Stock markets in the US and Europe are in for a correction, while the euro is set to rise, according to Saxo Bank’s Chief Economist Steen Jakobsen, nomatter what happens between Greece and its creditors. Steen also looks at the impact a rate hike from the US Federal Reserve would have on USD and what currencies could gain once the Fed decides to move on rates, noting that "the consensus has it wrong on the timing of US rate hike," as the credit cycle topped in June 2014. He believes that commodities and metals in particular offer opportunities for investors.
As he warns, "Change is Gonna Come..."
- The consensus has it wrong on the timing of US rate hike
- The marginal cost of capital is still rising
- We need to accept a new period of lower growth is coming
- Bonds market is rising without the economic growth to support it
- The credit cycle peaked in June 2014
- WTI crude will rise to set up excellent energy returns
- Gold is still set to outperform this year
First, my analysis of the Federal Open Market Committee. There remains only one question of relevance for the future cost of capital. Will the US Federal Reserve do a 'one-and-be-done' (or maximum two), or will they start a traditional rate hike cycle?
Last week's FOMC gave us a clear indication. They believe they will hike twice this year (September/December) and then go slower at 100 basis points per year.
In the chart below, yellow represents the slower hike cycle now in place. It’s of course still above the Wall Street consensus, but even Wall Street is beginning to understand that Fed hikes will not be based on economic data alone, but on an almost desperate need to normalise the monetary policy.
Source: Bloomberg
I personally think both are wrong. For me, the higher and more aggressive Fed in the balance of 2015 will 'kill' the nascent growth pulling US and Europe back towards zero growth, which will give us one more look at all-time low interest rates before we start a new secular change.
Of course, the more direct play is to wait for the Fed to hike twice and then go short the 'cost of capital' as in short equity and bond vs. long commodities and emerging markets with a weaker US dollar.
But I still see total move of +100 bps from the low in Germany and US yields to top in 2015 – then a selloff/recession, then the REAL START of a new cycle based on the true improvements coming into the micro economy.
What will this entail?
Better lending demand; monetary aggregates rising; the Silk Road closer to being online; big and improved current account balances; lower energy prices; the moving of money from non-productive 'paper money' in Wall Street to Main Street; the reversal of the 80/20 rule I have so often mentioned.
The reason this recent move higher in yields is 'false' is that it’s only the 'term premium' which is going up. Or in plain English: it’s the inflation compensation in the bonds market which is rising without the economic growth to support it.
Interest going up on higher demand and growth is fine, but interest going up as monetary derivatives is often dangerous. Please remember, we're coming from zero inflation, zero growth and zero reform. The move from zero-bound will be full of false starts and disappointments.
If you're going through hell, keep going...the move from zero growth will hurt. Photo: iStock
The consensus and Fed position is now roughly like this:
- Fed: Two hikes in 2015 – then 100 bps per year from there onward.
- Wall Street consensus: One hike this year and then 125/150 bps next year and then 100 bps onward. (Why is it the sell side always sees next year as the time to 'change' – never this year?)
Part of the difference in the future path is based on your premise/assumption of long-term growth potential. US growth used to be 3.0-3.5%, but now it’s more likely 2.0-2.5%. This has a big implication on the Fed and the analysis of it.
Of course if 'new lower growth' is accepted at 2.0-2.5% the threshold for hiking is also equivalently lower!
The study supporting this claim was the following paper: Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy by the Fed economists Dave Reifschneider, William L. Wascher and David Wilcox .
One and done, or two strikes and out? The surveys say...
Source: Bloomberg
The more pertinent question, however – and the major risk to Fed's expected slow and gradual rate hike cycle – is lack of trading liquidity.
Citibank did an excellent job of putting it into context this morning:
Citibank US Economic Views: FOMC Edition
The above chart shows how the value at risk of the the eight biggest market makers has gone from $1.4 billion before the crisis to less than $400 million. This is one of the 'quantitative' charts I have seen on this illusive 'risk capital'.
VaR is the grease which keeps the trading engines humming. We are basically playing a game of musical chairs, but not the traditional version with one chair missing when the music stops...but four chairs missing.
This makes for more volatility and excessive moves when investors move their money across asset classes. Trust me – there is simply too small a market to cater to a world of finance where every mom and pop have a major portfolio in ETFs and mutual funds and where everyone, like in 2000, is either a major real estate developer or a 'major trader/investor'.
For example, more than 5,000 hedge funds have been started in China in the last three months. 5.000! There are only around 8,000 hedge funds active at any time in the rest of the world!
Source: Charles Schwab cartoons
Let's take a look at some more charts.
This shows a test of the 50-day moving average support line – we had nice bounce today, but the 'marginal cost of capital' is rising:
As expected, we see signs of a classic seasonal mean-reversion in US data:
Citigroup’s Surprise Index supports the mean-reversion theory – a nice bounce and timely for a Fed September hike:
The Merrill Lynch Option Volatility Index is a new chart. The 2013 spike was the taper-tantrum – keep an eye on this one for the 'musical chairs in bonds':
Financial stocks didn’t like the slightly higher probability of a September hike:
Reflection of credit cycle? The peak was in June 2014 – a year ago!
Macro forecasting
I'll close with my latest bigger macro calls. Here's a reminder of the main points of my major strategy change as detailed in an article on May 18:
The headlines for the next 6-7 months say:
- US, German and EU core government bonds will be 100 bps higher by and in Q4 before making a final new low in the first half of 2016. The US 10-year yield will trade above 3.0% and bunds above 1.25%.
- Energy: WTI crude will hit US $70-80/barrel, setting up excellent energy returns.
- The US dollar will weaken to EUR1.18/1.20 before a retest of lows and then start multi-year weakness.
- Gold will be the best performer in commodity-led rally. We see it at $1,425/35 an ounce by year-end.
