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“And so it begins”
With his speech this week, Chair Powell has begun, in earnest, the process of signalling a shifting Fed policy from one of gradual 25bps rate hikes to one of 'no preset policy' path.
"Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy — that is, neither speeding up nor slowing down growth,"
Source: Jerome Powell, 28th November 2018
Whilst 'economists' seem keen to argue that markets have overinterpreted Powell’s words (e.g. see HERE), we suspect it’s more a case of economists themselves exhibiting their own behavioural biases (i.e. anchored to their own forecasts). In reality, Powell’s change of language was a clear signalling of the Fed’s change of intent (especially given that Clarida had already begun the same shift in policy, twelve days prior in an interview with CNBC).
“And so it begins” – the switch from a path of steadily tightening global monetary policy towards a global easing bias. Indeed, if our theme for this year is correct (i.e. '2015 - all over again'), then we will need the world’s central banks to shift dramatically from their current course (i.e. to an easing stance). That is clearly the implication of a variety of money creation metrics from across the global economy, which have slowed sharply.
Signs that money is too tight!
In particular, the signs that money is ‘too tight’ are multiple, from both an overall global perspective as well as amongst key global economic regions.
Starting with a global perspective: Global GDP weighted M1 money supply is growing at its slowest rate since the GFC (i.e. at 4.4% Y-o-Y).
FIG 1: Global GDP weighted* M1 money supply growth (Y-o-Y %)
*using nominal GDP weights
Breaking that down by region, starting with China….
Chinese M1 money supply growth slowed again in October (reported earlier this month). Growth is now running at 2.7% Y-o-Y, its slowest rate (other than one data point in 2014) since October 1989 (FIG 2). Interestingly in that respect, the Chinese devalued their currency by 26% overnight on 18th December 1989.
FIG 2: Chinese M1 money supply (Y-o-Y %)
That weak money growth is also evident in the commercial banks’ reserves at the PBoC. These are now contracting by 10% Y-o-Y, illustrating the tightness of money in the Chinese banking system. That is, as the Fed has tightened its monetary policy, by both raising interest rates and shrinking its balance sheet, it has created a shortage of global dollar liquidity which is causing capital to leave China’s economy. As such, and to slow the depreciation in the RMB, the PBoC is (once again) drawing down its FX reserves (FX reserves have been falling since China started to stabilise the currency in August this year). The other side of that transaction is shrinking commercial bank reserves at the PBoC (FIG 3). This dynamic is explained in detail in this piece HERE.
FIG 3: Chinese FX reserves vs. commercial bank reserves with the PBoC (Y-o-Y %)
The Chinese shadow banking system is also shrinking, at its fastest pace on record….(FIG 4)….whilst, interestingly overnight, Bloomberg reports that the Chinese authorities are:
“preparing to end [their] $176 billion experiment with peer-to-peer lending……Alarmed by a surge in defaults, fraud and investor anger, Chinese authorities are planning to wind down small- and medium-sized P2P lending platforms nationwide, people with knowledge of the matter said. Regulators may also order the largest platforms to cap outstanding loans at current levels and encourage them to reduce lending over time, one of the people said, asking not to be identified discussing private deliberations. Shares of P2P platform operators sank in New York.”
Source: Bloomberg LINK
Peer to peer (P2P) has been one of the key areas of shadow bank lending and a source of liquidity for business and home buyers (N.B. it’s been used by home buyers to finance a deposit so that they can get a mortgage).
FIG 4: Chinese shadow bank lending (monthly change, RNB bn. 1 & 6 months smoothed)
Currently, despite a handful of relatively minor policy changes, the Chinese are not, though, easing (meaningfully) in response to signs of tightening liquidity. Overall total liquidity (from the two main liquidity sources), for example, continues to flatline (i.e. open market operations and the medium-term lending facility). These two combined have trended sideways since early 2017. Furthermore while there have been other sources of stimulus, in aggregate they have been limited (see HERE).
FIG 5: Liquidity proxy (China) – aggregate OMOs plus MLFs
Naturally if our assessment of the trilemma, and the linkage between Chinese monetary policy and US monetary policy, is correct, then significant Chinese stimulus can only occur once/if the US authorities ease up on tightening*, i.e. once a second ‘Shanghai Accord’ is agreed upon. Whether or not that is possible, in this current environment of challenging US-China relations, is not clear. This weekend’s discussions between Trump and Xi are important in that respect. Realistically, though, progress is, at best, likely to be limited. The challenging China-US relationship, dubbed by many as cold war v.2, is about much broader areas of interaction that simply trade issues (see here for US Vice president Mike Pence’s overview of the relationship – LINK).
*unless the Chinese allow their currency to fall, or the authorities tighten capital controls.
US monetary conditions tightening (as well)
It’s not, however, just China that is suffering tightening monetary conditions. Certain indicators in the US are showing a sharp slowing of growth (despite the relatively more promising cyclical outlook). Unusually the growth of the US’s commercial banking systems’ balance sheet is running at one of its slowest rates in recent decades. This implies little appetite for risk/animal spirits amongst the banking sector and an environment in which inflation will struggle to accelerate.
FIG 6: US commercial banks’ overall balance sheet growth (Y-o-Y %)
Consistent with that lack of growth in the banking system, US money supply growth (M1 – both real and nominal) has slowed notably in recent months.
FIG 6a: US real and nominal M1 money supply growth (Y-o-Y %)
In the Eurozone, monetary conditions also remain too tight for the current economic environment (FIG 8). As we laid out HERE (this week), a policy error at the ECB appears to be brewing. There is a clear slowing of growth across a number of parts of the Eurozone economy. That’s neatly encapsulated by the leading economic indicators (FIG 7).
FIG 7: Euro area leading economic indicator (OECD, M-o-M %)
FIG 8: EZ monetary conditions (annual change) vs. ECB balance sheet (Y-o-Y %)
Evidence of that stress showing up in financial markets
Evidence of that tightening money across the globe is showing up in a number of market indicators, including:
1). Chinese junk bond yield which are close to their early 2015 highs (and close to their highest since 2012) – FIG 9
FIG 9: China & Asia high yield corporate bonds (%, yield)
2). US high yield credit spreads, which have widened notably in recent weeks (although not to the extent that they widened in 2015, FIG 11). US ‘CCC’ rated yields have also picked up sharply in recent weeks (FIG 10).
FIG 10: US CCC rated corporate bond yield (%)
FIG 11: US high yield corporate bond spreads (%)
…while…..
3). the situation is similar in Europe….with Eurozone high yield corporate bond spreads widening by close to 200bps in 2018.
FIG 12: Eurozone high yield corporate bond spreads (bps)
..and investment grade spreads at close to their widest since the Euro crisis.
FIG 13: Eurozone investment grade corporate bond spreads (bps)
Central banks’ reaction functions
That slowing money supply and money creation growth, coupled with rising signs of stress in financial markets, highlights the need for central banks to shift their ‘collective monetary policy stance’. Currently the Fed has just begun that process (i.e. of shifting), the PBOC has eased, but not meaningfully, while the ECB retains its tightening course (i.e. its path to ending QE). Indeed, that ECB tightening stance was reaffirmed by Draghi in comments last week:
“Generally, there is good reason to be confident that underlying inflation will gradually rise in the period ahead”…..“Wages are rising as labour markets continue to improve and labour supply shortages become increasingly binding in some countries”…. “Underlying drivers of domestic demand remain in place”
Source: Mario Draghi, 26th November 2018
Without a meaningful shift in that collective global monetary policy stance, though (i.e. a significant liquidity loosening), a tough first quarter in 2019 is likely for risk assets (i.e. after a relief rally into year-end/January). Once that meaningful shift in policy has occurred, then we’d expect a renewed bout of reflation. Until that time, though, watch central banks closely. Their words and actions are especially critical at this moment in time. Indeed a continuation of the ‘2015 all over again’ theme would imply another significant sell-off is necessary to fully shift the central banks’ collective monetary thinking. Of note, and consistent with that thinking, this current SELL-off continues to closely map the 2015-16 SELL-off (FIG 14).
FIG 14: S&P500 – this SELL-off mapped against the 2015 (and early 2016) SELL-offs
Have a great weekend.
Kind regards,
Longview
Longview Research recently published
This week:
Extract from Quarterly Global Asset Allocation No. 36, 29th November 2018:
"ECB Policy Error Underway…(again)" – available HERE
Global Macro Report, 28th November 2018:
“Japan: Cyclical Weakness Likely” – available HERE
Weekly Market Positioning Update, 27th Nov 2018:
"Record SHORTs in 2 year Treasuries"
Last week:
Longview on Friday, 23rd November 2018:
"Brewing for a Bounce; & Brewing Rotation" – available HERE
Commodity Fundamentals Report No. 88, 21st Nov 2018:
“Oil: The Coming Supply Response” – available HERE
Weekly Market Positioning Update, 19th Nov 2018:
"Equity positioning: Becoming increasingly fearful"