Money/Credit/Debt
In recent travel, our clients remain focused on downside risks to today's range-bound markets. And for good reason. Uncertainty regarding Chinese reaction function is the biggest source of political risk in today's markets. We discuss it in detail in this month's report, along with an update on our views of Brazil, Russia, and Turkey. In addition, we examine the potential casualties of the European immigration crisis and the likelihood of Donald Trump becoming the president of the United States.
Expectations of a deepening EM/China growth slump and RMB depreciation have been the key to the selloff in global risk assets. There is no basis for these expectations to improve. Therefore, there are few fundamental reasons for EM and global risk assets to rally much further. Stay put. In Brazil, the impeachment rally is unsustainable and will reverse sooner than later. Stay short Brazilian risk assets.
This month's Special Report reviews the main factors driving the "lower for longer" bond yield view. A key finding is that the demographically-driven portion of the expansion in world capital spending has come to a virtual standstill, representing a major hit to underlying demand growth.
Credit growth acceleration in China is a bearish development in the long run. Potential non-performing loans at Chinese banks could wipe out 40-55% of their equity capital. "Muddling through" for China, from its own internal standpoint, is possible. However, Chinese stocks and China-related equities worldwide will remain in a bear market. From the perspective of the rest of the world, China is now in recession.
DM central banks are shifting back into easing mode, with the BoJ's surprise cut the most dramatic example. Japan's adoption of negative rates represents another deflation-fighting step, ultimately leading to a price-level targeting regime and debt monetization. While the real yen will ultimately decline, near-term strength would force more aggressive policy. Stay neutral global equities, preparing to decrease exposure on any sustained rebound. U.S. 10-year yields are still on track to reach our target of 1.5% by year-end.
An improvement in the euro area credit impulse is encouraging, but we explain why it is not enough to sustainably boost risk-assets.