Long before the Fed had no choice but to taper QE3 and ultimately halt it, we warned that the Fed will do just that as a result of the dwindling liquidity in the US Treasury market [18], and declining net Treasury issuance (to a great extent helped by the decline in oil imports from the shale boom, a boom which is now ending) the Fed would have no choice but to gradually move out of the bond buying business. Temporarily.
Because while the past year has allowed the private sector to boost its much needed Treasury inventory, aka "high quality collateral", it has also given the Fed a buffer zone of more Treasurys to monetize whenever it is ready to proceed with Jim Bullard's wet dream: QE4. And while it is still anathema to even think the Fed may have no choice but to ease at a time when consnesus is bickering over when the Fed will hike, increasingly more are speculating that as a result of the global deflationary wave (if not so much when it comes to Cartier watches in Russia and Suntory whiskey in Japan), the Fed will have to forget all about hiking and proceed straight to QE4.
Such as Nomura's Bob Janjuah.
Here is the latest Bob's World missive, in which he discusses just that.
I will write a 2015 outlook note in the new year. I am still thinking about the key issues, namely global growth weakness and the disinflationary and deflationary winds blowing through the global economy, and how these key twin factors will affect global policy and global markets. For now I continue to believe that four very strong deflationary factors are driving things – global indebtedness levels (which have gone UP since the financial crisis), demographics (rapidly ageing populations pretty much everywhere other than sub-Saharan Africa, the Middle East and, notably, India), technology (which is significantly disinflationary and deflationary in terms of the cost of goods and even services) and globalisation (whereby the average global worker has little or no pricing power).
As such, and with the above caveat that I will present my full views and thoughts early next year, as of now I see 2015 as more of 2014. Namely, a stronger USD versus the world, lower bond yields and flatter yield curves with long duration assets in core government bonds markets offering the most value, and much more volatility (I expect to see increased year-on-year volatility in 2015). This volatility should make equities an unattractive place to be particularly on a Sharpe Ratio basis (2014 has been bad enough, but 2015 will I think be even worse). And in credit markets it will mean being much more invested in the highest quality assets and much less invested in the riskiest parts of the credit markets – namely USD EM credit and the US high yield market owing to the significant concentration of issuers and issuance in the vulnerable energy and energy-related sectors.
If I boil 2015 down to one thing, it will be the US consumer – on the basis that the US is the relative bright spot in the global economy. For 2015 to end up being a bullish year for risk assets with attractive Sharpe Ratios I think the US consumer will have to deliver as I see no other obvious driver of global economic growth and inflation. There will need to be US consumption growth of 4% to 5% if this bullish outcome is going to play out. This will require the US consumer loading up on debt again. As of now, I rate this as only a slim possibility rather than a probability, hence my views in the paragraph above. As mentioned I will revert on all of this with more thoughts and detail early in 2015, and of course the outlook for crude oil and the geopolitics behind the crude price will be something I will focus on. Suffice it to say that the idea that lower crude oil prices are necessarily a net positive for the US consumer is, in my view, overly simplistic and not even necessarily correct.
For now I wanted to focus on the next month or so in terms of markets. When I last wrote I highlighted how uncomfortable I was with the bounce in risk assets after the capitulation in mid-October. This concern only got bigger as risk assets rallied over November simply because the data flow, the news flow, and in particular the price action below the surface in equities was flashing warning signs. Some will dismiss this, but the Hindenburg Omens that US stock markets were giving off in very early December were a clear warning.
Since early December the S&P has dropped over 100 points (5%) and the 10yr Note has rallied over 30bp. Other equity markets around the world have generally fared even worse, and some other core bond markets have done even better. Where do we go from here?
A positive policy shock between now and mid-late January seems unlikely. And it is very difficult to understand what will happen next in Russia and/or what will happen next with respect to OPEC, Saudi Arabia and the oil price shock. Positive outcomes seem very unlikely. So for me the pressure that has weighed on markets over the last two weeks seems likely to continue.
Of course the facts can change, and even more certainly interim bounces can and do occur. But on balance I think the key level to focus on is unchanged from my notes of September and October – a weekly close at or below 1905 on the S&P. This is my first target in this current risk-off leg. It would also mean much weaker equity markets globally (the US markets ARE a relative safe haven), much stronger core bond markets globally (sub 2% 10yr Notes), the iTraxx XO index well above 400bp, and some reversal in the USD’s strength (the DXY index is already off by 1.5 points from its early December high of 89.5, with 86.5 my next target). And if we get a weekly close in the S&P below 1905, and in particular consecutive weekly closes below this key level, then the October lows (1820 on the S&P) would be the next target. This in turn would give me a target for 10yr Notes closer to 1.75%, the iTraxx XO index closer to 450-500bp, and a DXY index target of 85 or possibly even lower.
I realise that it is not normal to have a bearish risk view for December through to mid-January. Normally markets tend to ramp up in December and early January before selling off later in January. But this year I do think things are different. One look at the moves in core bond markets over 2014, when almost everyone I talked to had been bearish bonds, paints a stunning picture. I would entitle this picture ‘The Victory of Deflation’, or (as many folks now talk about (but still generally dismiss)) ‘The Japanification of the World’. I may end up eating my words in 2015 if the US consumer does come through, but if he or she does not, then we may well need QE4 from the Fed to battle the incredibly strong headwinds of deflation around the world. And I will revert on this subject, but to me the coming ECB QE and more BOJ QE are woefully inadequate substitutes for USD Fed QE.
Lastly, and in order to protect myself over the next few weeks against a meaningful bounce (driven by a change in the facts most likely) my stop-loss would be a weekly close in the S&P above 2020 (a key level as per my last note) on a consecutive basis.
Good luck and a Merry Christmas and Happy New Year to all.
Rgds
Bob
