Right now it is popular to believe the global economy is about to come crashing to a standstill. Every time you turn around there is another article about how global trade has collapsed, or how commodities are headed to zero. The doomsday predictions about China and the rest of the emerging markets have hit epic proportions.
Not to be outdone, this morning the IMF cut their global growth forecast. From the Globe and Mail:
The International Monetary Fund cut its global growth forecasts for the third time in less than a year on Tuesday, citing a sharp slowdown in China trade and weak commodity prices that are hammering Brazil and other emerging markets.
The Fund forecast that the world economy would grow at 3.4 per cent in 2016 and 3.6 per cent in 2017, both years down 0.2 percentage point from the previous estimates made last October. It said that policymakers should be considering ways to bolster short-term demand.
Although most market watchers blame the global slowdown on China, I think they are mistakenly diagnosing a symptom as the cause for the recent economic malaise. China is a complete disaster, but the root cause of the slowdown is the Federal Reserve’s (relatively) hawkish monetary policy.
Investors mistakenly believe Yellen is a dovish Federal Reserve Chairperson. Yet ever since taking the reigns, Yellen has; tapered and ended Quantitative Easing, and then raised rates. She has consistently tightened even in the face of a rising US dollar, a collapse in commodities and plummeting inflation expectations.
Have a look at the Federal Reserve’s favourite market based inflation expectation indicator:
Inflation expectations have sunk to new lows under Yellen’s watch. And what is especially amazing is that even in the face of this obvious global economic slowdown, Yellen and her Federal Reserve committee members have kept their foot on the throat of economy. Apart from a slight wavering last fall, the FOMC has consistently stayed on message. They are attempting to normalize rates come hell or high water.
As they withdraw liquidity out of the financial system, the global economy is slowing. Yes, it is slowing more in countries like China that have experienced a massive credit boom and have their currency pegged to the US dollar, but make no mistake – the Federal Reserve’s policies are causing the slowdown.
Which brings me to my divergent view. Most investors believe the US is the cleanest shirt in the dirty laundry pile. The United States seems to be the only “safe” place to invest. The rest of the world is an economic and financial disaster, so why bother investing anywhere else? The rising US dollar and the confidence from a tightening Federal Reserve is attracting even more capital. We have entered a virtuous self reinforcing cycle.
The Federal Reserve, and all the investors that have flocked into US risk assets, are mistakenly believing the American economy can handle the stronger US dollar. In this day and age of massive over indebtedness and limited growth, NO COUNTRY can handle the enormous currency appreciation the US has experienced over the past year and a half.
In the mean time, the US dollar’s rise is unleashing a global deflationary wave that is causing more and more pain throughout the world. The American economy is not immune to this deflation, they are simply behind in feeling the economic effects.
And here comes my out of favour view. On a relative basis, the US will under perform the rest of the world versus consensus expectations.
Everyone thinks world growth will stink up the joint and that the US will be the sole bright spot. I am willing to bet that world wide growth surprises to the upside (especially versus the extremely pessimistic expectations) and that US growth disappoints tremendously.
What makes me willing to err on leaning this way? Mostly worldwide expectations that have being driven down so far. The fact the IMF is downgrading global growth doesn’t worry me. In fact, it makes me think that by the time these clowns get around to cutting estimates, it is time to think about looking for better growth.
The Federal Reserve’s obstinence about raising rates is about to come to an end. The market is forcing their hand. They simply cannot afford to have prices (and inflation expectations) plummet at the recent rate. The US economy is about to roll over, just as everyone is expecting it to out perform.
And this rolling over will be the start of the relative out performance of the rest of the world’s economy.
Have a look at this chart of the 18 month lagged G7 year over year growth versus the inverted 18 month inverted Brent crude oil price change:
Over the past 25 years a big crude oil price decline has always been met with growth in the following quarters. I don’t expect this time to be any different.
The moment the Fed eases up on the brake pedal, we are going to find all of these depressed economies lift. The US will lag because the adjustment required will not be easily fixed.
I am buying US fixed income while selling European and Japanese bonds. The US bond market will converge back to the other major countries as the world wakes up to the fact the American economy is not immune to the global deflation the Federal Reserve has unleashed.
And in the mean time, while everyone is busy driving crude oil prices to zero, I want to leave you with this chart:
The International Energy Agency said on Tuesday some 230 million barrels of new storage will be completed over the coming year – nearly half of it in strategic reserve sites in China.
A senior trading source identified 40 million barrels-worth of new commercial storage in China alone set to become operational over the coming year. Most is in Shandong province, a hub for so-called teapot refineries, many of which will be allowed to import oil for the first time this year.
What economy is going to do badly in the coming year again? The one importing boatloads of crude after the biggest decline in history? Or the one whose biggest bright spot for creating jobs over the last five years has been the result of a shale oil boom? Yeah, I know… Everyone hates China and loves the US, so it is tough to look like an idiot fading consensus all alone, but I don’t mind… I know I am an idiot…
Thanks for reading,