Globally, average short term rates have remained around zero. That will be a core pattern throughout 2018.
Central banks may tweak a few rates here and there, announce some tapering due to "economic growth", or deflect attention to fiscal policy, but the entire financial and capital markets system rests on the strategies, co-dependencies and cheap money policies of central banks. The bond markets will feel the heat of any tightening shift or fears of one, while the stock market will continue to rush ahead on the reality of cheap money supply until debt problems tug at the equity markets and take them down.
Central bankers are well aware of this. They have no exit plan for their decade of collusion. But a weak hope that it'll all work out. They have no dedicated agenda to remove themselves from their money supplier role, nor any desire to do so. Truth be told, they couldn't map out an exit route from cheap money even if they wanted to.
The total books of global central banks (that hold the spoils of QE) have ballooned by $2 Trillion in assets (read: debt) over 2017. That brings the amount of global central banks holdings to more than $21.7 trillion in assets. And growing. Teasers about tapering have been released into the atmosphere, but numbers don't lie.
That's a hefty cushion for international speculation. Every bond a central bank buys or holds, gets a price-lift. Trillions of dollars of such buys have artificially lifted all bond prices, and stocks because of the secondary-lift effect and rapacious search for self-perpetuating returns. Financial bubbles pervade the world.
Central bank leaders may wax hawkish –manifested in strong words but tepid actions. Yet, overall, policies will remain consistent with those of the past decade to combat this looming crisis. US nationalistic trade policies will push other nations to embrace agreements with each other that exclude the US and shun the US dollar.
Meanwhile, here are some themes to watch for 2018:
1) Central Bank "Tightening" and "Tapering": More Talk than Action
The Fed predicted three hikes for 2017, and for the first time in three years of announcing rate increases, met its own forecast. Thus, Federal Funds Rates rose by 75 basis points.
In Europe, the European Central Bank (ECB) kept rates in the zero percent range. Gearing up to Brexit, the Bank of England raised rates by a mere 25 basis points. In Japan, the Bank of Japan (BOJ) kept rates negative. The People's Bank of China (PBoC) didn't alter its benchmark rate this year, though it did increase its medium-term lending facility and its open market reverse repo agreements by a whopping 15 basis points in 2017. Those aren't exactly definitive tightening bias moves.
The ECB announced a "tapering" bias, but in practice, merely cut its monthly purchasing pledge while extending the total period of purchasing. This was a typical central bank 'bait-and-switch' maneuver, the net effect of which will be more QE, not less.
Japanese Prime Minister Shinzo Abe's snap election victory last fall secured BOJ head, Haruhiko Kuroda in his spot, or at least, provided a green light for more easy money provisions to the Japanese capital markets.
In the US, Jerome Powell will assume the helm at of the Fed on February 4. How different will his policies be from those of Janet Yellen or Ben Bernanke? Not much. He voted in favor of the Fed's monetary easing programs (even with hesitation) every time. Powell will embrace the same unlimited easy money policy on any sign of market weakness, as the global web of central banks remains as omnipresent as ever.
2) Rising Stock Markets for Now; But on Shakier Ground
Global stock markets, being the easiest place to park cheap money will rise at first in 2018. This will take place on the back of another spurt of record corporate buybacks. The move will carry on due to a self-fulfilling prophesy of return-seekers (from hedge to pension funds) until met by a span of corporate or bank scandals or geo-political risk.
In the US, the Dow Jones finished the year up 28.11% adjusted for dividends (compared to 16.47% adjusted for dividends in 2016.) President Trump took credit for the equity euphoria, as Obama and other presidents have done in the past.
The reality is that stock markets were bolstered by historically cheap money and more than $14 trillion of QE. If the Fed (or any major central bank) was to unwind the $4.5 trillion of assets it's holding, markets would plummet. That's why the Fed isn't moving much, nor are other central banks, to truly reduce the size of their artificial market intervention. But when markets fall back to earth – the drop will be quick and painful.
On the flipside, there's economic reality. Job growth is at its slowest pace since 2011, wage growth is relatively stagnant and job market participation sits at four-decade lows. While the stock market continues to shatter records, the real economy remains left behind.
3) Expanding Debt and Corporate Defaults
Debt is at epic levels any way you slice it, public debt, corporate debt, credit card debt, student loan debt. There will be a tipping point – when money coming in to furnish that debt, or available to borrow, simply won't cover the interest payments. Then debt bubbles will pop, beginning with higher yielding bonds. Leverage is a patient enemy.
Fueled by low rates and a strong investor appetite, debt of nonfinancial companies in the US has accelerated rapidly, to $8.7 trillion, a figure equivalent to more than 45 percent of GDP. Nonfinancial corporate debt outstanding grew by $1 trillion over the past two years. US tax cuts will propel more issuance at first, due to the perception of more money available later with which to repay it. That is not the same as actual profits.
This is the year where borrowing fueled by central banks slams into a wall of growing defaults. Expect corporate defaults to rise on the back of even slight rate hikes. Defaults will deepen in non-Asian emerging markets first. That's because those currencies haven't done as well against the US dollar as in other countries, and central banks and governments aren't as able to sustain that debt through various intervention maneuvers.
Meanwhile, major central banks will find ways to fuel corporate bond markets to stave that crisis off as long as they can. The ECB's corporate buying program kicked into high gear in 2017, for instance, driving corporate spreads and rates downward. The ECB's corporate sector purchasing program (CSPP) will expand the ECB's corporate bond holdings to over 20 percent of its whole book, double today's percentage.
Other central banks will try to do the same, but face headwinds. China has a $3.4 trillion corporate bond market showing signs of struggle. With more than $1 trillion of local bonds maturing in 2018-19, it will become increasingly expensive for Chinese companies to roll over financing, which is why the PBoC will maintain its QE programs in 2018.
4) Weakening Dollar, Rising Gold and Silver Prices
The dollar index that tracks the dollar against other major currencies (including the Euro and the Pound sterling) hit 14-year lows in 2017. As the index dropped accelerated, it exhibited a counter-historical diversion from the behavior of the US stock market. That pattern looks set to continue in 2018, despite any minor US rate increases that did not serve to bolster the dollar against other major country currencies last year.
It's also counter-intuitive for the currency coupled with rising rates to underperform the one with easier policy. Yet, that's what happened between the US dollar and the Euro in 2017. The Euro's surge will carry on given that its strength better reflects surrounding economic reality, than the dollar does for the US, where the stock market has far outpaced economic factors like wages and job force participation levels.
Similarly, gold and silver will rise against the US dollar, as bitcoin enthusiasts and gold bugs converge. Nations like China, India and Russia continued to stockpile gold in their quest to diversify against the dollar last year. China's Gold Bar Demand rose by more than 40%. The more gold these nations buy, the more the dollar could decline relative to their currencies, especially if they sell US treasuries, or reduce purchases, to buy gold. Even my old firm, Goldman Sachs noted the bitcoin boom hasn't dampened gold demand.
5) Ongoing Economic Power Shift from the West to the East
The economic power shift from West to East, and from the US dollar to the Chinese yuan, will continue for economic and geo-political reasons as China forges more solid global trade relationships and the US retains its nationalist stance.
Given the Trump administration's isolationist and pro-bilateral trade agreement doctrine, China will augment its economic, military and diplomatic presence globally. The Chinese government has invested billions in the BRICS Development Bank and Asian regional organizations like ASEAN. That type of long-term groundwork will expand in 2018.
As it did in 2017, Japan embarked upon greater cooperation with India and Russia to hedge its US relationships. The Japanese economy also hit a growth streak in 2017. Its economy has been expanding since the start of 2016, the longest streak since 1999.
Japan will keep developing its Eastern influence and seek new relationships as Prime Minister Abe consolidates his power. For the Bank of Japan, that means, despite some talk to the contrary, maintaining its aggressive QE program. The ongoing supply of cheap money will provide a bid to the Japanese stock market and massive liquidity to its banks.
6) Easy ECB policy / Sterling Rising into Brexit
In 2015, Mario Draghi, the head of the ECB, decided to extend Euro-QE into March 2017. Then, he extended Euro-QE to December 2017, with a promise to do more if necessary. There was taper talk in the ECB's QE program this year. In October, the ECB announced, that starting in January 2018, its asset purchases will follow a monthly pace of €30 billion until the end of September 2018, "or beyond, if necessary." Ultimately, on an absolute value basis, the move was camouflage that will lead to more QE for Europe, not less.
Over in the United Kingdom, having fallen 14% in 2016 due to Brexit anxiety, the Pound executed an impressive rise helped along the way by the BOE's 25 basis rate hike. The Pound recorded its best annual performance against the dollar since 2009, with an almost 10 percent rise. Meanwhile, the Euro gained an impressive 14.1 percent vs. the dollar.
Brexit is still looming. Yet, the Sterling has had a good run, and given the receding uncertainty over what Brexit could look like, this trend should extend in 2018. Once everyone realizes that UK banks aren't moving to Frankfurt no matter what Brexit looks like, the Sterling will outperform the Euro. This will be positive for UK banks that have better capital cushions and are considered more stable.
7) Infrastructure Focus
Currently, the US federal government spends about a modest $100 billion annually on infrastructure. States and cities have tapped out at $320 billion in allocated funding. How they could afford increases at more than double that rate is a mystery.
Yet, the US remains at a huge infrastructure disadvantage relative to Asia and Europe. Any official talk of a bill combined with associated news coverage alone would lift bidding interest for government contracts, and share prices of companies in the sector.
And we will hear more talk about a bi-partisan infrastructure bill and associated public-private partnerships in the wake of the Trump - GOP tax bill victory and into his second year in office. The problem is that his proposed spending of at least $200 billion over the next decade is contingent on $800 billion coming from state and local sources. Many states don't have the budget to meet such infrastructure demands. This means other funding or increased federal spending will be hotly debated in 2018. Engineering and infrastructure companies will reap the benefits of related expectations and attention.
8) Cryptomania Grips More Tightly
As for Bitcoin, despite its predisposition to being a Ponzi scheme, it should rise (and sustain its high degree of volatility) through 2018 for a few reasons. First, many funds have been green lighted to get involved in the second half of 2018 and ETF's are on the horizon, albeit with a plethora of surrounding problems and regulatory hesitations. Second, futures exchange activity will broaden the market. Third, establishment banks like Goldman Sachs have announced plans to set up crypto-trading desks and promoted the possibility of bitcoin becoming a legitimate global currency.
There will be growth of the number and diversity of exchanges beyond Coinbase in the manner of PayPal which is already a player in that space, as well as for Coinbase itself. Expect the start of many payment exchanges that can process both regular currencies and cryptocurrency transactions ala the dot com bubble, rendering the idea of crypto-independence more and more fuzzy.
Conversations amongst the financial elite at G7 gatherings and other similar forums will encapsulate more crypto focus. Central banks will ultimately create or utilize some elements of crypto currencies for themselves, and adopt ways to regulate the market, as will regulatory agencies that will focus more on crypto than regular banking activities (both need that monitoring to protect people.) Meanwhile, there will be more buying of cheaper crypto currencies (or assets as I consider them) like Litecoin and Ripple. The fight between those that believe in crypto's decentralized nature will hit a wall of resistance from banks and central banks, but that fight might take years.
