Macro Alert: Europe heads towards disinflation
During the past few weeks every policymaker in the world has proclaimed stability and improvement. Now, one day of data ruins this illusion. Eurozone CPI 'collapsed' in October from 1.0 percent to 0.7 percent (versus 1.1 percent expected!). Europe now has less inflation than Japan (see chart below).
There's no doubt disinflation is becoming the main theme. As such, it is important to remember that from a policymaker's perspective disinflation is the worst of all evils in economics.
The key theme for a while has been that US 10-year nominal rates and the US yield curve overall dictates all markets. Since early September I have advocated being into long maturity US, German and Danish bonds and my approach is now supported by a disinflation theme which could ruin the 'year-end rally' party in equities.
The simplest way to define the present market is:
It’s a race between the perceived further monetary stimulus from global central banks and the consequent repricing of yield curves and nominal rates relative to poorer data, especially concerning inflation but also housing and employment.
Source: Thomson Reuters
Source: Thomson Reuters
Purchasing divide increases
Furthermore, Eurozone unemployment has 'dis-improved' to 12.2 percent in September, a record high. If this is a recovery, then I do not want to see a crisis! The non-savers are losing purchasing power, while the savers are gaining purchasing power, creating even bigger divide and more inequality.
Debt is now an even bigger burden on growth and the overall economic outlook and debt projections are likely to shoot much higher, thereby upsetting present budget goals and projections being made by government officials. Corporations' balance sheets will no longer expand as making new investments and buying new machinery will be cheaper if they wait.
Japanisation in Europe and downward indicators
Europe basically asked for it (disinflation) and is now getting it: Japanisation. With no real reforms, Europe has experienced a lost decade where extend and pretend and hope were the main drivers. Now time is running out for this 'non-action' policy. This increases the odds on our main call for Europe next year: zero growth in Germany and new lows in global interest rates. We have maintained this call from August and continue to remain confident about it.
2014 is the low point
The economic impulses have a different sinus curve around a mean. What’s so significant about our forward-looking work is that most of our indicators point downwards in 2014 – hence our call for lower interest rates, lower employment, lower inflation, lower valuations and lower housing. 2014 is a year where all macro impulses point down and hence create downward movement, but the good news is that 2014 is the low in our projected cycle. In the fourth quarter of 2014 or the first quarter of 2015 we will see a low and thereafter a true and quick recovery with inflation right behind it. Of course our projections this early on are uncertain but the trend is clear.
Into 2014 and 2015 it’s about:
- final deleveraging
- rediscovery of monetary pricing, and
- a forced or non-forced exit from quantitative easing.
Futility of QE
A lot of analysis now indicates the futility of QE and the Federal Reserve can’t ignore this. What makes the point even more actual is the fact that all research papers point to QE having increased inequality, rather than having reduced it. This is a growing theme in this policy cycle, where even German Chancellor Angela Merkel is trying to construct European Union policy where she, at least by word, acknowledges the need for more social balance on macro policies.
Below is my trading strategy in light of the above and attached is what I call my 5+ (five) themes which are important to watch.
For some time Saxo Bank has been calling for 1770/1800 in the S&P500, 8000+ in the DAX, 78-79 in DXY (US dollar index), higher gold and 2.25 percent in the US 10-year Treasury yield. During the last few days we have seen a slightly more hawkish Fed (ignoring data but indicating December is still a possibility for the commencement of tapering of Fed asset purchases). Our targets have been reached in both the DAX and S&P and now the disinflation threat has changed my Alpha from being 100 percent long equities to being 50 percent short equities.
My fixed income strategy remains in place with a long-term goal of new lows in global rates in 2014. Fixed income is under-owned. Even now and after consolidation we will reach 2.10-2.25 percent in the 10-year Treasury this year.
EURUSD is clearly suffering from air sickness now at 1.4000. This equates to Europe being in recession, but ironically it will be disinflation which drives the European Central Bank to cut rates so they become negative.
Short S&P from 1758.00 stop @ 1815.00 in Dec Futures
Long IEF, Bunds, Danish 1.5 percent 2035, 10-year futures
Neutral on all FX – but looking to sell GBP.USD and AUD.USD
Long small EMG
80 percent long fixed income
20 percent cash
—Edited by Yvette Roper