Article / 22 January 2016 at 11:30 GMT

Steen's Chronicle: Excuses change nothing, but everyone feels better

Chief Economist & CIO / Saxo Bank
  • Two years' gains wiped out in three weeks!
  • People are worrying too much about China
  • Focus should be on central bank divergence
  • Recovery requires a weaker US dollar

 Why, oh why can anybody be surprised by China's slower pace? Photo: iStock

By Steen Jakobsen

"A business (economy) that makes nothing but money is a poor kind of business" – Henry Ford

What a start to the year! In the space of three weeks we have lost all of the gains in the stock market from 2014 and 2015.

The chart below is MSCI World, MSCI Emerging markets and MSCI Europe – the picture is the same for the US, Japan and China. A wasted two years of “lower for longer?”…. .absolutely!

Congratulations! Three weeks into 2016 and we have lost ALL the gains of 2014 and 2015!

 Source: Bloomberg, Saxo Bank

Meanwhile, Italy is on the brink of a new banking crisis, Portugal's new government is about to reverse all of the gains made over last five years and UK is getting pushed towards the EU exit door. Add to this the major political issue of refugees, a US election which anyone with an iota of sanity can see is going from bad to terrible, and a Middle East imploding from low oil prices.

Scapegoating China

Yes, it’s a tough start to the year and to my confusion, pundits and strategists alike continue to look to China for excuses. China is the easy scapegoat, but seriously if anyone is surprised about China's growth slowdown and its need to buy time for changing its economic mix they should have their college fees refunded!

To explain the mechanics of the present correction, which is now entering a bear phase, I made this illustration: The three drivers of markets (Main market focus)

3 drivers

Note: The cycle axis or velocity is the US dollar. (Higher dollar = slower speed, weaker dollar = higher speed.)

There are three major drivers of markets:

(i) The Fed rate cycle: being the dominant central bank of the world it dictates absolute direction of global rates. The hike in December came after a big increase in funding costs for the corporate and private sectors, but now policy rates (central banks) and market rates are aligned and projected to rise.

The price of money is always the most important input to any economy and right now the market is pricing 1.7 hikes in 2016 (42.5 bps) and the Fed is promising 3-4 hikes (75/100 bps).

When focus again returns to the Fed and its rate cycle it will be a game of "who blinks first". The Fed backing down or the market moving up? For now, clearly, the market continues to fade and mistrust the Fed’s intentions.

(ii) Oil prices: everything you have done today and everything you will do for the rest of the day will have electricity consumption in it. Oil is a main generator of car fuel and electricity so the input cost of energy is a key determinant for real wages and real consumption. 

Oil has negatively affected both the price of money and growth globally. The price of money is affected by the fact that there's less “slush money” – the Middle East and all the commodity producers no longer run current account surpluses and hence they have less money to invest in US and European fixed income markets. This drives up the price of money and academic studies have shown that the net reduction in yield when "slush money" is flowing freely has been roughly 100 basis points. (I.e.: Long-term bond yields would have been 100bps higher in this cycle were it not for these investors.)

Likewise, growth impulses from commodity market countries has been net negative due to less money available for importing capital goods and services.

Oil and energy prices, however, also add upward drive to growth. Europe will in 2016 feel the full impact of lower energy prices. As a net energy importer it stands to make considerable gains in disposable income at consumer and business level. This will make it difficult for the European Central Bank to be keep printing money throughout 2016.

The ECB, however, is always lagging the real world. (Don't forget in early 2014 ECB chief Mario Draghi dispelled any notion of deflation!) The lag means that the ECB will move aggressively, but doing so it will have ignored the fundamental net positive impact from energy and the overall healing of the consumer and business sector in Europe. Conclusion: the ECB will be on pause by this summer and central banks will again be facing in the same direction…

(iii) China: that GDP growth is coming down is hardly any surprise! 

Furthermore, the West continues to see and analyse China based on balance sheet assumptions. This is creating seriously incorrect conclusions. Does China have issues? Absolutely! Will China have a hard landing? Maybe, but it's unlikely. Will China then see a soft landing? No, that is unlikely, but it will have a “long landing”. Meaning that it has enough private savings to keep the game going and on top of this are benefits from the Silk Road, the internationalisation of the RMB and the AIIB bank. This is not what a collapse looks like. China is structurally slowing down, but Chinese tourists will spend $275 billion overseas this year and the new China export is tourists and soon, money too.

The “devaluation” is more of a test drive of free capital movements and a support for the economy through raising liquidity to finance debt servicing. That China is finally again moving forwards with more free capital movement and facilitating credit for finance hungry emerging markets countries is hard for me to interpret as a net negative and major focus point!

What is interesting is how aggressively the market is using China as an excuse – it is best shown by this customer survey by BAML:

main themes

Get this! Since the last survey (November 2015)  the Fed has hiked policy rates, but the market has moved its focus from the Fed rate cycle to China in a big way:

In November, 59% of those surveyed saw the Fed as the biggest macro theme, now less than 23% feels it is important!. China, meanwhile, has moved from 27% to 66%!


The market continues to only be able to focus on one risk at a time. 2016 so far has been all about China but the “only” real concern should be the disparity between where the Fed sees the rate cycle in 2016 (3-4 hikes) and what the market predicts (1.7 hikes). How that evolves is the next directional move in macro.

The weak data start will not get the Fed to step off the pedal in January, but as data starts to come in for January I fully expect the Fed to back to down to first 2-3 hikes, then 1-2, and even ultimately 0-1 but for now, we are involved in a Mexican standoff.


We came very negative into Q1 as our “Mind the gap” Q1 Outlook also projected, but we are getting to levels where “value” again is materialising, especially in the tiered credit spectrum (investment grade and above) and energy/materials.

My model is 100% risk-off, but I am now hedging with CALL options on equity upside and my strategy is more and more….short on the day and closed by the end of the day, awaiting new information. (Rotation back to the Fed being the main focus.)

My USD call – weaker in 2016 - is close to being initiated. The long-term momentum is turning slowly. (I will keep you posted on when it turns).

That is still the main conclusion: The US dollar direction is still the king, the gasoline of the market. The higher the trade weighted USD goes the less risk assets will return. The path of least resistance for investors, policy makers and world growth remains the same: We need a weaker US dollar.

Safe travels,

Steen Jakobsen

– Edited by Clare MacCarthy


Steen Jakobsen is chief economist and CIO at Saxo Bank

Hi Steen, thanks for your great insight, and optimism. I have a question - you mentioned in a previous post that there has been around 15 Trillion in new debt since 2008. At the same time, correct me if the figure is wrong, the FED has printed around 4 Trillion. Japan and Europe have been busy printing money too but whichever way I look at it, debt is being created at a much faster rate than money, which is a bit of a problem seeing as debt must be paid back. Is this accurate and if so how do you see this situation ultimately panning out?
bilarikis bilarikis
Nice article Steen...I believe usd will be weaker at the end... It's the overeaction of the market that made it so strong the last 3 months. And maybe billions of US loans in foreign currencies!!! At the end though FED sees that it will hurt her own matket if not changing side.


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