"10-Year Treasury Yields Headed To Zero Percent" - Saxo Bank CIO

Tyler Durden's picture

Authored by Mike Shedlock via MishTalk.com,

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).

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.

Asset allocation

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”

Conclusion

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.

Here’s hoping.

It could get worse before it gets better. Photo: Shutterstock

-Steen Jakobsen is chief economist and CIO at Saxo Bank

Mish Comments

  • 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

Related Articles

  1. Fed Study Shows Phillips Curve Is Useless: Admitting the Obvious
  2. North Korea Explodes Hydrogen Bomb, Triggers 6.3 Magnitude Earthquake: What’s Trump to Do?
  3. Disputing Trump’s NAFTA “Catastrophe” with Pictures: What’s the True Source of Trade Imbalances?
  4. Moral Outrage Over Low Wages: Canada Joins Trump With Threats of Walking Out on NAFTA
  5. Cummins New Electric Semi Truck Takes on Tesla: Another Cog in Autonomous Puzzle
  6. “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.

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The_Juggernaut's picture

When they go negative I'm going to start a ponzi scheme that pays zero percent.

venturen's picture

you mean another central bank?

Seasmoke's picture

Why wait. Start a ponzi today. 

Ron_Mexico's picture

but only those who get in early will get the zero rate of return. Those who get in later will have to pay you.

lasvegaspersona's picture

10 year pays zero= there is nothing worth investing in

But don't worry the debt mountain will collapse like the scene from Idiocracy and we shal alll be free of our debt (and our assets)

Cursive's picture

It's all going to zero, 'cept of course the SPX.

Ron_Mexico's picture

"They" will defend that all the way to Hell and Beyond . . .

Iconoclast421's picture

This credit impulse thing doesnt mean jack. Maybe if it hits -20 then it might mean something.

venturen's picture

FUCK YOU....YOU MORONIC CENTRAL BANKS!

wisehiney's picture

Now I am fucked.

It was perfect sweet and fine.

Until these jackasses agreed with me.

buzzsaw99's picture

even if gartman gets on board it doesn't change a thing.

judgment day is inevitable.  [/the terminator]

Bill of Rights's picture

You can take the Trump disapproval stuff and shove it...

Doom Porn Star's picture

Yeah.  As if anyone had even tried to tie Obama's approval ratings to the strength or weakness of the $US or the level of an index or whatever.

Pure bunk.

Approval rating of Congrass is in the shitter and has been for years; but, THAT isn't being equated with the GFC or poor markets or whaterver the fuck; and many of THOSE assholes seem to cling to their jobs for decades while the economy underperforms and US manufacturing is offshored, etc. etc..

President Dwight D. Eisenhower: "Beware the Congressional Military Industrial Complex".

Maybe we should consider that a thoroughly dysfunctional, dishonest, corrupt Congress is the fucking problem.

taketheredpill's picture

 

Everybody betting on a rise in Interest Rates (Government rates NOT Corporate) fails to look at why Government rates are falling and have been since 1980's.

 

They also expect pre-2008 conditions to spontaneously occur in a post-2008 world.

 

I still expect Gold to do well, since the Central Banks will never admit defeat (and the politically unfeasible outcomes) and will ultimately go "All In" in a global race to destroy their currencies.

 

Pre-2008 Inflation is different than the Post-2008 inflation we will enentually get.

 

 

 

taketheredpill's picture

 

Everybody betting on a rise in Interest Rates (Government rates NOT Corporate) fails to look at why Government rates are falling and have been since 1980's.

 

They also expect pre-2008 conditions to spontaneously occur in a post-2008 world.

 

I still expect Gold to do well, since the Central Banks will never admit defeat (and the politically unfeasible outcomes) and will ultimately go "All In" in a global race to destroy their currencies.

 

Pre-2008 Inflation is different than the Post-2008 inflation we will enentually get.

 

 

 

oddjob's picture

0% is still too expsensive for something somebody conjures up for free.

venturen's picture

how are they going to raise rates....the debt piles would go nuclear.

 

They are betting S&P 100,000 will rescue their ass while pretending to raise rates for a 100 years...we are already 10 years in

Nomad Trader's picture

Everybody betting on rising rates? As far as I can tell, everyone is betting on lower rates. Indeed, it's so "obvious" now that someone above said "Duh" as though TY at 0% was a given. Now that is a good indicator.

rbg81's picture

I knew the Eonomy was going into a permanent tank when they started streaming Porn for FREE.

Ron_Mexico's picture

You'd think this guy gets paid not to let the cat out of the bag.

Two Theives and a Liar's picture

Solid article. Good ZH red meat like the old days! Now, back to Russia, Trump, Climate Change Doom Storms and Lil' Kim...

east of eden's picture

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).

Uh, bartender, that will be a double Canadian, on the rocks please.

CAD - get it while you can still afford it.

pitz's picture

No reason to hike in Canada though.  CPI is deflating.  Unemployment is horrificially bad.  Poloz made a giant mistake.

DesertRat1958's picture

Eventually the life expectancy of everything goes to zero. Relax and enjoy as the revolution will not be broadcast.

lasvegaspersona's picture

yabut...The Revolution Starts Now..Steve Earle

Salmo trutta's picture

"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."

 

How funny.  March is the start of the 2018 recession.  The credit impulse model is about as good as the Taylor Rule.  I discovered the Gospel in July 1979.  See my ex-ante, rates-of-change, RoC, in monetary flows, M*Vt:


http://bit.ly/2sW5vGi

 

But then the G.6 release was discontinued (by mistake).  So I use a surrogate metric (which underweights Vt). 

Monetary policy objectives should be formulated in terms of desired rates-of-change, roc's, in monetary flows, M*Vt (volume X’s velocity), relative to roc's in R-gDp. Roc's in N-gDp (though "raw materials, intermediate goods and labor costs, which comprise the bulk of business spending are not treated in N-gDp"), can serve as a proxy figure for roc's in all transactions, P*T, in Professor Irving Fisher's truistic: "equation of exchange".

And Alfred Marshall's cash-balances approach (viz., a schedule of the amounts of money that will be offered at given levels of "P"), viz., where at times "K" is the reciprocal of Vt, or “K” has the dimension of a “storage period” and "bridges the gaps of transition periods" in Yale Professor Irving Fisher’s model. Roc's in R-gDp have to be used, of course, as a policy standard.

Neither financial transactions not “animal spirits” are random:

American, Yale Professor Irving Fisher – 1920 2nd edition: “The Purchasing Power of Money”:

“If the principles here advocated are correct, the purchasing power of money — or its reciprocal, the level of prices — depends exclusively on five definite factors:
(1)the volume of money in circulation;
(2) its velocity of circulation;
(3) the volume of bank deposits subject to check;
(4) its velocity; and
(5) the volume of trade.
“Each of these five magnitudes is extremely definite, and their relation to the purchasing power of money is definitely expressed by an “equation of exchange.”
“In my opinion, the branch of economics which treats of these five regulators of purchasing power ought to be recognized and ultimately will be recognized as an EXACT SCIENCE, capable of precise formulation, demonstration, and statistical verification.”

-- Michel de Nostredame

 

 

Horse Pizzle's picture

0% is what the Treasury can afford.  Banks will buy US Treasuries of they lose their license. 

pitz's picture

Google and Amazon are not monopolies.  How delusional.

And inflation, not deflation will be the problem in the USA, as all those USD$ wash ashore.  Deflation will be a problem ex-USA though.

Cutter's picture

Just how does the financial industry, banks and insurance companies, survive in a world where the 10 year is at 0?  Not saying it won't happen, but just how long do they survive in such a rate environment?  

Also, think the author is making one,very large, assumption: foreign bond buying will remain a constant.  Given the geopolitical situation, I anticipate a day in the not too distant future, where China attempts to weaken the US military threat by selling their US bonds.  As the second largest holder, barely behind Japan, with that demand out of the market, it couldn't help but raise rates.  And if Japan experiences a bond crisis, the rates on their bonds might exceed ours, also helping to dry up Japanese demand.  

Not saying we wont see 0, but there are some surprises that could actually send rates much higher.

CStanford's picture

The Fed believes in the Phillips Curve because when people work, they spend money.  To think otherwise is akin to asking hair not to grow.  Heck, it costs money just to get out the door to work-- transportation, clothes, meals at work, etc.    Machines and robots don't spend money, that's true, but if employment statistics are accurate, and more people are working as time goes along, then the economy will start to heat up.  

CStanford's picture

Double post, Sorry.