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Olduvai III: Catacylsm
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Although the global economy has been undergoing a sustained period of synchronized growth, it will inevitably lose steam as unsustainable fiscal policies in the US start to phase out. Come 2020, the stage will be set for another downturn – and, unlike in 2008, governments will lack the policy tools to manage it.
Chinese 10yr bond yields have been rising steadily since October 2016. They never reached the low or negative levels of Japan or Germany. 1yr bonds bottomed earlier at 1.76% in June 2015 having tested 1% back in 2009.
The pattern and path of Chinese rates is quite different from that of US Treasuries. Last month rates increased to their highest since 2014 and the Shanghai Composite index finally appears to have taken notice. The divergence, however, between Shanghai stocks and those of the US is worth investigating more closely.
The chart below shows the yield on 10yr Chinese Government Bonds since 2007 (LHS) and the 3 month inter-bank deposit rate over the same period (RHS):-
Source: Trading Economics
From a recent peak in 2014, yields declined steadily until October 2016, since when they have begun to rise quite sharply.
The next chart shows the change in yield of Government bonds and AAA Corporate bonds across the entire yeild curve:-
Source: PBoC
The dates I chose were 29th September – the day before the People’s Bank of China (PBoC) announced their targeted lending plan. The 22nd November – the day before the Shanghai index reversed and 6th December – bringing the data set up to date.
The general observation is simply that yields have risen across the maturity spectrum, but the next chart, showing the change in the spread between government and corporate paper reveals some additional nuances:-
Source: PBoC
Spreads have generally widened as monetary conditions have tightened. The widening has been most pronounced in the 30yr maturity. The widening of credit spreads may be driven by the prospect of $1trln of corporate debt which is due to mature between now and 2019.
Another factor may be the change in policy announced by the PBoC on September 30th. Bloomberg – China’s Central Bank Unveils Targeted Lending Plan to Aid Growth provides an excellent overview:-
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Olduvai IV: Courage
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Olduvai II: Exodus
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NEW YORK – As we mark the decennial of the collapse of Lehman Brothers, there are still ongoing debates about the causes and consequences of the financial crisis, and whether the lessons needed to prepare for the next one have been absorbed. But looking ahead, the more relevant question is what actually will trigger the next global recession and crisis, and when.
The current global expansion will likely continue into next year, given that the US is running large fiscal deficits, China is pursuing loose fiscal and credit policies, and Europe remains on a recovery path. But by 2020, the conditions will be ripe for a financial crisis, followed by a global recession.
There are 10 reasons for this. First, the fiscal-stimulus policies that are currently pushing the annual US growth rate above its 2% potential are unsustainable. By 2020, the stimulus will run out, and a modest fiscal drag will pull growth from 3% to slightly below 2%.
Second, because the stimulus was poorly timed, the US economy is now overheating, and inflation is rising above target. The US Federal Reserve will thus continue to raise the federal funds rate from its current 2% to at least 3.5% by 2020, and that will likely push up short- and long-term interest rates as well as the US dollar.
Meanwhile, inflation is also increasing in other key economies, and rising oil prices are contributing additional inflationary pressures. That means the other major central banks will follow the Fed toward monetary-policy normalization, which will reduce global liquidity and put upward pressure on interest rates.
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