As we kickoff trading for the week, look at who just warned this will end in tears.
It’s Only Just Begun
December 21 (King World News) – Top Citi analyst Tom Fitzpatrick: Wishing all our regular readers (Both of them J) the very best for the Holidays and hopefully a Healthy (Most importantly) and Happy New Year.
As I write the final diary of the year it is hard to believe that this is “Diary: Week 44”. When I started this, we were looking at a scenario that looked like it could play out in weeks. Now we are approaching the final weeks of the year and the “Last Chapter” in this story looks far from written. Before the Great Financial Crisis I thought I had seen pretty much everything in my career (From the Plaza accord to the Crash of ’87 to the Savings and Loan crisis, The Gulf wars, the Implosion of the ERM, the Asia/Russian/LTCM crises, the various LATAM crises the Dotcom bubble and Y2k, 911 and more.
After the Great Financial crisis I was convinced that I had now seen it all and there was likely nothing left in the World in general and its impact on financial markets in particular left for me to see. Little did I know 2020 has without a doubt been one of the most monumental (if not the most monumental ) years in our lifetimes (and not in a good way) and while I am both hopeful and optimistic that 2021 will be better it would be naïve to believe that we are going back to the “old normal” anytime soon. The economic, societal and financial consequences of 2020 will be here with us for some time to come…
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From a financial markets perspective that is hugely important. To repeat a sentence I often use:
“The only thing unthinkable in an environment like this is that anything is unthinkable”
We have articulated our 2021 views in our annual The 12 Charts Of Christmas but I thought in this final note I would take a step back and make some observations/statements. These are expressed below as “facts” but of course they are really just my subjective opinions borne of 36 years watching financial markets.
- Getting the vaccine is a game changer in the battle against this virus but things are not going to change overnight. There are still many challenges ahead and there will likely be some hiccups along the way. As a consequence there is NO chance we will see any attempt at withdrawing fiscal or monetary stimulus anytime soon from the World’s largest economy and the Central Bank of The World (The Fed).
- If anything it is far more likely that further stimulus on both counts will be forthcoming for some time to come.
- We already have the greatest coordination of Fiscal and Monetary policy in modern times and that is only likely to increase with Janet Yellen at the Treasury and the changing of the guard at the White House.
- When we look at prior crises it is clear that political brinkmanship continually gives way to pragmatic Bipartisan action when needed and it will not be any different this time. There will clearly be a less antagonistic relationship between the White House and Congress and also between the main political parties themselves. This is a close as you will get to a Country being on a “War footing” and you will continue to see policies adopted for the greater good.
- In his recent speech Chair Powell could not have more clear that he is engaged in a “Whatever it takes” policy. This should not be a surprise given the monumental shift seen in Fed policy earlier this year. In my view that is the greatest shift in policy in the post Volcker era. The Fed has no intention of taking any chances this time by withdrawing accommodation until the economy/employment and inflation are “hot”. Even then, if there is any doubt, expect the word “transient” to be used on multiple occasions to justify holding the line.
- It is easy to forget that after the Great Financial crisis (under a more orthodox Fed regime) there was not even a “sniff” of withdrawal of accommodation until tapering in 2013 and the first Fed Funds rate hike came in Dec 2015 without a 2nd hike until Dec 2016.
- So, until the patient (US economy) can stand on its own two feet (and even some way into the recovery stage) we can expect the “whatever it takes” attitude to continue at both the Fed and the Treasury. After all, increased debt issuance that is purchased by the Fed just becomes a “book keeping entry”
- So as we look at not just the year but the years ahead what should we anticipate?
- I am going to steal a phrase used recently by one of the smartest Senior Fund managers I know (Steve you know who I am talking about) and say get ready for “The Roaring 20’s”. What we have seen in 2020 is unprecedented, the reaction function is unprecedented, the future polic moves will likely remain unprecedented and the outcome in financial markets may likely be way more extreme than anybody is imagining.
So what might that mean for the years ahead?
- Equity markets are likely to continue to rally to levels that few people might be able to fathom today. After a 47% fall in the DJIA between 1920 and 1921 it then rallied nearly six fold between 1921 and 1929
- The USD will remain in a depreciating cycle into at least 2024 with the USD index likely to lose at least 30% of its value. An important note to realise here is that the DXY is quoted with the USD as a base and its main component EURUSD is quoted with EUR as a base. So if you believe that the DXY can fall 30% then a like for like comparison is for USDEUR to also fall 30% not for EURUSD to rise 30%. Why is that important?
- A rise in EURUSD would suggest a move to around 1.59 over the coming years. USDEUR (the inverse) stands at .8163 (inverse of 1.2250). If that falls 30% it would take us to 0.5714. That number inverted back to EURUSD is 1.75
- The continued monetary and fiscal stimulus will likely mean that Breakevens on the back of inflation (which will of course be transitory) and inflation expectations will likely go much higher. Let us remember that from 2008-2012 (Where we had less fiscal and Monetary stimulus and anticipated correctly an eventual normalisation of Fed policy) 10 year breakevens went from negative 8 basis points to positive 273 basis points. A similar move here could see breakevens as high as 3% + in coming years(Something not seen in our data back to 1998)
- Commodities will roar on the back of USD debasement, extraordinary financial accommodation and ultimately rising nominal U.S. and likely Global growth. We have already talked about the possibility of Brent Crude back at $70+ in 2021 and Copper re-testing its all-time high at $465. This should also be good for precious metals and we continue to anticipate new trend highs for both Gold and Silver in 2021 which means new all-time highs for Gold at least. Ultimately we do expect these precious metals moves to also be multi-year and Silver also eventually testing its all-time high near $50 if not more.
- Bitcoin had a huge recovery to new all-time highs in 2020 but this looks like the start rather than the end of a big move and our bias is that it could have a really strong 2021 and potentially longer as it increasingly gets more and more adoption by mainstream institutional clients and establishes itself as digital Gold in the “Roaring 20’s.
- Nominal yields remain the trickiest: In a 1970’s dynamic the picture would be clear. The backdrop above would signal a likelihood of sharply rising nominal yields, sharply rising real yields as inflation takes off. However we are missing a big factor today versus the 1970’s. That factor is Paul Volcker There is no chance that the Fed under chair Powell or any potential successor is going to take a Volcker approach. They would view that as a total disaster in terms of the economic and societal pain it would inflict so as noted above they will let things run hot.
- Despite this I do expect that nominal yields can rise somewhat in 2021. In various pieces during the summer we have mentioned at least towards 1.30%+ with the possibility of a move towards 2%. In all honesty I am less confident about the 2% move in 2021 (not least after Chair Powell’s comments last week). I think 1.30%+ is still possible, likely even, but let us not forget that that is still amazingly low levels of nominal and still likely negative real yields. In the 1970’s we had both Volcker and no QE. Now we have no Volcker and a clear policy bias towards MMT in all but name. Inflation and high nominal growth can devalue the debt but a surge in nominal yields could derail that scenario. I fully expect that 2021 and likely further will see a co ordinated approach between the Treasury and the Fed to continue to provide whatever stimulus is needed while also “managing” any “disruptive” move higher in yields. That is not to say they will not rise, but I suspect they will look to manage that in a controlled fashion in order to ensure it does not have an unacceptable tightening in monetary conditions.
- Housing/real assets (suburban in particular) can continue to well of the back of low and likely lower still mortgage rates, good affordability and historically low supply (Noted in the 12th chart of Christmas) demographics and a continuation of the normal housing cycle path of 16-17 years (Peak and fall in 1973-1975, 1989-1991, 2006-2008 and 2023-2025?)
Will this ultimately end in tears? Possibly so. However my bias is that those tears will be much further down the line (The last roaring 20’s did end in tears- in 1929) and before then there will be a “lot of water under the bridge”
I want to thank everybody for listening to my pontifications in 2020. Hopefully you found at least some of them helpful.
I wish everyone some rest and relaxation during the holiday period.
Enjoy family time, recharge your batteries and get ready because 2021 is going to be a “Barn Burner of a year” in financial markets.
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