Chart of the Week: Japan Machine Tool Orders

Japan machine tool orders is an old school business cycle indicator that we monitor closely at Saxo. It is not that popular nowadays, though it still highlights very interesting developments about the state of the economy, economic activity in Asia and where we are heading to. Since early 2018, orders have gone through a very sharp collapse, which is worse than during the 2015-16 China turmoil, as you can see in the below chart.

According to the preliminary report for January released a few days ago, orders are down for the 16th consecutive month, at minus 35.6% year-on-year to 80,775 million yen. The impact of the outbreak of the new COVID-19 coronavirus was still limited in January, so we expect orders will slide further in February and in March as the impact will be more visible.

Due to the epidemic, the US-China trade deal signed last month has not brought any relief to trade data and orders. As uncertainty remains regarding the exact economic cost of the ongoing crisis, Japanese machine tool makers are likely to rethink their own investment plans, postpone investment in China, and maybe cut jobs.

Contraction in orders also acts as a wake-up call for investors signaling that global growth is unlikely to rebound in Q1 this year, contrary to what the consensus forecasted at the end of 2019, and that they should be prepared for falling CAPEX.

Saxo Quarterly Credit Impulse Update

Based on preliminary data, Global Credit Impulse, which is based on 18 countries representing ¾ of global growth, is about to turn positive. It is currently standing at minus 0.1% of global GDP. Following the Powell pivot in early 2019, we have seen an increase in the flow of new credit in China and most of the developed countries, with the exception of the United Kingdom.

The real game changer has been the reversal in China Credit Impulse we have discussed yesterday (access to the analysis). For the first time since the end of 2017, China Credit Impulse is back in expansion territory, evolving at 0.7% of GDP.

We expect that Credit Impulse will continue to expand in 2020 on the back of more debt stimulus through a significant increase in the amount of bond issuance targeting infrastructure investments. The global economy is at a turning point and we could see the current business cycle lasts much longer than many expect if the credit expansion in China continues at steady pace this year.

In the United States, Credit Impulse is at 0.2% of GDP and we believe it will continue to move south due to the continued decline in C&I loans and leases growth. This key indicator of the credit cycle in the US was out at minus 1.6% YoY in Q4 2019, which is the worst growth level of the upcycle. It can be partially explained by the fact that CAPEX growth has been moderate and that secondary demand for loans has been weaker, which ultimately pushed banks to be less inclined to originate. The current level of US Credit Impulse is still not consistent with recession, but it confirms our growth slowdown scenario for 2020.

In the United Kingdom, Credit Impulse contracts for nine quarters straight, at minus 1.2% of GDP. The length of the contraction is similar to that of the GFC, but with a smaller amplitude. The lack of new credit growth coupled with five consecutive quarters of contraction in business investment are strong arguments in favor of upcoming recession. However, we think that GDP growth bounce is on the cards in early 2020 due to better visibility on road to Brexit and possible stockpiling boost as was the case in Q1 and Q3 2019.

In France, Credit Impulse is reaching one of the highest levels of the Eurozone, at 2.1% of GDP. Credit push is certainly a better explanation for the good performance of the French economy in 2019 than solely the stimulus measures taken in order to appease the Yellow Vest Movement that have been mentioned here and there. Incoming credit has been strongly fueling the economy since 2018, with bank loan growth evolving continuously above the stunning level of 5% YoY since July 2018. We expect that credit inflow will continue to be the major driver of GDP growth in 2020.

What is Saxo Credit Impulse ?

The notion of Credit Impulse has been introduced for the first time by Michael Biggs in November 2008. It represents the flow of new credit issued from the private sector as a percentage of GDP. It is considered as the second derivative of credit growth and arguably the biggest driver behind economic growth.

The idea behind Credit Impulse is based on basic Keynesian economics. Since spending is a flow, it should be compared with net new lending, also a flow, rather than credit outstanding, a stock.

The main advantage of Credit Impulse is that it helps to solve a number of conundrums that cannot be explained by an analysis focusing on the stock of credit. In addition, it has been demonstrated that, for many time periods and countries, a strong correlation exists between Credit Impulse and other economic data, especially private sector demand, and financial assets.

Before the GFC, the USA, Japan and Europe were the main drivers of the global credit cycle but, since 2009, a major shift has happened resulting in China becoming the dominant actor. As a result, China Credit Impulse is key to monitor in order to assess the evolution of the global economy.

Christopher Dembik, Head of Macro Analysis at Saxo Bank.

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Chart of the Week : China Credit Impulse

In today’s edition, we focus on the Chinese economy. The latest data released tend to confirm a cyclical rebound is at work. In last December, there have been a massive jump in imports (+17.7%) and in exports (+9%) in CNY terms. On the top of that, inflation (PPI and CPI) is finally at a turning point.

We expect that the rebound in PPI will continue and that PPI will turn positive in Q1 while higher CPI is likely in the short-term due to stronger demand for pork in January ahead to the Spring Festival that will take place the last week of January. However, afterwards, we should see lower CPI will could give more room for maneuver to the PBoC.

The improvement in data is consistent with our leading indicator for the Chinese economy, credit impulse, which leads the real economy by 9 to 12 months. It is back in positive territory for the first time since the end of 2017, running at 0.7% of GDP (chart below). This is certainly one of the most important macroeconomic news of the past months. As China represents about 1/3 of global growth impulse, positive credit impulse means we could see the constructive global ripple effects in the coming months.

We believe China’s growth will significantly improve in Q2 2020 on the back of positive credit push, lower political risk and more debt stimulus. The US-Chinese trade deal won’t solve all the issues, but it should help both countries to focus on stimulating domestic growth.

Over the past few hours, we have had more information regarding the details of the agreement. One of the main Chinese commitments is to purchase $200bn of goods ($75bn for manufacturing goods, $50bn for energy, $40bn for agricultural goods and $35 to $40bn of services) but, as mentioned previously by our Head of Commodity Strategy, Ole Hansen, such an amount is unlikely to materialize.

We also see that China is tapping further the bond market: based on preliminary data, the local government bond issuance for January is three times the 2019 level and 70% of bonds that will be issued this year will be infrastructure bonds versus 35% last year.

China is also fueling the housing market bubble which is key for China’s growth as it represents roughly 70% of Chinese’s people wealth. In a move to encourage urbanization, China has recently decided to scrap residency restrictions in some smaller cities and it plans to build a record 20 million apartments this year, which is nearly twice the number of new births. In 2020, it seems that China is inclined to prioritize growth over debt, which is ultimately positive for the global economic momentum.

Access to MacroChartmania.

Christopher Dembik, Head of Macro Analysis at Saxo Bank.

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Monthly Macro Outlook: Green Shoots and Other Remarks

Bearish scenarios and fears of recession have been a big part of investment markets all year and, yet, a global rally lifted almost every asset classes in 2019, apart from industrial metals and the euro and the Swiss franc.

The primary explanation for the rally is related to the “Powell pivot” and the shift towards more monetary stimulus decided by most central banks at the global level. This is the first time since the global financial crisis that more than 60% of central banks are easing.

The scale of the total rate cuts in 2019 ranges from 10 basis points in the Eurozone and Denmark to 1000 basis points in Turkey. A bunch of central banks have recently mentioned a rate cut pause in the short term, notably the Federal Reserve, but we strongly believe that more rate cuts and further asset purchases are in the pipeline in 2020 in order to stimulate growth.

We also have faith that the idea of green QE backed by MMT will be a big part of the public debate in the coming years. Looking forward to the next 5 or 10 years, our conviction is that sectors that manage to mitigate and enable climate changes will outperform others. By contrast, we doubt that the current belief in the digitalization of everything will bring the high expected return.


Looking at fresh data, we have more and more indications that we are close to a bottoming in global growth and that stabilisation is underway. This is the case for China which – I repeat again – represents roughly 30% of global growth impulse (more than the combined contribution of the United States and the Eurozone). In other words, when China sneezes, the world catches cold.

The OECD composite leading indicator (CLI) for China, which is designed to anticipate turning points in the economy six to nine months ahead, has been following an upward trend over the past few months. The year-on-year rate is at its highest level in two years, at 6.2%. It seems to indicate that the worst may be behind us for the Chinese economy.

November credit data tell the same story. Credit growth picked up sharply on a month-to-month basis with banks lending more than expected. The broadest measure of credit in China, total social financing, also experienced a big jump. This is the confirmation that the counter-cyclical efforts implemented by the authorities have put a floor on growth slowdown and should start to support economic growth into 2020.

We have a bunch of other green shoots. Output’s indicators are still well-oriented with volume of rail freight growing at 9% and electricity production at 7% on a year-on-year basis. Another coincident indicator we closely monitor at Saxo is the evolution of excavators, as it gives early signals about the state of industrial production. It is currently in recovery mode at 23% YoY in October, which corresponds to levels reached in 2016 when the economy was getting out from the slump.

Compared with the previous slowdown of 2016, the economy is in better position, with strongest business confidence and consumer confidence, but the main downside is the negative trend in the car industry which represents around 10% of the country’s GDP. Despite the recent trade war breakthrough, it is likely that the car industry slowdown will continue next year as tariff impact piles up and manufacturers lose US orders. Like this year, it will remain a major drag on economic activity in 2020.

In relation to lower growth, we expect that China will announce a major policy move in the coming days. The authorities could set a more realistic GDP target for 2020 “around 6%”. Over the past few weeks, key local high-profile figures (such as the professor Yu Yongding, who served on the Monetary Policy Committee of the People’s Bank of China from 2004 to 2006, and former China central bank adviser Liu Shijin) have raised the question of whether to maintain 6% growth.

In China, such a public debate on economic policy is rather rare, so it is worthy to mention it. It is also of great significance regarding the evolution of China’s public policy, and it indicates that the authorities will probably focus more on the quality of growth and the restructuring process instead of the level of growth. If we are right, it means for the rest of the world that global growth, which has been so dependent on China’s big fiscal and monetary push over the past years, is likely to remain close to decade-low in 2020.


Talking about the rest of the world, the OECD leading indicators confirm the ongoing stabilisation. After 21 months of deceleration, the composite leading indicator moved back to a recovery, which is historically positive for risk assets.

Over the past few months, there have been a lot of questions about the risk of recession in the United States, but up-to-date data points out that this risk is now lower than a year ago. The US CLI has bottomed in past September and is currently standing at 98.5.

The year-on-year rate is still negative at minus 1.43%, but there is some improvement on a month to month basis. In addition, one of the most watched charts by permabears is also indicating lower risk ahead. The recession probability tracker over the next twelve months from the Federal Reserve Bank of New York, which tracks the difference between 10-year and three-month Treasury rates, has started to decrease a bit and is back around 30% – a level that is well below the trigger level.

In-line with the Fed’s latest Summary of Economic projections, we believe the US economy is in good place. We forecast 2020 US growth at 1.6% (which is lower than the Fed projection of 2%), that inflation will be contained, and the unemployment rate will stay below 4%.

We disagree with the Fed on the rate cut pause and consider that there is room for further rate cut in H1 2020, as the US monetary policy is still too restrictive, and it will be necessary to cope with China’s lower growth and uncertainty about the next step of the trade truce.

Our initial reaction to the announce of phase one deal is that it is a farce. We are referring to President Trump messing up communication on Twitter on Friday, but foremost to the fact that most of phase 1 details have not been fully revealed yet. This is a perfect example of “pretend and extend”.

Both countries are sending a positive signal to the market that will prolong the current trade truce, but tensions on economy beyond trade (export controls or capital flow restrictions) and geopolitics are likely to remain elevated in 2020 due to the US presidential election.

We have little doubt that President Trump will continue to play hardball against China and to be hawkish on trade issue while at the same time being reluctant to increase tariffs as it could create a negative shock on US consumption. We think the market is getting used to the trade war farce so any breakdowns, if limited, should not have a major impact on asset prices.

As this is my last piece of year, I wish you a very happy holiday season and all the best for 2020. See you in January!

Christopher Dembik, Head of Macro Analysis at Saxo Bank.

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UK Credit Impulse Contracts for Seven Consecutive Quarters

In fact, the UK economy is going through a false stabilisation that won’t last long. Q1 UK growth has returned to the average of the G7 countries, but this is mostly due to stockpiling ahead of March 31, the initial Brexit deadline. This is not the sign of a very dynamic economy in our view. It also primarily reflects lower growth momentum in the G7, not real stronger momentum in the UK. In addition, consumer surveys are rebounding but this is mostly caused by higher wages (+3.4% YoY in Q1 2019 according to the latest OECD update) and postponed Brexit.

We identify a bunch of risks that could derail growth in coming quarters:

  • The likelihood of no-deal Brexit at the end of October 2019.
  • Deterioration in the trade war front that could impact more negatively the global supply chain.
  • The lack of money supply growth in main economies is leading to low growth until at least mid-end of 2020.
  • The risk of recession in the US has significantly increased for 2020. Based on leading indicators, the probability is now comparable to the probability measure in advance of the last 3 recessions.
  • Rising tensions between the United States and Iran in the oil-strategic routes of the Strait of Hormuz that could lead to disruptions in the global oil market.

More fundamentally, even if none of these events materialises, which is rather unlikely, the UK economy is condemned to a prolonged period of low growth. The number one issue of the British economy is not really Brexit but the lack of new credit growth which is essential in a highly leveraged economy.

Our leading indicator, the credit impulse, is tracking the flow of new credit in the economy and explains economic activity nine to twelve months forward with an “R2” of .60. As of now, UK credit impulse has been in contraction for seven consecutive quarters and is currently running at minus 4.4% of GDP. The length of the contraction is similar to that of the GFC but with a smaller amplitude. The lowest point reached in the post-referendum area was minus 7.4% of GDP versus a drop up to minus 20% of GDP in 2009.

Prolonged contraction in UK credit impulse marks the end of the massive credit boom that started in 2015 and lasted until 2017 and will ultimately constraint in the long run private consumption, which contributes to roughly 60% of GDP.

In the chart below, we have plotted the evolution of the flow of new personal loans and overdrafts since 2002 as a proxy of UK household financial stress. It has been in contraction since April 2018 and is currently back to where it was in 2011, at minus 1.8% of GDP.

Real higher wages are bringing some relief to UK consumers at the moment, pushing a bit up the saving rate from historically low level of 3% reached after the referendum, but it is likely to be short-lived as Brexit – no matter which trade and political agreements will prevail with the EU – will undoubtedly have negative ripple effects on businesses, labor market and growth due to higher uncertainty. In a more constrained economic environment, companies will be more reluctant than now to keep lifting pay by cutting their margins, even in a context of full employment.

On the top of that, the risk of policy error has significantly increased. In 2010, the credit cycle has rebounded very fast and strongly after recession due to the Bank of England lowering interest rates and the massive injections of liquidity in the financial system. In post-Brexit UK, such a stimulus is unlikely. The BoE has lately sent very mixed messages about the next move of monetary policy, pointing out risks to growth at its latest Monetary Policy Committee meeting but also expressing concerns about household inflation expectations that keep increasing above 3% up to 5 years.

Though it is getting more or more likely that the next move will be an interest cut rather than a hike, the UK central bank has less room than the Fed and the European Central Bank to stimulate growth in a context of high inflation expectations. This monetary policy dilemma makes a move in terms of fiscal policy even more urgent than before to mitigate the Brexit impact.

Christopher Dembik, Head of Macro Analysis at Saxo Bank.

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Monthly Macro Outlook: The gloom deepens

Developed markets have been more resilient and often served as safe havens, especially the US market, while emerging markets suffered from low volumes, risk aversion and a strong USD. Over the past month, the MSCI Emerging Market Index lost 9%, with a drop of 14% for the SK stock market and, also, 14% for the South Africa’s JSE. Investors are adjusting their growth expectations which will likely increase pressure on central banks to balance their monetary stance in a more accommodative direction.

Downwards adjustment in new credit in China

Looking at the latest Chinese data, we still expect pickup in growth. April new lending numbers were a bit soft, but we know that monthly credit flow data have always been volatile, even in a period of stronger stimulus policy. In addition, it is not surprising to have a downwards adjustment after so much new credit went through in Q1 (representing about 9% of GDP).

As was the case during the 2016 slowdown, the state sector has also recently started to serve as a shock absorber, with state investment growth moving higher to offset deceleration in private investment. This trend is likely to become clearer as the trade war intensifies. Overall, the ongoing US-China conflict will probably be bullish for China’s growth, as the government is forced to open wide the credit tap and to step in in the economy to stimulate sectors that are the most exposed to US tariffs, such as the communication service sector.

Rest of the world: No V-shaped recovery

Contrary to expectations expressed at the beginning of the year, China’s stimulus hasn’t so far had noticeable positive ripple effects on either neighbouring economies or at a global level. Basically, exports are in contraction in most Asian economies, except for Vietnam due to a jump in exports to the US of 28% YoY in the first five months of 2019.

In April, China’s exports were down 2.7% YoY, Japan’s exports came out at minus 2.4% YoY and Thai exports were doomed for a second straight month of decline at minus 2.6% YoY. Deterioration will continue at least in the short term. In May, South Korean exports over the first 20 days of the month were out at minus 11.7% and Taiwan’s Ministry of Economic Affairs warned that YoY exports could be out between minus 7.6% and minus 10% in May.

In the United States, the outlook is more negative than in Q1. There are still several economic data indicating the economy is strong, but red signals are popping up here and there and start to raise the concern of investors. Recent Q2 US data were weak: manufacturing activity dropped to more than 9-year low, durable goods orders keep falling, suggesting deceleration of industry activity and one of our favourite indicators tracking the general state of the broad economy, the Chicago Fed National Activity Index, is back to where it was in Spring 2016, at minus 0.32.

On the top of that, the Atlanta Fed’s GDP Now tracker has GDP growth for Q2 at 1.2%, way off the 3.2% reported in Q1. As we see the negative impact of trade war and the economy is not fuelled by massive tax cuts anymore, growth in the second quarter is likely to disappoint and be out close to 1%, which reinforces our view that the Fed’s next move will be an interest rate cut. Only based on the breakdown of US-China talks, there is a strong case for at least one rate cut in H2 and further cuts will depend on how much of a deterioration we see in economic data in coming months, looking especially at financial conditions and evolution of consumption and inflation.

G20, political risk and central banks on the agenda in June

Looking ahead, the month of June will be very busy for investors. Elections are back on the agenda in Europe, with snap elections by the end of June in Greece, in September in Austria and the start of the Leadership Campaign in the UK on June 10 following PM May’s effective resignation on June 7.

In our view, the ongoing political process in the UK makes its exit from the EU scheduled for the end of October very improbable. The new Tory leader will be elected at the end of June and might call for snap elections in September/October as he or she will be looking for popular legitimacy. It is getting clear that a new exit deadline will need to be negotiated with the EU.

In other part of Europe, following its strong performance at the EU elections, the Italian Northern League could seize this opportunity to call for early elections in order to get rid of its bulky coalition partner, the Five-Star Movement. Tensions about the Stability Pact between Brussels and Roma are also likely to increase as the European Commission will probably start disciplinary steps against the country on June 5. We see Italy-Germany 10-year bond spread to further move towards 3% in the near term.

Another consequence of the EU elections is that EU leaders will announce in coming weeks the name of the successor of Mario Draghi as president of the European Central Bank. In a perfect world, the best candidate based on monetary policy knowledge, academia and government experience and charisma would be Benoit Coeuré but he lacks the support of his home country, France.

A more realistic and consensual option would be Finland’s Olli Rehn who is quite aligned with Mario Draghi’s dovish stance. However, experience and knowledge will not be the first and main criteria and still other options are on the table, including Jens Weidmann and Klaus Regling. It is not certain that Draghi’s successor name will already be unveiled when the ECB next meets on June 6.

There is little doubt about the outcome of the meeting in terms of monetary policy: the ECB has no other choice than to adopt a dovish stance as the economy is slowing down, fears of lower activity are spreading to Germany’s services (as pointed out by Markit: “the surveys highlight that fears of a slowdown may have started to spread to services, where confidence is now at its joint-lowest since 2014”) and market-based inflation expectations are uncomfortably low. The 5y5y euro inflation swap is running slightly below 1.30%, for the first time since September 2016, and core inflation that will be released on June 4 is set to collapse to 0.8% according to consensus.

The only direction for the ECB is to be more dovish and, no matter who will be the next ECB president, he will need to stick to economic reality and the need for central bank life support.

Finally, on the trade war front, we still expect there will be ultimately an agreement but, as of now, there are too many pending issues on both sides to reach it. The upcoming G20 in Osaka, where presidents Trump and Xi should discuss ongoing tensions, should not lead to any significant steps towards resolution.

Contrary to what has been written here and there, the probability that China will massively sell T-bonds is close to zero as this nuclear option would hurt China as much as the US, as bringing down the value of China’s existing holdings of T-bonds. However, retaliation on rare earths exports (such as a ban to export to the US) or further depreciation of the CNY are still possible options if things get nastier between Beijing and Washington.

Christopher Dembik, Head of Macro Analysis at Saxo Bank.

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Don’t Forget the US-Iran Dispute, It’s not Gone Away…

Relations between the two countries have deteriorated sharply since April

On April 8t, the US administration labeled Iran’s elite Revolutionary Guard Corps as a foreign terrorist organization.
On April 22, the USA ended exemptions from sanctions for eight countries (China, India, Italy, Greece, Japan, South Korea, Taiwan and Turkey) still buying oil from Iran.

On May 8, the USA unveiled new sanctions against the Iranian mining and steel sectors. In retaliation, Iranian President Rohani announced the same day that Iran will no longer comply with two of its JCPOA obligations: the country will stop exporting its surplus of enriched uranium and heavy water, which means that at some point it will exceed the ceiling of stock authorized by this multilateral nuclear accord.

In addition, if other signatories of the agreement (notably Europe) do not help Iran economically, the country threatens not to respect other constraints related to its nuclear programme. In other words, Iran could enrich uranium for military purposes again, which could be interpreted as a casus belli, an event that justifies war, by Washington.

In recent days, the United States has announced the dispatch of military forces in the region, including the deploying of the USS Abraham Lincoln aircraft carrier and the USS Arlington assault ship.

How to explain this sudden increase of tensions?

As a reminder, new US sanctions against Iran were unveiled in November 2018, with targets including 50 banks and their subsidiaries and 200 members of the shipping industry and some restrictions against oil exports (excepting the eight countries mentioned above).

Iran has certainly been slow to react to these new US sanctions for two main reasons: (1) the Iranian regime believed that President Trump would not be re-elected next year, which is getting less and less certain, and (2) it believed that the other JCPOA signatories would help the country economically in order to offset the impact of the US withdrawal from the agreement and US new sanctions. Europe has launched INSTEX to bypass US sanctions but with little effect on trade and the Iranian economy so far. The two other signatories, Russia and China, do not seem eager to engage in a diplomatic standoff. China is even looking to reduce the amount of Iranian oil it is buying, likely in CNY, in order not to increase confrontation with the US.

In addition, in both camps, there are war hawks that push for conflict (in Iran, the Revolutionary Guard Corps are looking to extend their influence over the region, and in the US, neoconservatives like National Security Advisor J. Bolton are dreaming of regime change in Iran).

What could happen next?

It is likely that President Trump does not want to wage war. He even disavowed publicly J. Bolton on that option for Iran. At this stage, it would not make sense at all. The sanctions strategy was bearing fruit by weakening Iran economically leading to inflation at two digits (above 40%), depreciation of the IRR versus the USD at around 143,000 rials to the USD (vs fixed official rate of 42,000 IRR), contraction in GDP that could reach 6% this year according to the IMF and oil exports dropping to their lowest level in decades, at 0.5 million barrels vs 2.5 million barrels one year ago.

An escalation could also jeopardise the stability of the region and efforts to bring solution to the Palestinian-Israeli conflict. In addition, it is unlikely that the Trump administration wants to fight on two fronts (they have certainly learned the lesson from Napoleon’s defeat) as it mostly focuses its attention on China.

The risk of escalation or accident with military implications (eg: US navy ships boarding Iranian ships in the straits of Ormuz) should not be underestimated as it is reinforced by the lack of direct line of communication between Washington and Tehran. Contrary to the Cold War where the red phone connected Washington and Moscow (it was installed in 1963 after the world was on the bridge of nuclear war), such a system does not exist between the two countries to de-escalade tensions.

What could be the market impact?

So far, market impact has been limited. Investors were mostly focusing on the US-China trade war as their top risk and the oil market received welcome signals from other oil producers willing to step in to replace Iran’s barrels. This explains why oil prices have decreased 8.3% since the US announced in late April it would not grant waivers for sanctions on Iran’s oil exports.

However, as we have often said in relation to this and other situations, market complacency, including in relation to the US-Iran tensions, is worrying. Based on all the negative geopolitical surprises that have impacted the market since 2016, it is crucial for investors to also monitor the situation in the Middle East. Our central scenario is not an escalation of tension, but an accident can always happen with notable market implications, especially when there is no direct line of communication between the two camps.

Christopher Dembik, Head of Macro Analysis at Saxo Bank.

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Credit Impulse Flashes a Warning to Major Economies

At the start of the year, the consensus narrative was that growth was well-oriented and risks were limited despite the threat of trade war and sluggish global trade overall. Many analysts still consider growth to be solid, citing solid Q1 GDP growth in several key major economies. Looking at the US and Japan, however, growth is not as resilient as it seems. In both countries, the strong Q1 figures were mainly driven by an increase in stockpiling, which is not the sign of an incredibly dynamic economy.

There is more bad news, as well: it may get worse. We make this bold statement based on the recent fall in credit impulse. Economists used to refer to the stock of credit to understand the business cycle, but academic research since the great financial crisis (Biggs, Calvo, Ermisoglu) pointed out that the flow of new credit – what we call credit impulse – is a better method of assessing where the economy is heading. Credit impulse leads the real economy by nine to 12 months with a correlation of 60%.

Based on our latest estimates, global credit impulse is falling again and now stands at -1.8% of global GDP. The amplitude of the contraction is similar to that seen in Q4 ‘15. That year, the decrease in credit impulse led to the lowest global growth level seen in the current cycle, with global GDP growth reaching just 3.09% in 2016. We have not yet reached that point, but recent developments on the trade war front urge caution on growth forecasts.

So far, half of the countries in our sample are in contraction and the other half, excepting certain emerging market countries like India and Russia, are experiencing a deceleration in the flow of new credit in the economy. In developed countries, the trend is most concerning in the US. US credit impulse is running at -2.2% of GDP, the lowest level since 2009.

The US Composite Leading Indicator, watched by asset managers all around the world, is also confirming this negative signal with the index now at its lowest point since Autumn 2009; the year-on-year rate has fallen from 0.68% to -1.65% over the past 12 months. Such levels are usually consistent with the risk of recession. In addition, the three-month moving average of the Chicago Fed National Activity Index, which gives a broad overview of the state of the economy, is back to where it was in Spring 2016.

With the US economy no longer supported by massive tax cuts and facing the negative economic consequences of the trade war, particularly those felt by US consumers, the outlook may continue to deteriorate in the months to come. This reinforces our call that the current business cycle, especially in the US, is more fragile than most suspect.

We fear this is only the beginning. As you can see in the chart below, we have plotted the global credit impulse against the Chinese credit impulse. China’s credit impulse, which roughly represents 1/3 of the global growth pulse, tends to lead the global credit impulse by one year. As long as the Chinese credit impulse does not return to positive territory, we expect the global credit impulse to move downward in the coming quarters leading to lower-than-expected growth.

The policy response will be crucial in the near term. Due to trade war-related uncertainty, investor belief in a global V-shaped recovery in H2 is growing less certain. We think China is ready and able to further open its credit tap to mitigate the impact of trade war, but this is a challenging task that implies the implementation of very targeted support policy. The goal here would be to avoid fueling the debt bubble as much as is possible. The manufacturing goods sector, most notably the communications sub-sector, represents the largest share of Chinese exports and thus is the most vulnerable to ongoing tensions. It will certainly be subject to support measures very soon.

There is little doubt that China can stimulate its economy, but the same is less certain for the US and the euro area due to policy constraints. In the US, fiscal policy has already been deployed, ultimately fueling a massive federal deficit in a period of growth. The tax cuts had a very strong macroeconomic impact, but the effect could be completely erased if the Trump administration decides to impose a 25% tax on the remaining share of Chinese imports worth $300 billion. Investors expect a lot from the Federal Reserve – bets of a rate cut at December Federal Open Market Committee meeting stand around 60-70%, although it remains quite early to call such a move.

This is also simply not the way that policymaking works at the Fed. We have all noticed the red signals related to the trade war but based on the Fed’s track record, this is not sufficient for a rate cut. At best, we can only really expect a dovish adjustment of forward guidance at this point. For a rate cut to manifest, we would need a combination of lower inflation, a sharp decrease in consumption and tighter financial conditions, and this is not yet the case. The risk is therefore high that investors will be disappointed by the Fed’s answer to rising trade tensions.

My final word comment concerns the euro area. Potential growth here is lower than in the US, which explains why growth is not higher. Despite headwinds hitting the manufacturing sector, domestic demand is resilient. There is little margin for the European Central Bank to stimulate the economy in case of a pronounced downturn (a new round of TLTRO is clearly not enough) so the only leverage left is fiscal policy, but we have very strong doubts that EU policymakers will be able to reach a common ground on that topic.

Populist parties, particularly in Italy, are pushing for further fiscal stimulus. This could make sense if we are talking about coordinated productive investments, but they are constrained by the Stability and Growth Pact that should, but probably never will, be reformed. In other words, despite being the second global economic power, the EU is still one of the weakest points among developed markets due to its lack of any real policy response capacity.

Christopher Dembik, Head of Macro Analysis at Saxo Bank.

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This article is provided by Saxo Capital Markets (Australia) Pty. Ltd, part of Saxo Bank Group through RSS feeds on FX Empire.

Latest Trade War Developments

Between Trump tweets and Chinese whispers via state-controlled media, it can be difficult to pinpoint precisely where things stand in the ongoing battle between the world’s two economic superpowers. Christopher Dembik says the CNYUSD rate is the best proxy we have. Here’s why.

As Saxo Head of FX Strategy John Hardy and I both mentioned yesterday, we need to look closely at the Chnese yuan this week. In my view, the yuan fixing is the right proxy to understand how the US-China trade negotiations are going. And it isn’t pretty! Since the end of last week, the yuan/dollar fixing has been cut by 45pips to 6.8365. As negotiations are probably going nowhere in the coming days, we could see the fixing moving closer to 6.90. However, I don’t think that the psychological threshold of 7.00 could be reached as it would have deep negative consequences on local firms that use their CNY profits to repay their USD debt. A large devaluation is still a risk but is not the central scenario for the Chinese authorities.

Softer tone in the US vs tougher tone in China

Yesterday evening, senior Trump administration officials tried to appease tensions. US secretary of the Treasury Mnuchin confirmed, without giving much detail, that the US-China trade talks are still ongoing. The tone is clearly different in China where the official media, such as CCTV and People’s Daily, adopted a tougher stance. It is interesting to note that in the previous rounds of trade disputes that occurred since Autumn 2018, People’s Daily articles mostly used the term “trade friction” instead of “trade war” until now… As of yesterday, all the articles and TV reports mention “trade war”. This terminology change means a lot and confirms that the negotiations have entered a more dangerous phase. In addition, China has tightened its “national security” review for foreign investments, which can be considered as another step in the retaliation process.

This is not 2018 again in the FX market

Looking at the initial reaction of the market yesterday, it is likely that the USD will not benefit from the trade war, contrary to what happened in 2018, as investors expect its main US impact would be to damage the economy and increase the likelihood of Fed rate cut this year. Investors are betting that there is a 60%-70% probability that the December 12 Federal Open Market Committee will see a rate cut. Policymakers are starting to pay attention and it may influence forward guidance in the upcoming June meeting by increasing the focus on the market reaction to the trade war and macroeconomic effect of higher tariffs (leading both to higher inflation and less growth which wwould pose a serious policy dilemma to the Fed).

Trump’s approval rate is still high

On the US domestic front, President Trump is now seeking $15 billion to bail out farmers in order to mitigate the negative impact of the trade war. Interestingly, more and more Republican Congressmen that were interviewed yesterday on US TV were very vocal against the latest measures decided by the Trump administration. It is, however, unlikely to have any influence on the ongoing process or to push the administration to comprise with Beijing. Trump is looking at polls and the message they send is bright and clear: as of yesterday, 42% of US voters supported Trump’s policy (FiveThirtyEight). His electoral base has remained stable, faithful and very broad since he was elected.

What’s next?

  • By May 18 – Potential US tariffs on global auto sector.
  • June 1 – China’s move to raise the rate of additional tariffs to 25% on 2,493 US products (representing $60 billion worth of US imports) will come into effect. In addition, list 3 tariffs from 10% to 25% decided by the USA against China will truly be implemented for all products. For the moment, an exemption applies to list 3 products exported before May 10 and arriving in the US before June 1. For these products, the duty rate is still at 10%.
  • June 17 – The USTR will hold a public hearing on potential duty of up to 25% tariffs on virtually all Chinese goods (list 4 tariffs) that are not currently covered by previous tariffs hikes. It will be followed by at least a week of discussions.
  • June 28 – Likely meeting between presidents Trump and Xi at the G20 meeting in Osaka to reach a compromise on trade issues.

Central scenario for coming weeks

In the coming days and weeks, the market reaction will be key to monitor, and it may have a much important impact on Trump’s will to compromise with China than any other factors. So far, risk-aversion has been contained. The VIX is revolving around 20, still far from the risk zone of 22, but we should expect a sudden spike in volatility as the wrestling match between China and the USA continues. Our central scenario has not changed. Though the probability of an agreement has decreased, it is still likely to happen but not as early as expected.

The latest events do not prove that there has been a breakdown in trust between the two parties, but it will certainly be much more complicated to reach a fair and balanced agreement due to recent tensions. I fear that China will be reluctant to compromise at first as it could be perceived that its position is dictated by outsiders. Paradoxically, the “close relationship” between the two presidents could be a disadvantage in the negotiation process. If we remember the negotiations between the Soviet Union and the USA in the 1970s as part of arms control talks, there was little trust between both countries and certainly no privileged relationship between the two leaders. However, they understood it was their common interest to find a middle ground. Such a situation is not that certain as it seems abundantly clear that President Trump is convinced that tariffs will mainly hurt China and benefit the USA.

The first real deadline is June 28, at the occasion of the G20 meeting in Japan, that could be the opportunity for both countries to find a solution regarding the last points of disagreements. In case of failure, it would open the door to a nastier course of events this summer and potentially the implementation of list 4 tariffs.

Christopher Dembik, Head of Macro Analysis at Saxo Bank.

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This article is provided by Saxo Capital Markets (Australia) Pty. Ltd, part of Saxo Bank Group through RSS feeds on FX Empire.

Chart of the Week: Yuan fixing

The People’s Bank of China cut the yuan fixing by 42 pips to 6.7954 per USD today, which is the lowest level in the past three months

Click here to download this week’s full edition of Macro Chartmania.

One day earlier, the yuan fixing was at 6.7912. The PBoC’s move tells us a lot about the current state of the US-Chinese trade war. Since negotiations started, at Saxo, have considered that the yuan fixing is the right proxy to understand how short-term negotiations are going.

Things haven’t gone very well lately and, as expected, Beijing’s first answer to the US tariff costs 25% increase was to depreciate its currency. In the short-term, coupled with a strong credit flow, it should bring some relief to the Chinese economy since it will limit the erosion of export price competitiveness.

China still has room to let the CNY depreciate further, in case there is no diplomatic improvement with the United States, but it is unlikely that we’ii reach the psychological threshold of 7.00 that is often discussed by investors. In our view, the bottom line is that China cannot allow too much FX weakness as this would hurt local firms that have profits in CNY and a huge amount of debt in USD to refinance in coming months (short-term external debt is about 1.3 trillion USD). Again, this is fine-tuning policy at best.

Christopher Dembik, Head of Macro Analysis at Saxo Bank.

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This article is provided by Saxo Capital Markets (Australia) Pty. Ltd, part of Saxo Bank Group through RSS feeds on FX Empire.

UK April Services PMI Out of Contraction

The UK April Services Purchasing Managers’ Index is out – it reached 50.4 vs 50.5 forecast and prior 48.9. As widely expected by investors, it is getting out of contraction, but the trend remains negative in the long run. We can explain this increase by the fact that the original Brexit deadline of March 29 was postponed and by positive momentum in the labour market (notably higher wages). Overall, as pointed out by IHS Markit, the rate of expansion was much softer than on average in 2018 and a large number of respondents continued to highlight Brexit uncertainty as the main risk for the UK economic outlook. This should prompt customers to postpone spending in coming months, an attitude could be accentuated by low household saving ratio compared to the historical standard of 4.8%.

The big picture

Our view for the British economy has not changed much over the past few months. Brexit uncertainty remains a key issue, but the number one issue is the lack of new credit growth. Our in-house credit impulse for the UK, which leads the real economy by nine to 12 months, is running at -2.2% of GDP, one of the weakest levels seen in developed countries.

All the other leading indicators also point to downside risks as Brexit anxiety is still hurting confidence and business. The UK OECD leading indicator, which is designed to anticipate turning points in the economy six to nine months ahead, fell in February for the 19th straight month. The year-on-year rate started 2018 at minus 0.6%; it now stands at -1.52%, which is quite a swing over such a period of time.

In addition, new car registrations, which are viewed as a leading indicator of the wider economy in the UK, have been tracking downwards since 2016, driven by falling consumer confidence. The drop since the pre-Brexit referendum is stunning – about 12%! The UK economy may still be able to run above potential for a few more quarters, mostly due to stockpiling for Brexit but, as one of its key drivers, new credit, is vanishing, it will ultimately lead to less growth and increased risk.

Christopher Dembik, Head of Macro Analysis at Saxo Bank.

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This article is provided by Saxo Capital Markets (Australia) Pty. Ltd, part of Saxo Bank Group through RSS feeds on FX Empire.