Portugal has finally gone cap in hand to the European Union, the European Central Bank is about to raise rates and the market is obsessed by Fed speak and looking for clues on when the second round of creating money — or quantitative easing — will come to an end.
Investors though should be looking East for clues on what will happen next, as we enter the “central bank danger zone,” according to Steen Jakobsen, the chief economist at Saxo Bank in Copenhagen.
“The market is obsessing over every little nuance in the latest rhetoric from the fractious FOMC (Federal Open Market Committee) voters among the Fed and the various ECB members,” Jakobsen wrote in a note to clients.
“But are central banks independent actors in this global economy or are they beholden to other forces that we should be paying more attention to?"
One point that is ignored is the fact that monetary policy rates are mostly dictated by the world’s net savers, countries that can export capital and thus dictate global money flows, he explained.
China is leading the way on monetary tightening and has been raising rates to curb inflation after it led the world in 2008 in cutting them.
Clearly, Chinese lending rates have led inflation, and as a second derivative the inflation expectations – those very same inflation expectations that are now getting every single central bank to talk hawkishly, he said.
“China is in tightening mode and at the vanguard on that front,” said Jakobsen who believes the globe’s other key exporter of capital is now providing the world with the third round of quantitative easing.
“At present we are confronted with an odd combination of policies from the key global net savers while FX carry trades are storming higher,” he wrote.
“The fundamental support for carry trades and the global economic growth is fading, as the data for G-10 currencies is failing to meet expectations and suggests strong deceleration in many cases,” Jakobsen added.
Courtesy of QE3-light from the Japanese, the risk-on trade is back, and a new leg of the bull market in stocks and commodities is on the way as a result, making him very nervous.
“The market appears very confident in its view and there are increasing signs of complacency. But for that complacency and QE3-lite boost to be justified or sustainable, we need for economic performance to close the widening gap with the raging new rallies in asset prices and other risk measures,” Jakobsen wrote.
“Either the economic engine restarts here or we risk engine failure and an ensuing slowdown that could see severe dislocation as reality fails to meet up with expectations,” he added.
“Gravity does exist — even in finance, eventually,” Jakobsen said.