Economic Growth
The Fed's statement underscored its 'go slow' approach, with a June hike increasingly unlikely, but September and December still in play. The BoJ stood pat, reluctant to admit that NIRP was a flop soon after it was launched. Nevertheless, we expect fresh easing this summer. Chinese stimulus should last a few more months, but commodities will resume their structural downtrend thereafter. Remain tactically bullish risk assets; be prepared to turn more cautious in Q2.
EM/China growth improvements and the associated rally will falter on their own without tightening by policymakers. The short duration of these mini-cycles and a lack of observable catalysts make it impossible to precisely time selling out of EM positions. This makes us reluctant to chase the rally. Regardless how the impeachment process proceeds, Brazil is heading into a fiscal/public debt crisis.
This week <i>Global Alpha Sector Strategy</i> in conjunction with <i>Emerging Markets Strategy</i> is sending out a <i>Special Report</i> on EM deep cyclical sectors, discussing debt and cash flow dynamics, identifying how far advanced the capital expenditure down cycle is, and determining if recent EM deep cyclical strength should be bought or faded.
Japan is in a liquidity trap: bad economic news is good for the yen while good economic news is bad for the yen. Chinese reflation could help risk assets in the months ahead, but poor EM fundamentals will reassert themselves later this year. The yen bull market is not over yet. The BoC was more positive on growth than anticipated. The BoE's Super Thursday was a non-event.
A stronger yen is hampering efforts to revive the Japanese economy and the BoJ's failed NIRP experiment leaves open the option of direct currency intervention. Probability is also high that the April 2017 sales tax hike will be postponed, perhaps indefinitely. A major stimulus package, "helicopter drops" of money, and a 4% inflation target may be the only way to permanently overcome deflation. Near-term, further yen strength is likely, but the long-term path is down.
One of our highest-conviction investment ideas for the next few years.
Clients should forgive us for being too gloomy at the start of the year -- it is difficult to be optimistic in the dead of a Montreal winter. However, with springtime comes the reflation trade, born on the wings of massive Chinese fiscal and credit expansion. In this report, we discuss how long (not very) the trade can go (and how to play it). Our In Focus feature returns to pessimism, with a discussion of why the Anglo-Saxon laissez-faire economic model may be in for a big pendulum swing.
Chinese PPI deflation will likely continue to ease going forward. There are non-trivial odds that the PPI deflation may turn positive. Our models predict a sharp upturn in China's profit cycle. Meanwhile, Anti-corruption investigation cases have dropped substantially since the beginning of the year, a sign that the Communist Party may be reorienting priorities to boost economic growth.
Risk assets will continue to edge higher over the next couple of months on improving economic data, notably from China. Longer term however, EMs - including China - are starting a prolonged deleveraging cycle, keeping commodities and cyclical stocks on the back foot. The dollar will likely follow the mirror image of commodities: down slightly the next two months, up substantially thereafter. A stronger dollar, in turn, will limit any rise in Treasury yields. Long-term investors should remain modestly overweight duration.