Chinese equities is likely telling us that, for now at least, we’ve seen the worst in the underlying Chinese economy and could be in for some positive surprises, particularly in Q2’19 growth data.
Beyond this, there are significant structural inbound flows headed to the Chinese equity and bond markets as China continues to open up to the world. If you have not done so already, check out Saxo’s China Bond Connect to access the $12 trillion-plus Chinese bond market
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