I guess most of us have a tendency to characterize each year as being ‘eventful’. But in fairness 2016 does fit this description perfectly. Who would have thought that the United Kingdom would leave the European Union or that ‘bad boy’ Donald Trump would become the 45th President of the United States? Very few did, and the polling agencies were certainly not among them. And who would have thought that financial markets would weather these unlikely outcomes so well? The year 2016 in financial markets was full of surprises, drama, and… more central bank madness. This blog takes you through 2016 in just 20 ‘tweets.’
The year started with a bang. A Chinese bang to be precise. In just four trading days the Shanghai Composite Index fell by 12% as China’s economic slowdown and depreciating currency spooked investors. Globally, equity markets lost more than USD 4 trillion in value in the first 10 trading days of the year. ‘Hello 2016!’
China’s ever-growing debt pile caused investors headaches too. In all, but one, years after the financial crisis debt grew faster than GDP. Hence, lower growth will aggravate China’s already elevated debt-to-GDP level.
Worries about China soon expanded to other major emerging economies and not without reason. On average GDP growth in ‘the countries formerly known as BRIC’ had fallen to practically zero, extending a downward trend that started during the aftermath of the financial crisis. The world’s growth engine had stalled.
February. The engine failure at the core of global growth had a profound effect on commodity prices as well. In particular, on oil. The price of oil had been declining since the middle of 2014 as the breakeven price needed by the US shale industry went down rapidly. With lower oil demand as a result of lower global growth an oil glut was born. Crude oil plunged and hit a low of USD 26 on February 11th. Energy bond spreads went through the roof, predicting the default of over half the US high yield energy companies.
Add lower oil prices, hence lower inflation to central bank madness and you get this. Totally crazy yield curves. Especially those in Japan and Europe, but as we know by now this was only the beginning.
Perhaps we reached peak bond madness on June 13th this year. On that day the yield on the Swiss 50-year maturity government bond fell below the yield on a 1-month US Treasury yield. That’s right, you got a bigger return for lending your money for one month to the US government than for lending your money for 50 years to the Swiss government.
Just one day later, the German 10-year government bond yield, the mother of all European bond yields, went below zero for the first time in history. The benchmark yield, the starting point of all bond yields in Europe, turned negative. Hence, negative yields really did became the new normal!
If that wasn’t enough, June brought much more ‘fun’ in the form of ‘Brexit.’ Defying all poll data, the UK voted to leave the European Union. And all economists agreed: this would mean hell. And at first, it seemed they were right. Take Greek banks, for instance. Not the most credible companies to begin with but Brexit, it was said, would push them over the edge. Hence, the following Tweet.
And after two days of Brexit we had this. Total chaos and complete meltdown!
But soon things started to reverse. The UK did not fall into the abyss, as was ‘promised’ to us by the economists. Quite the contrary, the massive drop in the British Pound (it would fall to as low as 1.18 against the US dollar by October) was great news for the bigger UK companies, which realize a relatively large part of their sales abroad. Forward-looking indicators like the Manufacturing PMI also quickly recovered, as did stock markets around the globe.
One trend did continue, however. Bond yields fell even further and in July the total amount of outstanding, negative-yielding debt had risen to an unbelievable USD 13 trillion! Negative yields really were the new normal.
It’s no coincidence that the low in bond yields was reached in the same month in which global #inflation fell to the lowest level since the financial crisis. Inflation expectations also fell to historically low levels and central bank credibility was on the line.
July was also the month in which the world’s oldest bank, Banca Monte dei Paschi di Siena, started making headlines, again. As we all know by now, the bank is loaded with nonperforming loans and the only way out, I doubt if this is the right way of putting it, is government intervention.
Moving on to September, in which investors ‘celebrated’ the eighth anniversary of the (unofficial) start of the financial crisis. On September 15th it was exactly eight years ago that Lehman filed for bankruptcy, the largest bankruptcy in US history!
We have reached November, which competes with June for the title of being the most eventful month of 2016. For me, November is the clear winner because of the US elections. I woke up at 2:30 local time, which proved to be a pivotal time in the elections, as the first rumors emerged that Trump was still in the race of winning Florida. Well, we all know how this ended, and for me November 9th was one of the most energizing and tiring days of the year. Oh, by the way, do you remember that those same economists I mentioned earlier predicted that a Trump victory would mean hell?
As equity markets rallied on the Trump euphoria that broke out soon after his victory (hell was nowhere in sight) bonds came under pressure. Finally! Promises of spending big on US infrastructure lifted inflation expectations. OPEC reached an unexpected deal on an oil production cut, which lifted oil prices, and last but not least the Fed stepped in and told us that the time for rate normalization had come. Hence, we got a lift-off in bond yields, first in the US, but soon globally.
A couple of days before the Fed’s December rate hike the ECB showed its true color. It extended its already massive bond-buying program until the end of 2017, which was longer than expected, and decided to reduce the amount on monthly buying from EUR 80 billion to EUR 60 billion from next March. And yet, some ECB watchers spoke of ECB TAPERING. Right!
The decisions by the Fed and the ECB show that both central banks are now in total divergence mode. And that results in some really great charts. The first is the renewed momentum in the rise of the US dollar. After a pause of more than a year the greenback has now restarted its third major rally of the last four decades.
But the next chart is even better. The divergence in central bank policy has pushed the gap between interest rates in the US and Europa to historical levels. For example, the gap between the 10-year bond yield in the US and Germany is now roughly 230 basis points. That is nothing less than amazing!
That leaves one final chart, which brings this blog back where it started, China. In recent weeks worries about China’s ever-growing debt level have increased once more. Despite numerous measures the slow down loan growth, debt as a percentage of GDP keeps climbing. So maybe, just maybe, we start 2017 the same way as we started 2016, worrying about China.
Thank you for reading the Year-End Blog. Enjoy your holidays!