The Global Leverage Cycle: You Are Here
While one can make an argument that the central banks have now destroyed all
traditional "cycles", including the economic
"virtuous cycle", the business cycle and even the leverage cycle, the
question remains how much longer can the Fed et al defy mean reversion
and all laws of nature associated with it. That said, assuming the fake market
environment we find ourselves in persists for at least another year, this is
what the leverage cycle would look like assuming $10 trillion in global central
bank assets were a pro forma new normal.
Keep a close eye on China: it is on the cusp between the end of the leverage cycle (where as we reported over the past two days, it has been pumping bank assets at the ridiculous pace of $3.5 trillion per year) and on the verge of having its debt bubble bursting. What happens then is unclear.
Some thoughts on the above graphic from SocGen:
For the first time post-crisis, we expect advanced economies in 2014 to see a marked increase in their contribution to global growth. Emerging economies have over the past few years offered a welcome support to global growth, but this relied in part on a build-up of credit that now needs to be paid down. The hope is for advanced economies to take over the baton from the emerging economies as the main driver of global growth. The US is now poised for sustainable recovery and in Japan hopes remain that Abenomics will work. The euro area, however, continues to lag. As such the growth relay from emerging to advanced is likely to prove a bumpy process. Commodity markets will sit at the heart of this dynamic – our strategists look for range-bound markets in 2014.
This new rotation of the global leverage cycle is an integral part of our monetary policy outlook, which we discuss in greater detail in the following sections. Several features are worth noting:
Time for emerging economies to deleverage: Post crisis, emerging economies adopted accommodative economic policies to offset the collapse in demand for their output. Providing a further boost, accommodative monetary policies in advanced economies drove significant financial flows into the region. Combined, these fuelled credit expansion. With the turn in the US interest rate cycle back in the spring, external financing conditions tightened. Moreover, in a number of emerging economies, policymakers have become increasingly concerned by a build-up in leverage; this is not just a story of level, but also one of speed. As seen from our leverage cycle, we believe the emerging economies have now moved to a phase of deleveraging. Our emerging market theme, however, is not just one of a cyclical downturn. As we have highlighted on several occasions, we believe potential growth is structurally slowing and no more so than in China.
China must tame excess capacity: With NFC debt at over 150% of GDP and significant excess capacity, China is ripe for deleveraging. Already in 2013, a notable feature of our forecast has been that the Chinese authorities would resist market pressure to ease monetary policy and further fuel the credit bubble. Nonetheless, shadow bank credit has continued to expand and, with that, problems of excess capacity. China’s challenge now is to deleverage and reform. The two in many ways go hand in hand and we discuss these issues in Boxes 5 and 14. It is worth nothing here that reform in China is tantamount to removing the 100% implicit state guarantee. And looking ahead, even state-backed companies could be allowed to fail. Herein resides also a potential trigger for the risk scenario of a hard landing, should such a company failure be poorly managed and spin out of control.
Japan’s corporate sector to cut savings to invest: Investment and savings are two sides of the same coin and to secure sustainable recovery in Japan, corporations need to reduce savings and invest. The BoJ’s monetary policy is already working through the currency channel and our expectation is to see a pick-up in corporate investment next. This is not just a function of monetary policy, but also the two remaining arrows of Abenomics, namely fiscal stimulus and structural reform. We see significant opportunities medium-term from reform as discussed in Box 13. Short-term, the BoJ is poised to deliver further stimulus and we look for additional asset purchases to be announced early in the new fiscal year (commencing April 1).
US credit cycle is turning: Credit channels have been repaired, household balance sheets deleveraged and excess housing stock unwound. Combined, these lay the foundations for sustainable recovery. In 2013, fiscal tightening exerted a headwind to growth, but this is now easing allowing GDP growth to accelerate to 2.9% in 2014. For the Fed, setting the right monetary policy during this transition will be challenging. A glance at our leverage cycle suggests that the challenge as recovery gains traction over time is to avoid a build-up of excess leverage. This is not an immediate concern to our minds. Although we forecast household credit expansion, our forecast for household income growth is higher, entailing some further reduction of the household debt-to-income ratio.
UK housing credit has been boosted by government measures: Supported by policy initiatives, UK housing is staging a recovery. This is highly dependent on mortgage loan conditions and the BoE will be keen to keep rates low. We expect the Bank to lower the unemployment rate threshold on its forward guidance from 7.0% to 6.5% (and reduce the NAIRU from 6.5% to 6.0%). The hope medium-term, is that this housing-driven recovery will eventually become broader based with stronger confidence, consumption, exports, corporate investment and lower unemployment. Much will depend, however, on euro area recovery as of 2015. Longer-term, a possible UK referendum on EU membership remains a point of uncertainty.
Euro area still facing headwinds: Individual euro area economies are in very different stages on the leverage cycle. Germany is the most advanced, followed by France, Italy and Spain. For several euro area economies, financial fragmentation and fiscal austerity remain serious headwinds. 2014 will see the arrival of a Single Supervisory Mechanism. As we discuss in Box 10, progress on a Single Supervisory Mechanism continues to disappoint and our base line remains for only a gradual repair of credit channels. Moreover, structural reforms are also not progressing at the desired pace, albeit with significant variation from country to country. The danger for the euro area is to become trapped in a lost decade of very low growth and low inflation. The ECB still has options. The real game changer opportunities, however, reside with governments to deliver quantum leaps on reform – at both the euro area and national levels. For now, progress remains disappointingly slow.
Summing up our view, 2014 will thus be the first year post crisis when advanced economies make an increased contribution to global GDP growth.
Keep a close eye on China: it is on the cusp between the end of the leverage cycle (where as we reported over the past two days, it has been pumping bank assets at the ridiculous pace of $3.5 trillion per year) and on the verge of having its debt bubble bursting. What happens then is unclear.
Some thoughts on the above graphic from SocGen:
For the first time post-crisis, we expect advanced economies in 2014 to see a marked increase in their contribution to global growth. Emerging economies have over the past few years offered a welcome support to global growth, but this relied in part on a build-up of credit that now needs to be paid down. The hope is for advanced economies to take over the baton from the emerging economies as the main driver of global growth. The US is now poised for sustainable recovery and in Japan hopes remain that Abenomics will work. The euro area, however, continues to lag. As such the growth relay from emerging to advanced is likely to prove a bumpy process. Commodity markets will sit at the heart of this dynamic – our strategists look for range-bound markets in 2014.
This new rotation of the global leverage cycle is an integral part of our monetary policy outlook, which we discuss in greater detail in the following sections. Several features are worth noting:
Time for emerging economies to deleverage: Post crisis, emerging economies adopted accommodative economic policies to offset the collapse in demand for their output. Providing a further boost, accommodative monetary policies in advanced economies drove significant financial flows into the region. Combined, these fuelled credit expansion. With the turn in the US interest rate cycle back in the spring, external financing conditions tightened. Moreover, in a number of emerging economies, policymakers have become increasingly concerned by a build-up in leverage; this is not just a story of level, but also one of speed. As seen from our leverage cycle, we believe the emerging economies have now moved to a phase of deleveraging. Our emerging market theme, however, is not just one of a cyclical downturn. As we have highlighted on several occasions, we believe potential growth is structurally slowing and no more so than in China.
China must tame excess capacity: With NFC debt at over 150% of GDP and significant excess capacity, China is ripe for deleveraging. Already in 2013, a notable feature of our forecast has been that the Chinese authorities would resist market pressure to ease monetary policy and further fuel the credit bubble. Nonetheless, shadow bank credit has continued to expand and, with that, problems of excess capacity. China’s challenge now is to deleverage and reform. The two in many ways go hand in hand and we discuss these issues in Boxes 5 and 14. It is worth nothing here that reform in China is tantamount to removing the 100% implicit state guarantee. And looking ahead, even state-backed companies could be allowed to fail. Herein resides also a potential trigger for the risk scenario of a hard landing, should such a company failure be poorly managed and spin out of control.
Japan’s corporate sector to cut savings to invest: Investment and savings are two sides of the same coin and to secure sustainable recovery in Japan, corporations need to reduce savings and invest. The BoJ’s monetary policy is already working through the currency channel and our expectation is to see a pick-up in corporate investment next. This is not just a function of monetary policy, but also the two remaining arrows of Abenomics, namely fiscal stimulus and structural reform. We see significant opportunities medium-term from reform as discussed in Box 13. Short-term, the BoJ is poised to deliver further stimulus and we look for additional asset purchases to be announced early in the new fiscal year (commencing April 1).
US credit cycle is turning: Credit channels have been repaired, household balance sheets deleveraged and excess housing stock unwound. Combined, these lay the foundations for sustainable recovery. In 2013, fiscal tightening exerted a headwind to growth, but this is now easing allowing GDP growth to accelerate to 2.9% in 2014. For the Fed, setting the right monetary policy during this transition will be challenging. A glance at our leverage cycle suggests that the challenge as recovery gains traction over time is to avoid a build-up of excess leverage. This is not an immediate concern to our minds. Although we forecast household credit expansion, our forecast for household income growth is higher, entailing some further reduction of the household debt-to-income ratio.
UK housing credit has been boosted by government measures: Supported by policy initiatives, UK housing is staging a recovery. This is highly dependent on mortgage loan conditions and the BoE will be keen to keep rates low. We expect the Bank to lower the unemployment rate threshold on its forward guidance from 7.0% to 6.5% (and reduce the NAIRU from 6.5% to 6.0%). The hope medium-term, is that this housing-driven recovery will eventually become broader based with stronger confidence, consumption, exports, corporate investment and lower unemployment. Much will depend, however, on euro area recovery as of 2015. Longer-term, a possible UK referendum on EU membership remains a point of uncertainty.
Euro area still facing headwinds: Individual euro area economies are in very different stages on the leverage cycle. Germany is the most advanced, followed by France, Italy and Spain. For several euro area economies, financial fragmentation and fiscal austerity remain serious headwinds. 2014 will see the arrival of a Single Supervisory Mechanism. As we discuss in Box 10, progress on a Single Supervisory Mechanism continues to disappoint and our base line remains for only a gradual repair of credit channels. Moreover, structural reforms are also not progressing at the desired pace, albeit with significant variation from country to country. The danger for the euro area is to become trapped in a lost decade of very low growth and low inflation. The ECB still has options. The real game changer opportunities, however, reside with governments to deliver quantum leaps on reform – at both the euro area and national levels. For now, progress remains disappointingly slow.
Summing up our view, 2014 will thus be the first year post crisis when advanced economies make an increased contribution to global GDP growth.
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