On Monday, while documenting the ECB’s annual report which you’ll recall finds Mario Draghi explaining how pretty much everything good that’s happened in the eurozone for the past several years is down to ECB policy (I mean, he doesn’t put it that way, but that’s the impression you come away with), we brought you the following chart and color from BofAML:
Synchronized global growth was the buzzword of 2017 and generally expected to continue into 2018. However, global data surprises have turned negative for the first time since mid-2017, potentially due to forecasts being optimistic in the first place. While trade tensions have been widely cited as the reason for the drop in global equities, the realized weakness in global data may be a more straightforward explanation. Chart 1 depicts the stable relationship between MSCI World returns and global data surprises over the past five years.
There you go. In other words, the “synchronous global growth” pillar of the “Goldilocks” narrative may be crumbling at a time when late cycle dynamics are set to push up inflation – “still-subdued inflation” is of course the other pillar of “Goldilocks.”
Needless to say, the threat of a trade war only exacerbates the situation, as tit-for-tat tariffs would invariably weigh on global growth and also have the potential to put upward pressure on prices. The real problem for central banks – and I’ve been over this a thousand times if I’ve been over it once – is that they haven’t had sufficient time to replenish their ammo. Suddenly expansionary fiscal policy and the trade war threat are two things they weren’t counting on so now, it’s a race against time to see if DM CBs can squeeze in enough hikes and taper QE enough to rebuild their capacity to respond to a potential downturn.
Well, with the above in mind, Nedbank is out with a new strategy note in which the bank warns that “market positioning indicates a high conviction in the current ‘narrative’ – ie that global synchronized growth will continue.”
For Neels Heyneke and Mehul Daya, that consensus and the “outsized positions” that go along with it “are fraught with risk” considering that financial conditions are tightening. Here are what they call “the drivers of the slowdown in dollar-liquidity”:
- A slowing of global trade
- China slowing down its shadow banking system
Typically when positions are as large as they are currently, the risk is that if the prevailing narrative of the time does not play out perfectly, violent reversals will ensue. Positioning for a weaker US dollar is stretched and is currently at the -2 SD level. Since 2016 EM and commodity FX net-long positioning grew substantially (amid the weaker USD environment). This is now currently just below the +2 SD level.
The commodity market is one of the most important and largest generators of global $- liquidity. The inflation narrative is reflected in record high net-long positions in the oil and copper market. A slowdown in global growth, and the Chinese authorities reining in the Chinese shadow banking system, would pose a threat to commodity prices.
Expectations are at record highs for US long bond interest rates to rise higher. We do not subscribe to this view, especially in an environment where US credit creation (US M2 yoy %) is well below trend growth from the 1960s. As global financial conditions tighten, inflationary pressures should dissipate.
Despite the volatility shock earlier this year, the SP500 market still has a net long position at +2SD above trend. The VIX is a perfect example of how a stretched position can swing. The net-short (-3 SD) VIX position changed to an extended long position in the space of one month.