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ALPHA SOURCES

JUNE 18, 2018


ALPHA SOURCES

FOCUS ON THE OBVIOUS

T he market always tries to distract


investors from what the obvious
themes, a bit like a good striker sell-
are, especially for macro traders who
have deservedly re-gained their mojo
this year. But no matter how much joy
ing a dummy to a goalkeeper, before investors have in the murky world on
he tugs it away. I’ll try my best to avoid emerging market currencies, they will,
that mistake here. Seen from my desk, sooner or later, have to take a view on
the state of play in the global economy the two themes highlighted above.
currently can be boiled down to two Using money supply as part of global
stories: First, the intensifying slowdown business cycle analysis is a controver-
in real narrow growth in the major sial topic. For some analysts, it is the
economies, and second, the fact that holy grail, while others will walk out of
monetary policy divergence between the the room if you even mention it. Many
Fed and the rest of the world is being economists prefer the credit impulse—
stretched to hitherto unseen extremes. the second derivative of loan growth—
This doesn’t mean that other stories— but if you actually draw the charts, you
EM wobbles, Italian bond market woes, will find that this indicator very often is
and trade wars—aren’t important. They closely aligned with M1 growth.

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ALPHA SOURCES

SHOW ME THE MONEY The slowdown in China is particu-


I am no fundamentalist, but I am larly striking. Real M1 growth slid to a
a big fan of money supply as a busi- 36-month low of 4.2% in May,
ness cycle indicator, mainly because it extending the slowdown, which began
is, from an empirical perspective, one in earnest in the middle 2017. The last
of best leading indicators. Its main time growth was this weak was in the
deficiency is that it isn’t equally reli- latter part of 2015, which preceded
able across the major economies. It is the swoon in global markets in the first
a good predictor for growth in the euro quarter of 2016. The PBoC is aware
area and China, but not in the U.S. of the situation; it recently cut its RRR
As an aggregate global leading indica- ratio and my colleague Freya Beamish
tor, though, it is an indispensable tool in believes that it has effectively given up
any serious macro analyst’s toolkit, and following the Fed higher. That doesn’t
it is currently sending a clear message. mean, however, that the economy and
Momentum in global real M1 hit a new markets won’t have to pay a penalty
low in May, driven by broad-based for the slowdown in liquidity growth.
weakness across the major econo- In addition, China is not the only ma-
mies. Nominal money growth is slowing jor economy, in which narrow money
sharply—in part as monetary policy is is slowing rapidly. In the U.S. real M1
tightened at the margin—and headline growth ground to a near halt of 1.7%
inflation has shot higher. This is usu- in May, and in the Eurozone it fell to a
ally a bad combination for headline 43-month low of 5.7% in April.
global growth and risk assets. The Equity investors will ignore the
lead to real economic activity is any- slowdown in M1 growth at their
thing from six-to-nine months, and the peril. The final chart below shows that
chart shows that the trend in M1 current momentum in the MSCI World already
signals a grim near-term future for the has rolled over, and the trend in M1
global economy. signals further weakness.

fig. 01 / Waiting for the downturn? — fig. 02 / Slowly, but surely, equities are losing momentum

Global* real M1, y/y% three-month average, six months adv (Left) Global* real M1, y/y% three-month average, 2nd derivative, six months adv (Left)
JPM Global composite PMI (Right) MSCI World, y/y%, 2nd derivative
16 60
24 Forecast assumes year-over-year returns decline to 1 by 120
59 October 2018. It would imply a 2.7% downside from current
14 58 21 levels, to a end-Jan price on the MSCI world of $2040. 100
57 18
12 80
56 15
55 60
10 12
54
9 40
53
8
52 6 20
6 51 3 0
50
0
4 49 -20
48 -3
-40
2 47 -6
* U.S., China, EZ and the U.K.; latest monthly data. 46 -9 -60
* U.S., China, EZ and the U.K.; latest monthly data.
0 45
-12 -80
Jun 09 Jul 10 Aug 11 Oct 12 Nov 13 Jan 15 Feb 16 Mar 17 May 18 Jun 19
08 09 10 11 12 13 14 15 16 18 19

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THE FED IS GOING IT ALONE In my view, this trend is the


The slowdown in global liquidity single-most important issue for
comes at a time when the tightening macro-traders and -analysts to
bias of many major central banks is in take a position on at the moment.
the process of being dialled back. In Interest differentials are not always a
China, the PBoC appears to be in the reliable indicator for the dollar, but the
first stages of reversing recent headline story as a result of widening
tightening. In Europe, the ECB is end- monetary policy divergence ought to be
ing QE but also has all but committed easy: The dollar should rally against just
not to raise rates at all next year, and in about every other major currency out
the U.K., the Q2 data have so far been there. The idea here is relatively simple
horrible. Samuel Tombs, PM’s Chief U.K. in the end; the U.S. economy has legs,
economist, recently pushed back his while the rest of the world hasn’t. If you
forecast for the next BOE rate hike to don’t believe that, you also believe the
Q1 2019. Finally in Japan, Kuroda and Fed can’t fulfil its dots, in which case
the BOJ are still thinking, or perhaps there is a big trade to be made.
dreaming, about a world in which they Meanwhile, a world in which the Fed
can actually do something, but for now, is hiking while the rest of the world is
yield curve control remains in effect. looking on from the sidelines is a world
The feet-dragging by central banks in which the U.S. curve continues to
in Europe and Asia is in contrast to the flatten. The 2s5s recently fell to a cycli-
gung-ho attitude at the Fed. The Fede- cal low, and I am on record for saying
rales raised rates again last week, and that that it’s time to sell everything
the fourth dot for 2018 was added. The when it inverts. At this pace we can
first chart below shows that interest rate expect that to happen in latter part of
differentials—here between the Euro- 2019. That would be great setup for
zone and the Fed—have zoomed higher macro investors, except that it’s prob-
to new records, at least in this cycle. ably also a little too obvious.

fig. 03 / The trend that won’t stop — fig. 04 / Patiently waiting for the signal

U.S. vs EZ interest rate differentials, two-year yields, (Left) U.S. yield curve, five-year yields less two-year yields, %
U.S. vs EZ interest rate differentials, rate futures*, (Right) 1.8
3.5 3.5
* Dec 2019 expectations, using ERZ9 and EDZ9 1.6
3.0 1.4
3
1.2
2.5
1.0
2.5 0.8
2.0
0.6
1.5
2 0.4
1.0 0.2
1.5 0.0
0.5
-0.2
0.0 1 -0.4
14 15 16 17 18 02 03 04 05 06 07 08 09 10 12 13 14 15 16 17 18

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