Should We Worry About The Fall In Real Money Supply?

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Includes: DCHF, DEUR, DGBP, DJPY, DRR, ERO, EUFX, EUO, FXB, FXE, FXF, FXY, GBB, JYN, UCHF, UDN, UEUR, UGBP, UJPY, ULE, URR, USDU, UUP, YCL, YCS
by: Rothko Research
Summary

The recovery in oil prices will limit the slowdown in futures inflation prints, giving US policymakers more flexibility concerning their tightening cycle.

Global growth continues to ease; China real GDP growth came in at 6.6% in 2018, its slowest level in 28 years.

This year, we expect other significant drawdowns as long as global liquidity remains poor.

The global risk-on environment has led to a depreciation of the Japanese yen over the past two weeks. However, the flash-crash that occurred on Jan 2 showed how poor the liquidity is in this current market.

Macro News

Global: Price volatility market seems to have stabilized over the past two weeks, with the S&P 500 up more than 300pts since its December low and slowly approaching the 2,700 level. In addition, the recovery in oil prices will limit the slowdown in futures inflation prints, giving US policymakers more flexibility concerning their tightening cycle. However, if we look at global indicators such as yield curves or annual growth in real money supply, they are still showing potential weakness in equities in the months coming ahead. Global growth continues to ease; China real GDP growth came in at 6.6% in 2018, its slowest level in 28 years. In addition, the fall in the credit impulse, which we computed as the annual growth of the Total Social Financing (TSF) measure, has also been weighing on global equity performance in the past 18 months. In the short run, we could see further gains in the equity market benefiting from investors re-leveraging as the implied volatility goes down. However, we expect other significant drawdowns as long as global liquidity remains poor.

US: The significant rise in equities since the start of the year has decreased investors’ negative sentiment on the trajectory of the Fed Funds rate. As you can see on the chart, the extreme pessimism in US equities has pushed the 12-month implied yield curve (Mar20 – Mar19) into negative territory (-27bps) in early January, meaning that market participants were pricing a rate cut. Therefore, stronger gains in equities in the next quarter could increase the probability of a rate hike later on this year as the US economy is still showing strong fundamentals (GDPNow estimate for real GDP growth is 2.8% in Q4).

Euro: In its latest quarterly economic outlook, the IMF lowered its forecasts for 2019, for both developed and emerging market economies. Economists expect Germany to grow at only 1.3% this year, down 0.6% compared to the October forecasts. We think that the 0.1% downward revision to 1.5% for France was a bit shy relative to what is currently going on; our leading indicator is pricing further weakness in the coming months.

Japan: Headline inflation drops to 0.3% YoY, its lowest level in 14 months, on the back of a fall in oil prices, cuts in mobile phone fees and a drop in fresh food prices (-9.4%). Policymakers are expected to lower their inflation forecast to 1% for 2019 this week (vs. 1.4% in October). The global risk-on environment has led to a depreciation of the Japanese yen over the past two weeks. However, the flash-crash that occurred on Jan 2 showed how poor the liquidity is in this current market.

Figure 1

Source: Eikon Reuters

Global Inflation Update

Over the past few months, we clearly saw a significant decrease in the annual inflation growth for both developed and some emerging economies. Investors have therefore questioned if the global trend in inflation was done, therefore limiting the rise in global bond yields. We notice that most of the move was due to the fall in oil prices; therefore, the little recovery should limit the fall in inflation expectations.

Figure 2

Source: Eikon Reuters

FX Positioning

EURUSD: The trend has been bearish on the past week; however, we can notice an upward trending line where the euro found support each time. We took the opportunity to buy the pair on dips at 1.1350 with a target at 1.1550 (where the pair topped two weeks ago). We kept a tight stop at 1.1250 as the single currency is still vulnerable to a sudden sell-off in equities. We like the range 1.1180–1.17, which corresponds to the 61.8% and 38.2% Fibo retracement of the 1.0340-1.2550 range.

Figure 3 Source: Eikon Reuters

GBPUSD: Cable struggled to break through the psychological 1.30 resistance and is now trading at around 1.29, which corresponds to its 100D SMA and 61.8% Fibo retracement of the 1.20–1.4340 range. We still like to play the cross (EURGBP or GBPJPY) on sterling for the time being.

EURGBP: The pair fell below 88cents last week for the first time in two months, next support on the downside stands at 0.8690 (61.8% Fibo retracement of the 0.8310–0.93 range). We were stopped on our long position at 0.8820, but we still think it could be worth buying EURGBP at 0.8760 with a stop below 0.8680 and a target at 0.8860.

Figure 4

Source: Eikon Reuters

USDJPY: As expected, the Japanese yen has been weakening since the beginning of the year as risk-on has been levitating global equities. USDJPY failed to hit our 110 target; however, we keep the long position but increase our stop to 108 (which corresponds to our entry level). As the pair has been closely co-moving with the US 10Y, we closely watch the trend on LT interest rates to define our positioning on the yen.

Figure 5

Source: Eikon Reuters

USDCHF: The pair is almost up 3 figures in the past two weeks and seems on its way to retest the psychological resistance at parity. We would short USDCHF above 1.0070, keeping a tight stop at 1.0120 with a first target a 0.99.

Chart of the Week

This chart shows the significant co-movement between the annual growth in the money supply (real M1, 9M Lead) and the annual performance in global equities. Previous empirical studies examining the impact of monetary policy instruments on the equity market have produced mixed results; however, we can see that global equities tend to perform poorly when real M1 growth decelerates significantly. We do not price another drastic fall in the equity market for the moment; however, it is difficult to see a strong divergence between the two times series in the coming months.

The fall in real money supply, combined with the leverage loan maturity wall, higher interest rates and quantitative tightening, are all indicators that price volatility will remain elevated in the medium term.

Figure 6

Source: Eikon Reuters, RR

Disclosure: I am/we are long USDJPY, EURUSD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.