The CrossBorder Capital Blog

We remain firmly of the view that long-term yields will rise. The recent flattening of the US yield curve is almost entirely explained by rising short rates rather than falling long rates. Moreover, this flatter curve is unlikely to signal upcoming recession and a scramble for ‘safety’, because the curvature of the term structure remains low and the hump is positioned at a relatively long tenor. In short, a flat or inverted yield curve is a necessary, and not a sufficient, recession condition. Rather, US term premia have been exceptionally depressed over the past three years by massive inflows of cyclical ‘flight’ capital from Europe and EM. A heads-up to the direction of these flows can be taken from the performance of the Chinese economy and our estimates of Chinese term premia, both of which are rising. 2018 should see 3.5% tested on the benchmark US 10-year yield.

Big changes are underway in Asia. Investors may already be seeing this in the recent divergence between the rising Japanese stock market and the sideways-moving Yen. Digging beneath the surface, it seems clear that official BoJ/MoF policy towards the Yen has changed. We have long suggested that a move was imminent, ever since a recent BoJ-led research paper highlighted the changed structure and focus of the Japanese export economy away from supplying final goods to America and Europe, and increasingly towards sending intermediate goods to China. A stable Yen is now important. Put differently, the importance of the Yen/ Yuan cross is fast-rising relative to the Yen/ US dollar cross. It means Japanese liquidity and asset prices become more pro-cyclical. In short, Japan becomes more like another Asian Emerging Market and driven by the Chinese economy.

Our 2017 views have centred on two key themes: a stronger China and a weaker US dollar. We predicted the implications would be a higher Euro and strongly rising Asian stock markets, as regional policy-makers monetized the impact of capital inflows. We were ambivalent towards the Yen. Our hunch that things had changed in Japan may be borne out by subsequent events, which unusually have seen the Yen largely unmoved by a skidding US dollar, but Tokyo stocks upbeat. We argue again here that Bank of Japan policy looks to have made a sea-change towards targeting the Yen and no longer targeting the volume of liquidity at a set level. If correct, it provides further bullish ammunition for Japanese equities, but warns of upcoming problems for fixed income markets.

China's People's Bank (PBoC) continues to ease monetary policy, evidenced by its latest balance sheet expansion. The PBoC is now the World's biggest Central Bank. It deserves more attention not just for this reason, but because, unlike its Western counterparts, it retains an impressive control over its domestic monetary system. A green light from the PBoC is positive for the Chinese economy, positive for commodity prices and positive for EM equities. But a red light should worry all of us!

The price of gold bullion closely tracks liquidity and capital flows. Latest data point to broad stability in the bullion price and possibly a small future percentage rise. Further upward impetus would require either a collapse in confidence in the US dollar, triggering larger-scale capital outflows, and/ or still stronger QE injection by Central Banks. Looking ahead, we foresee neither. Even after the German Election result, we retain our view that the Euro is more likely to be the main net beneficiary as capital progressively quits the US and Central Banks reverse their QE policies.

Is a 2018 Bear Market Coming? Are the G4 Central Banks About to Make Another Major Error by Reversing QE? Watch Capital Flows to Find Out. This report analyses latest Central Bank QE actions against the background of global capital flows – or a potential clash between Tyrannosaurus and Godzilla? We argue that, although policy-makers have vowed to tread slowly in reversing QE, the facts that often dominant cross-border flows already appear to have peaked and that Central Banks are starting out from a much less accommodative position than widely acknowledged, must heighten systematic risks. Feeding these facts into a statistical probit model that has been informed by machine-learning techniques warns that the consequence may be a bear market in World risk assets starting in 2018. This is not yet certain, but watching the upcoming direction of cross-border flows will tell us a lot more.