In his latest Email article, Steen Jakobsen, Saxo Bank Chief economist and CIO has a bold prediction about interest rates.
With nearly everyone, even Janet Yellen at the Fed, predicting wage-induced inflation, Jakobsen makes a bold call in the opposite direction.
This is a guest post by Steen Jakobsen
Steen’s Chronicle: All Great Things are Simple, Except Right Now
“All the great things are simple, and many can be expressed in a single word: freedom, justice, honour, duty, mercy, hope” — Winston Churchill
Let’s start with what is currently simple, and what has been simple all year.
- The US dollar has peaked and started a multi-year cycle lower as both US and world growth can’t work without a weaker dollar (a stronger dollar kills growth through debt service, emerging markets, and commodities).
- Everything is deflationary: demographics, technology, energy, and the debt mountain.
- The credit impulse peaked in late 2016/early 2017 leaving global growth vulnerable in the fourth quarter of 2016 and into Q1’17.
- US interest rates are headed to 0% in 10-year government yields by the end of 2018, early 2019.
I am enclosing the word “simple” between a generously-sized pair of quotation marks because nothing is truly simple. But the themes outlined above have served us well throughout 2017 with the market having now given up on the Federal Reserve hiking rates beyond December. This is because inflation in the US (and Europe) is more likely to hit 1% than 2%, and because growth – despite certain green shoots – remains considerably below historically normal recovery levels.
Meanwhile, most central banks – most prominently the Fed – continue to believe in the old-school Phillips curve model, and through this mistake, they misguide markets on both inflation and growth – a classically dogmatic, bureaucratic way of thinking whose limits in a world of ever-changing technology are obvious.
• New call: energy prices to fall by 50% over the next 10 years.
For the balance of 2017 and into 2018, we will add that investors should expect considerably lower energy price levels to prevail as the electrification of cars goes mainstream. This will be led by China as electric cars represent a solution to the country’s pollution problems (viewed as “social priority number one” by authorities in Beijing).
Petrol and diesel consumption by cars represents 55% of all oil consumption in the world and we deem the recent announcement by Volvo – now owned by China’s Geely (disclaimer: Geely also holds a 30% share in Saxo Bank) to be an indication of new industry standards.
These being our main long-term macro themes, let’s look at the far more confusing short- and medium-term picture…
USD, Trump Disapproval Correlated 1:1
This probably comes as no great surprise but the correlation nevertheless confirms that even if Trump were successful in his policies, it would accelerate rather than slow the weakness of the dollar.
The US runs an expanding current account deficit. It spends more money than it makes, and Trump says that this needs to be reduced. Fine… let’s do that, but let’s also realize that this would mean US living standards would fall as the current account deficit corrects.
More precisely, the ability to spend money will fall as running a deficit is like living beyond your means. A surplus is the opposite.
Sometimes facts and understanding can get in the way of politics. I know it’s sad, but a current account is one of the few things that can’t be manipulated as there is an offset with another country at the other end!
Trump’s “America First” ethos is also anti-productivity as creating jobs for the mere sake of doing so is not the same as, and cannot compete with, creating productive jobs – and I apologize for stating the obvious!
It’s clear that one of the few sectors in which the US remains competitive is technology, but the problem here also partly comes down to Trump. One of his key policies and longest-held views, after all, is that China is the “bad guy”. The US president seems committed to launching a trade war with China that, together with the US technology sector’s lack of a Chinese footprint, will give investors a wake-up call sooner rather than later.
Right now, there are four billion people living in Asia (and the Indian subcontinent). By 2050, that number will have swelled to five billion – a five billion-strong market in which the US monopolies (Facebook, Google, and Amazon) have little or no market share.
Good luck paying for 30 years of profit in a single share of Amazon given these conditions.
Speaking of Amazon, I have to include this next chart. When listening to the younger traders on Saxo’s trading floor, it can seem like they forget that selloffs of 30-50% are the norm, not the exception, when looked at over a generation.
This is my Nasdaq long-term chart combined with the crazy explosion of the Fed’s balance sheet.
To understand the magnitude of the intervention made in 2008/09, look at the rate-of-change (ROC). Also, note how the Fed’s balance sheet no longer lends support to the market, but of course, negative convexity and reaching for yield carries the market forward by expanding P/Es into bubble territory … for now.
BoC leads on bubbles, Phillips curve declared dead (by me!)
The most interesting new development in central banking, however, is how some central banks are going it alone. Case in point? The Bank of Canada, which has now made two rate hikes independent of the Fed to deal with the country’s housing bubble.
House prices in Canada are up 13% year-to-date and 200% since 2000; most of this is financed by 25-year amortization on five-year terms (i.e., rates are reset at five-year intervals).
Two-year Canadian rates are now higher than their US equivalents for the first time ever, and the market is pricing in a 65% chance of another hike in December (and 40% in October).
The point? Canada’s central bankers are clearly acting on bubbles and excess while the Fed and the European Central Bank continue to monitor the non-existent link between tight labour markets and inflation.
This recent working paper from the Philadelphia Fed is interesting in terms of its relation to central bank policy and show even Fed’s own staff does not find support for the link between employment and inflation.
Why is this relevant? Because central banks’ modus operandi is to peg policy to academic papers. Remember how I alerted you to pivot on the change in central banks’ quantitative easing consensus based on new evidence which found that QE without fiscal stimulus was inefficient?
Well, I expect this paper to dictate a similar sea change away from reliance on Phillips curves and towards and increased focus on the deflationary effects of technology, demographics, and the debt burden.
Don’t Believe Your eyes
Don’t believe your eyes. The global economy is cooling.
This is Saxo Bank’s global credit impulse monitor (the credit impulse is the “rate of change of change” of credit in the market = velocity of credit).
This is Saxo Bank’s global credit impulse monitor (the credit impulse is the “rate of change of change” of credit in the market = velocity of credit).
Source: Saxo Bank
This indicator leads markets by nine to twelve months and the magnitude of the current slowdown almost mirrors the equivalent slowdown in 2008/2009.
I can already hear you protesting … “but the PMIs, the surveys, the data are improving!”.
Sure, but these are all lagging indicators despite their fancy names and survey-based questions.
Think of all economic and price data as having its own collective sine wave:
These sine curves (data points) move forward and will have different peaks and troughs, but what’s interesting is when they all peak or bottom. What our credit impulse model says is that from the peak in Q4’16 there is a high probability of a big slowdown in the global economy 9-12 months later – so from October 2017 to March 2018.
As I like to say, today’s economic data were created nine months ago by the amount of credit, the price of credit, and the energy prices seen following Donald Trump’s electoral win. The peak in activity seen in Q4’16/Q1’17, again, was created by massive credit creation post- the worst Q1 start in recent history (and one which drove the ECB and China to go full throttle on credit creation).
This call for a significant slowdown coincides with several facts: the ECB’s QE programme will conclude by end-2017 and will at best be scaled down by €10 billion per ECB meeting in 2018.
The Fed, for its part, will engage in quantitative tightening with its announced balance sheet runoff. All in all, the market already predicts significant tightening by mid-2018.
We argue that the market is always late to the facts, hence the slowdown is now and is manifesting into a political situation where geopolitical risk continues to rise, where Trump is a lame-duck president, and where the debt mountain continues to grow while the repayment burden increases via “too low” inflation.
This is a dangerous cocktail, particularly considering the high level of convexity and the low-volatility environment we are in.
We have had the same positioning since Q1’17 (we use a Permanent Portfolio approach):
- Equities: 25% (respecting the momentum)
- Fixed income: 50% (see attached memo)
- Commodities: 25% (overweight gold and silver)
- Cash: zero
We have recently reduced some of the risk as we are now:
- Equities: 10% (mainly gold mining stocks)
- Fixed Income: 25% (neutral weight)
- Commodities: 25% (neutral weight)
- Cash: 40% (overweight)
The cash weighting, of course, is “too high” but we want to wait out September and Q4 to see how the credit impulse plays out. It’s been a good investor year and as J.P Morgan once said when asked how he became rich, “I took my profit too early”
I have purposely avoided discussing North Korea (where I think military escalation is inevitable); ECB tapering (which will be slow if at all); the Fed noise on Gary Cohn, Stanley Fischer and the lack of board members; the German election (major non-event); and Trump (lame-duck from here) to focus on what in my opinion truly drives the market:
• The price of credit: Rising due to policy mistakes (read: Phillips curves)
• The amount of credit: Dropping hard – contracting indicating slow-down from Q4-2017 into Q2-2018
• Energy: The trend is clearly down and year-over-year changes dictate inflation inputs and direction
So brace yourself and your portfolio for still-lower government yields, the flattening of yield curves (financial sector underperformance), and expected returns for stocks that on a good day with tailwinds will do 2-3% per annum versus 9-10% historically.
When asked for the biggest lesson learned over more than 60 years in business, Vanguard founder John Bogle answered as follows: “reversion to the mean”. What’s hot today isn’t likely to be hot tomorrow, and the stock market reverts to fundamental returns over the long run.
Is it simple? Hardly. If anything, we are moving further away from the simplicity embodied by five of Churchill’s six famous words.
We are moving away from freedom in terms of both markets and individual rights.
We are moving away from justice as monopolies continue to expand and inequality rises.
We are moving away from honour as mutual respect and common principles recede from view.
We are watching duty decline as our environment penalizes those who would stand by deals made and blocks those seeking to make necessary changes; increasingly, it even punishes those who would be accepting or merciful towards failure,
In the final analysis, we are reduced to the last word: Hope.
It could get worse before it gets better. Photo: Shutterstock
— Edited by Michael McKenna
Steen Jakobsen is chief economist and CIO at Saxo Bank
- Asset deflation is coming. Price deflation will accompany or follow.
- Stocks are not priced for perfection, they are priced well beyond perfection.
- Reversion to the mean is a theory that I endorse. Stocks are headed for a major decline of 50% or more. How long the decline will take is the key variable. I don’t know, but I suspect many years rather than a 2008-2009 crash.
- A push is on for electric cars in China and Europe. Even if the US lags, demand for oil will decline. Add in a global slowdown, and the price of crude could easily collapse.
- I won’t be as bold as to predict 0% yield on 10-year Treasuries, but the idea has considerable merit. The Fed missed an excellent opportunity to hike and now pleads with the market to go along.
- I did not expect the Fed to get in more than two hikes. They got in four. Odds of a December rate hike, once near 70% are now around 33%. I stick with my prognosis: There won’t be another hike. The next move will be lower.
- A confrontation with North Korea may not be “inevitable” but any miscalculation by either side will make it so.
- It’s easy to be complacent about the chance of war, but if Seoul gets hits, an instant global recession will commence.
- Trump’s tariff policy is a disaster. The only saving grace is he hasn’t done much yet.
- Confidence in the Fed, ECB, Bank of Japan, and Bank of China will again come into question, in a major way. This will be good for gold.
Gold vs Faith in Central Banks
- Fed Study Shows Phillips Curve Is Useless: Admitting the Obvious
- North Korea Explodes Hydrogen Bomb, Triggers 6.3 Magnitude Earthquake: What’s Trump to Do?
- Disputing Trump’s NAFTA “Catastrophe” with Pictures: What’s the True Source of Trade Imbalances?
- Moral Outrage Over Low Wages: Canada Joins Trump With Threats of Walking Out on NAFTA
- Cummins New Electric Semi Truck Takes on Tesla: Another Cog in Autonomous Puzzle
- “Self Drive Act” Passes House Committee 54-0: Safety Standards Scrapped, 25,000 Driverless Cars Coming Right Up
My key call: Asset deflation is coming. Price deflation will accompany or follow. The Fed is likely to panic.
Trends in Sentiment, Asset Bubble, Gold
As protection against Fed policies, it’s wise to own some gold. In case you missed it, please consider How Much Gold Should the Common Man Own?
Finally, please consider my 38 slide powerpoint Venture Alliance Presentation on trends in sentiment, asset bubbles, and gold.
Mike “Mish” Shedlock
Rick Ackerman has had a 0.624% yield target on the THIRTY year T-Bond for quite some time, based mostly on technicals, but also some fundamental factors. I have quite a bit of respect for Rick’s calls, so Steen’s target yield of zero on the 10-year does not seem outlandish to me at all.
Tony Bennett said:
My comment below – when it clears moderation – meant to go here.
The dollar is going up, not down, as the current decline is clearly a correction. Furthermore, if the 30 year is going anywhere near zero, we are looking at the worst depression in history….
We have by far the largest debt in history, so it is not unrealistic to expect the largest depression in history.
Interesting thought. No one ever said previous depressions were the worst there ever would or could be. There will be a worse one some time.
With an interconnected globalised economy, if each area heads down together, it could be self reinforcing.
CHINA-US-EU. Japan, UK are a sideshow.
Bright spots might be Africa, India.
Broad Asian EM are very China dependent.
A really crappy depression is certainly not impossible and 30 yr near zero.
Tony Bennett said:
I’ll give a hat tip to our host here for calling a move down in $US.
Still can’t believe the failure of Mr Market to see the amount of printing ECB and People’s
Bank of China will have to do.
King Dollar will roar again … sooner or later.
The banking crises that are waiting in the wings for the Eurozone and China will be BIBLICAL.
Maximus Minimus said:
Jacobsen was talking about 10y bond, and Japanese 10y already is at zero. However, some junk European bonds yield less than US 10y bond, so there is room for correction.
Well thought out.
What about the impact of a weak dollar on the Eurozone?
German export prowess is aided by the Euro and critical to the Eurozone.
There is already nervousness concerning Euro/USD that will only increase if the USD weakens and/or EU growth picks up and the Euro strengthens further.
Add the Brexit shock to UK export trade and the UK proposed tariffs and VAT on EU imports – that would be one substantial hit to both sides.
EM debt service would be eased by a lower $ but I’m not sure the Euro will be so easy and there could be substantial stress there.
Tony Bennett said:
When I saw the topic and 1 comment …. I knew it was you.
There will be compression in yields between 10 yr and 30 yr. 50 bps (maybe less).
I have a substantial portion of my paper wealth in long dated STRIPS. If 30yr yield goes < 1% …. I'm buying a round of drinks for everyone at Mish's next mixer 🙂
I will definitely be there. 😀
Maximus Minimus said:
Did he just use ten thousand words to call the FED, and other central bankers a bunch of idiots? That is not a efficient use of words. /s
Link below is worth a read as to the way Germany will go as what DB wants, DB gets. End to Nirp for a start. Frankfurt as top banking dog in Europe. Banking consolidation.
Gaining an insight into how the chips will fall with a weak USD and stronger Euro is of interest globally.
How does the ECB handle all this? The more succesful, the stronger the Euro. The less succesful the longer Southern Europe suffers.
Saxo would be well advised to look at the impact on the Euro and its own backyard. How often do they report on that in a balanced fashion?
Good analysis by Steen. He could well be correct, though I disagree with many of his conclusions.
Unlike Steen, I do indeed believe economic growth throughout the world is steady, and even improving. I continue to forecast 2-3% or better worldwide growth, and 1-2% US growth. For example, he says that the Bank of Canada is raising rates because of a housing bubble. In fact the Canadian housing bubble was pretty much confined to Vancouver and Toronto, and those bubbles are already finished. The BOC stated they raised rates because economic growth in Q1 was 3.5%, and Q2 was 4.7% and they need to slow it down.
Secondly, he expects energy (oil) prices to drop 50% over the next 10 years because of electric cars. If he is correct about a recession coming, then maybe oil prices can drop up to 50% for a short period of time. But I don’t believe that there will be enough electric vehicles within 10 years to affect oil prices much at all. I expect oil prices to rise over the next 10 years, as the industry is not investing enough to replace the fields that are currently depleting.Low prices, as they say, are the cure for low prices.
A couple of things I do agree with are: we are in a deflationary economy (because of the impact of technology) and interest rates will stay low, though I don’t see the 10 year at zero.
tech advances is not what determines inflation (see the 90’s). Yes, you are correct, we could have lower demand in oil and still have higher prices. It’s not the demand, but the possibility of imbalances as well as production costs on the margin. Lastly, the market currently prices 0% rates by early ’19 at less than a 5% possibility, anyone that makes outlandish calls and simultaneously uses the term “simple” deserves a f’n kick in the head. You have to always keep in mind, you are reading the opinions of a guy who is a salesman, not a trader.
Pretty much agree with all your points. As far as inflation goes, there isn’t much pushing prices higher (certainly not wage pressures). Given a benign inflation environment, I believe that deflationary pressures are highly related to tech advances, which lower production costs of almost everything we purchase.
As far as salesmen, bloggers, media, etc. goes, outlandish (or sensational) stories are what get noticed. I can’t say I blame them. But I don’t have to agree with them!
Ron J said:
“Stocks are not priced for perfection, they are priced well beyond perfection.”
Stocks are priced for massive financial fraud.
We make our bets. Roll the dice. And see where they land.
In the years immediately ahead, we are about to live through the worst debt collapse the human race has ever witnessed. It’s the worst time to owe debt, own debt or be dependent on income derived from debt. US Treasuries are the only exception.
The derivative market is what dry tinder is to a forest fire. There are no firewalls to stop this conflagration.
The shift in popular sentiment is towards safe haven assets.
The dollar is still the world’s base currency, the least ugly of all the other uglies. As far as currencies go, it’s a safe haven currency and a magnet for weaker currencies in a deflationary economy. Any dips will be short term. Then it’s off to the moon.
Treasuries and stocks are safe haven assets. Short term dips always possible. Then off to the moon.
For Americans, a strong dollar should drive down prices of consumer staples but nowhere as fast as debt based assets.
I believe it was Jesse Livermore who is quoted as saying, “the hardest part about investing is the waiting.” The patience of gold and silver stackers is about to yield rewards beyond imagination. They are going to the sun.
Cryptocurrencies will establish a foothold outside the US as a safe haven.
My bet is on the sun.
A push is on for electric cars in China and Europe.
The push is from governments, not consumers. Another disaster in the making.
A confrontation with North Korea may not be “inevitable” but any miscalculation by either side will make it so.
NK has the bomb now. They are untouchable. I was first thinking, the CIA put up the money and hardware. If tensions fade into the memory hole, then likely it was China. The empire suffers another checkmate.
Hey Spirit. “we are about to live through the worst debt collapse the human race has ever witnessed”
Maybe. The US, for example, is about where Japan was (debt to GDP) 20 years ago. Yet, Japan is still managing to hobble along. Things can go on much longer than people think.
Secondly, once things get very bad, then the government will just start to change things up (ie. Social Security: raise the age, lower the payments). Or they just start printing, though we know that doesn’t end well.
I don’t know about you, but I plan on being alive for the next ten years to see how this plays out. I think we agree it’s coming to an end.
Hobbling along = declining standard of living. Going from living well to merely surviving isn’t catastrophic, but it is the exact opposite of the purpose of investing. And when society as a whole feels investment is pointless, you get, well, North Korea, the Middle East, Africa, etc.
Americans would rather hobble along than give up the welfare state.
John B. Goodrich said:
The central banks have a direct affect on inflation and interest rates. As to the latter, they cannot allow interest rates to increase, as their treasuries cannot otherwise finance their sovereign debt. None of what we’re watching is the free market for capital resources or an analytically controlled process of “managing the economy.” We are watching a corruptly manipulated market for credit, which has poisoned the free market pricing of all assets. It will not end well.
The idea that central banks are going to “solve” our economic dislocations is upside down. They “are the dislocations,” and they are destroying the middle class ability to save and the market’s ability to allocate capital. The investment banks and governments are the inevitable winners in this corruption.
Government, though necessary, is always corrupt. The larger it is, the more its corruption destroys its host.
Everything is deflationary: demographics, technology, energy, and the debt mountain.
Not everything is deflationary. State and local government debt continues to grow at alarming rates. No deflation in the public pension expected rates of return, which means inflation in state and local taxation. I don’t expect Steen to know how this is going to get resolved, but when the wheels start turning to resolve those messes you may come to regret your long-term investments.
That buildup of debt if paid by taxes is actually deflationary
Useful insights. Agree, reversions can be mean.
I am betting on a market crash because i cannot for life imagine how the central banksters are going to unwind their BS without market turbulence. How can you get out of this mess of debt and interest rate without a reset is beyond me. Also japan story does hold water because it is a global quagmire now. I fully expect i will be wrong like the last few years. How much more time and quantity (printing)the central banksters have is anybody’s guess but it cannot be forever. Keeping the market up like Atlas cannot go on for ever.
The Global Credit Impulse chart looks fairly meaningless. There doesn’t seem to be a reliable signal anywhere in that chart.
However, I do think there are several good points in the article.
0% is what the Treasury can afford to pay. Banks must purchase US Treasury bonds or they lose their banking license to government regulators. Such a business!
Zhang Jingfei said:
Hey Mish, what is your view on the current global electricity production capacity? I agree that a rise in electric cars will decrease petrol consumption but the electricity that powers these cars are mostly generated from oil and gas. So does an increase in electric car adoption mean higher demand for power generation from fossil fuels too?
I am highly sceptical of China’s commitment to clean up pollution – If they burn more coal – they won’t do what they say