background image background image background image

Steen’s Chronicle: The global policy panic

Macro 8 minutes to read
Picture of Steen Jakobsen
Steen Jakobsen

Chief Investment Officer

Summary:  The theme for the coming quarters is 'policy panic' as the rising price and declining quantity of money, the reversal of globalisation, and the ramp-up in energy prices places policymakers' backs firmly against the wall.


I have spent the fourth quarter of 2018 traveling extensively and I am convinced that the world is one or at most two quarters away from a global policy panic. What would this look like? Policymakers throwing everything they can at an economy that is sinking fast and still reeling from the mistakes of the last decade, exactly six months after all the same policymakers said the crisis was over. Quelle domage!

Europe is sliding back into recession despite a negative European Central Bank policy rate and Germany and its marquee names suddenly look a far greater risk than Italy’s populist government. Australia is a mess, both politically and economically, as the Royal Commission leaves banks tightening lending standards in an economy that is at least 50% driven by housing. 

The US credit market, meanwhile, is one standard deviation away from panic as the flows from corporate repatriation run dry and Federal Reserve policy normalisation kills the massive financial engineering game that drove so much of the last decade's unsustainable US corporate profitability growth.

China is still contemplating its next stimulus – tax cuts, mortgage subsidies, a stronger renminbi – and is wondering how to proceed towards its 100-year anniversary in 2049 in with its 2025 plan now pushed back to 2035. In India, the rupee is in free fall and the central bank of India has lost independence. Japan registered a negative nominal GDP growth number in Q3 – nominal growth – despite the ramping up of spending for the 2020 Olympics in Tokyo.

The UK, meanwhile, has suffered the biggest credit impulse contraction of any country, leaving the first half of next year a major risk for UK assets.

The reason for all this? The Four Horsemen we have identified over the last couple of quarters that are pressuring global markets, and the increasingly the economy as well:

The rising price of global money from the Fed’s tightening.
The declining quantity of money from not only the Fed’s tightening, but also a tapering of balance sheet growth from both the BoJ and ECB.
The reversing of globalisation as the US and China face off over trade.
The ramp-up in global oil prices before the recent decline, which was made especially painful by USD outperformance.

Since the global financial crisis, we suspended the business cycle and replaced it with only a credit cycle. Credit, credit and more credit crowded out productivity and inflated asset prices while doing little for the real economy and driving the worst inequality in generations. 

That’s the second conclusion I take from my global travels: inequality, both economically but also in terms of access to education and equal rights for women, is an issue which will drive all elections. Election hopefuls better get those female voters and the millennial generation right, otherwise are they are headed for the dustbin of history.

The mood in Europe, Middle East, Africa and Asia is the worst I have seen – including the conditions leading into 2008. There is, however, a new sense of urgency everywhere, and the classic response of...’it could be worse’ is now being replaced by frank questions on what to do next and how bad the trade war and populism can get.
 
A status check tells us that the situation is bad and will get worse if nothing changes. Looking ahead of the curve, however, we need to ask what might change the dynamic?

The price of money is the easy fix: there is perhaps a 25% chance the Fed doesn’t hike at this week's FOMC meeting. Tactically, I will play this meeting for a dovish surprise. A Fed hike in December will be a bridge too far and even if it does hike, it is still switching to a more neutral stance.

Besides, the price of money is the least important of the horsemen as the proximity of the zero-bound weakens the monetary transmission potential if the Fed was eventually to reverse course: aborting hikes will offer psychological support but nothing more.

The most important factor is the quantity of money, and even if all the major central banks opened their taps now it would still be late summer next year before economic activity levels would start improving. The lead of credit impulse into the economy is at least nine months, and is often longer depending on a country’s debt levels.

The price of energy in USD terms has moved back to where it was when we started this year, but not in the major emerging market importer countries like India, Indonesia and China; there, it remains elevated in local currency terms. This is a massive tax on consumption, so much so that I believe direct subsidies to energy and housing markets will prove key in the incoming policy response. Energy could go lower but Opec and non-Opec producers alike will try to keep the $50/barrel US price level in place. For the big oil importers, again, what’s needed is cheaper oil in local currency terms.

I believe a combination of the Fed pausing and China engineering the CNY up to 6.50/6.60 could help. China can pay the price of a 5% stronger currency as it reduces the burden on state-owned enterprises' US dollar debt and could power a massive boost in resolving the ‘trade impasse’. At the same time, a strong policy move like this from China with a weaker USD backdrop could drive a considerable relative revival in EM assets.

Finally, on the reversal of globalisation: there is no clear long-term solution here but the global economy is suffering, the S&P is down for the year, and China will do all it can for stability. The hunt for a solution is fully engaged and the odds of one appearing are rising fast. In our view, a solution need to show itself before February 5, the Chinese New Year – this is a top priority for both sides in the US-China trade dispute. The alternative is simply too dire.

After the Chinese New Year, we will see a powerful support for the Chinese economy as it is needed, and it will come.

But where does all of the above leave us, tactically?

Beware of incoming air pockets as policy response is reactive rather than predictive and may come a bit too late. This means that Q1 is the biggest risk, and this is where the cyclical low in assets and the economic cycle will come. We still see February as the low.
 
The challenges of the Four Horsemen dictate that when you have a smaller cake (quantity of money), the pieces are more expensive (price of money), and its more expensive to bake (energy) and harder to sell (anti-globalisation), then all companies and countries with high exposure to debt are the most vulnerable.

• We are short AUD and GBP versus USD on this.
• We are short unprofitable NASDAQ companies versus global mining companies and long EM versus US.
• We are long two-year US T-notes at 2.80%.
• If the Fed hikes in December, we go overweight US 10-year T-Notes and 30-year T-Bonds.
• Long CNY via short USDCNH on improved ‘trade impasse’ - see policy change and 6.60 target.
• Short DAX versus FTSE (playing on a weaker GBP) and versus OMX-Sweden (like SEK long-term).
• Long gold.

I will write an extensive piece on China from my two visits in the last four weeks. China continues to fascinate me, and humble me by my ignorance, but one thing is for sure: get China right and the rest is easy.

For now, I am convinced that the big macro theme in 2019 will be: The Great Policy Panic.

Still, 2019 could merely mark the start of the cycle or the early innings of the next cycle of intervention. 2020 is more likely to prove the real year of change. It fits the political cycle and it might take an even bigger scare for central banks and politicians to get their acts together – unfortunately.

Welcome to the Grand Finale of extend-and-pretend, the worst monetary experiment in history.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank A/S (Headquarters)
Philip Heymans Alle 15
2900
Hellerup
Denmark

Contact Saxo

Select region

International
International

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

This website can be accessed worldwide however the information on the website is related to Saxo Bank A/S and is not specific to any entity of Saxo Bank Group. All clients will directly engage with Saxo Bank A/S and all client agreements will be entered into with Saxo Bank A/S and thus governed by Danish Law.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.