Smartphone sales decline begins to impact global stock markets

The bad news continues for the world’s smartphone manufacturers and their suppliers.  And President Trump’s decision to add a 25% tariff on smartphone component imports from China from June 25 is unlikely to help. Morgan Stanley estimate it will add $160 to the current US iPhone XS price of $999, whilst a state-backed Chinese consumer boycott of Apple phones may well develop in retaliation for US sanctions on Huawei.

Chances are that a perfect storm is developing around the industry as its phenomenal run since 2011 comes to an end:

  • Global sales fell 4% in Q1 as the chart shows, with volume of 330m the lowest since Q3 2014
  • China’s market fell 3% to 88m, whilst US volume fell 18% to 36m
  • Apple has been badly hit, with US sales down 19% in Q1 and China sales down 25% in the past 6 months
  • Foldables have also failed to make a breakthrough, with Gartner estimating just 30m sales by 2023

This downbeat news highlights the fact that replacement cycles are no longer every year/18 months, but have already pushed out to 2.6 years.  Consumers see no need to rush to buy the latest model, given that today’s phones already cater very well for their needs.

Apple’s volumes confirm the secular nature of the downturn, as its volume continued the decline seen in 2018 as the iPhone comes to the end of its lifecycle. Its market share also fell back to 13%, allowing Huawei to take second place behind Samsung with a 17.9% share.  This decline came about despite Apple making major price cuts for the XS and XR series, as well as introducing a trade-in programme. Meanwhile, Samsung saw its profits fall 60%, the lowest since its battery problems in 2017.

The President’s tariffs are also set to impact sales, as manufacturers have to assume that today’s supply chains will need to be restructured. Manufacturing of low-end components can perhaps be easily relocated to countries such as Vietnam and other SE Asian countries.  But moving factories, like moving house, is a very disruptive process, and it is certainly not easy to find the technical skills required to make high-end components – which represent the core value proposition for consumers.

This highlights how second-order impacts are often overlooked when big announcements are made around tariffs and similar protectionist measures.  Not only do prices go up, as someone has to pay the extra costs involved. But companies along the supply chain see their margins squeezed as well – Apple suppliers Foxconn and Pegatron saw their gross margins fall to 5.5% and 2.3%, the lowest level since 2012, for example. So they will have less to spend on future innovations.

We can, of course, all hope that the current trade war proves only temporary. But President Trump’s decision to embargo Huawei from US telecom equipment markets suggests he is digging in for a long battle. Ironically, however, Huawei was one of the few winners in Q1, with its volume surging 50% despite its planned 2018 US entry being cancelled due to congressional pressure.  And other governments seem notable reluctant to follow the US lead.

The bigger risk, of course, for investors is that the profit downturn caused by protectionism cannot be “solved” by central bank stimulus. Since 2009, as the chart of the S&P 500 shows, they have rushed to support the market whenever it appeared poised for a return to more normal valuations. But it is hard to see how even their fall-back position of “helicopter money” can counter the impact of a fully-fledged trade war between the world’s 2 largest economies.

BASF’s second profit warning highlights scale of the downturn now underway

The chemical industry is easily the best leading indicator for the global economy.  And thanks to Kevin Swift and his team at the American Chemistry Council, we already have data showing developments up to October, as the chart shows.

It confirms that consensus hopes for a “synchronised global recovery” at the beginning of the year have again proved wide of the mark.  Instead, just as I warned in April (Chemicals flag rising risk of synchronised global slowdown), the key  indicator – global chemical industry Capacity Utilisation % – has provided fair warning of the dangers ahead.

It peaked at 86.2%, in November 2017, and has fallen steadily since then. October’s data shows it back to June 2014 levels at 83.6%. And even more worryingly, it has now been falling every month since June. The last time we saw a sustained H2 decline was back in 2012, when the Fed felt forced to announce its QE3 stimulus programme in September.  And it can’t do that again this time.

The problem, as I found when warning of subprime risks in 2007-8 (The “Crystal Blog” foresaw the global financial crisis), is that many investors and executives prefer to adopt rose-tinted glasses when the data turns out to be too downbeat for their taste.  Whilst understandable, this is an incredibly dangerous attitude to take as it allows external risks to multiply, when timely action would allow them to be managed and mitigated.

It is thus critical that everyone in the industry, and those dependent on the global economy, take urgent action in response to BASF’s second profit warning, released late on Friday, given its forecast of a “considerable decrease of income” in 2018 of “15% – 20%”, after having previously warned of a “slight decline of up to 10%”.

I have long had enormous respect for BASF and its management. It is therefore deeply worrying that the company has had to issue an Adjustment of outlook for the fiscal year 2018 so late in the year, and less than 3 weeks after holding an upbeat Capital Markets Day at which it announced ambitious targets for improved earnings in the next few years.

The company statement also confirmed that whilst some problems were temporary, most of the issues are structural:

  • The impact of low water on the Rhine has proved greater than could have been earlier expected
  • But the continuing downturn in isocyanate margins has been ongoing for TDI since European contract prices peaked at €3450/t in May — since when they had fallen to €2400/t in October and €2050/t in November according to ICIS, who also reported on Friday that
    “Supply is still lengthy at year end in spite of difficulties at German sellers BASF and Covestro following low Rhine water levels”
  • The decline is therefore a very worrying insight into the state of consumer demand, given that TDI’s main applications are in furniture, bedding and carpet underlay as well as packaging applications.
  • Even more worrying is the statement that:
    “BASF’s business with the automotive industry has continued to decline since the third quarter of 2018; in particular, demand from customers in China slowed significantly. The trade conflict between the United States and China contributed to this slowdown.”

This confirms the warnings that I have been giving here since August when reviewing H1 auto sales (Trump’s auto trade war adds to US demographic and debt headwinds).

I noted then that President Trump’s auto trade tariffs were bad news for the US and global auto industry, given that markets had become dangerously dependent on China for their continued growth:

  • H1 sales in China had risen nearly 4x since 2007 from 3.1m to 11.8m this year
  • Sales in the other 6 major markets were almost unchanged at 23m versus 22.1m in 2007

Next year may well prove even more challenging if the current “truce” over German car exports to the USA breaks down,

INVESTORS HAVE WANTED TO BELIEVE THAT INTEREST RATES CAN DOMINATE DEMOGRAPHICS

The recent storms in financial markets are a clear sign that investors are finally waking up to reality, as Friday night’s chart from the Wall Street Journal confirms:

“In a sign of the breadth of the global selloff in stocks, Germany’s main stock index fell into a bear market Thursday, the latest benchmark to have tumbled 20% or more from its recent peak….Other markets already in bear territory are home to companies exposed to recent trade fights between the U.S. and China.

The problem, as I have argued since publishing ‘Boom, Gloom and the New Normal: how the Ageing Boomers are Changing Demand Patterns, again“, in 2011 with John Richardson, is that the economic SuperCycle created by the dramatic rise in the number of post-War BabyBoomers is now over.

I highlighted the key risks is my annual Budget Outlook in October, Budgeting for the end of “Business as Usual”.  I argued then that 2019 – 2021 Budgets needed to focus on the key risks to the business, and not simply assume that the external environment would continue to be stable.  Since then, others have made the same point, including the president of the Council on Foreign Relations, Richard Haas, who warned on Friday:

“In an instant Europe has gone from being the most stable region in the world to anything but. Paris is burning, the Merkel era is ending, Italy is playing a dangerous game of chicken with the EU, Russia is carving up Ukraine, and the UK is consumed by Brexit. History is resuming.

It is not too late to change course, and focus on the risks that are emerging.  Please at least read my Budget Outlook and consider how it might apply to your business or investments. And please, do it now.

 

You can also click here to download and review a copy of all my Budget Outlooks 2007 – 2018.

Time to recognise the economic impact of ageing populations

Is global economic growth really controlled by monetary policy and interest rates?  Can you create constant growth simply by adjusting government tax and spending policy?  Do we know enough about how the economy operates to be able to do this?  Or has something more fundamental been at work in recent decades, to create the extraordinary growth that we have seen until recently?

  • As the chart shows for US GDP, regular downturns used to occur every 4 or 5 years
  • Then something changed in the early 1980s, and recessions seemed to become a thing of the past
  • Inflation, which had been rampant, also began to slow with interest rates dropping from peaks of 15%+
  • For around 25 years, with just the exception of the 1st Gulf War, growth became almost constant

Why was this?  Was it because we became much cleverer and suddenly able to “do away with boom and bust” as one UK Finance Minister claimed?  Was it luck, that nothing much happened to upset the global economy?  Was it because the Chairman of the US Federal Reserve from 1986 – 2006, Alan Greenspan, was a towering genius?  Perhaps.

THE AVERAGE BABYBOOMER IS NOW 60 YEARS OLD 

Or was it because of the massive demographic change that took place in the Western world after World War 2, shown in the second chart?

  • 1921 – 1945.  Births in the G7 countries (US, Japan, Germany, France, UK, Italy, Canada) averaged 8.8m/year
  • 1946 – 1970.  Births averaged 10.1m/year, a 15% increase over 25 years
  • 1970 – 2016.  Births averaged only 8.5m/year, a 16% fall, with 2016 seeing just 8.13m born

Babies, as we all know, are important for many reasons.

Economically, these babies were born in the wealthy developed countries, responsible for 60% of global GDP.  So right from their birth, they were set to have an outsize impact on the economy:

  • Their first impact came as they moved into adulthood in the 1970s, causing Western inflation to soar
  • The economy simply couldn’t provide enough “stuff”, quickly enough, to satisfy their growing demand
  • US interest rates jumped by 75% in the 1970s to 7.3%, and doubled to average 10.6% in the 1980s
  • But then they began a sustained fall to today’s record low levels as supply/demand rebalanced

BOOMERS TURBOCHARGED GROWTH, BUT ARE NOW JOINING THE LOWER-SPENDING 55-PLUS COHORT

The key development was the arrival of the Boomers in the Wealth Creator 25-54 age group that drives economic growth.  Consumer spending is 60% – 70% of GDP in most developed economies.  And so both supply and demand began to increase exponentially.  In fact, the Boomers actually turbocharged supply and demand.

Breaking with all historical patterns, women stopped having large numbers of children and instead often returned to the workforce after having 1 or 2 children.  US fertility rates, for example, fell from 3.3 babies/woman in 1950 to just 2.0/babies/women in 1970 – below replacement level.    On average, US women have just 1.9 babies today.

It is hard to imagine today the extraordinary change that this created:

  • Until the 1970s, most women would routinely lose their jobs on getting married
  • As Wikipedia notes, this was “normal” in Western countries from the 19th century till the 1970s
  • But since 1950, life expectancy has increased by around 10 years to average over 75 years today
  • In turn, this meant that women no longer needed to stay at home having babies.
  • Instead, they fought for, and began to gain Equal Pay and Equal Opportunity at work

This turbocharged the economy by creating the phenomenon of the two-income family for the first time in history.

But today, the average G7 Boomer (born between 1946 – 1970) is now 60 years old, as the 3rd chart shows.  Since 2001, the oldest Boomers have been leaving the Wealth Creator generation:

  • In 2000, there were 65m US households headed by someone in the Wealth Creator 25-54 cohort, who spent an average of $62k ($2017).  There were only 36m households headed by someone in the lower-spending 55-plus cohort, who spent an average of $45k
  • In 2017, low fertility rates meant there were only 66m Wealth Creator households spending $64k each.  But increasing life expectancy meant the number in the 55-plus cohort had risen by 55%.  However, their average spend had only risen to $51k – even though many had only just left the Wealth Creators

CONCLUSION – THE CHOICE BETWEEN ‘DEBT JUBILEES’ AND DISORDERLY DEFAULT IS COMING CLOSE
Policymakers ignored the growing “demographic deficit” as growth slowed after 2000.  But their stimulus policies were instead essentially trying to achieve the impossible, by “printing babies”.  The result has been today’s record levels of global debt, as each new round of stimulus and tax cuts failed to recreate the Boomer-led economic SuperCycle.

As I warned back in January 2016 using the words of the OECD’s William White:

“It will become obvious in the next recession that many of these debts will never be serviced or repaid, and this will be uncomfortable for a lot of people who think they own assets that are worth something. The only question is whether we are able to look reality in the eye and face what is coming in an orderly fashion, or whether it will be disorderly. Debt jubilees have been going on for 5,000 years, as far back as the Sumerians.”

That recession is now coming close.  There is very little time left to recognise the impact of demographic changes, and to adopt policies that will minimise the risk of disorderly global defaults.

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Chemicals flag rising risk of synchronised global slowdown

Chemicals are easily the best leading indicator for the global economy.  And if the global economy was really in recovery mode, as policymakers believe, then the chemical industry would be the first to know – because of its early position in the value chain. Instead, it has a different message as the chart confirms:

  • It shows changes in global production and key sectors, based on American Chemistry Council (ACC) data
  • It highlights the rapid inventory build in H2 as oil and commodity prices soared
  • But since then, all the major sectors have moved into a slowdown, and agchems into decline

As the ACC note:

“The global chemical industry ended the first quarter on a soft note.  Global chemicals production fell 0.3% in March after a 1.0% drop in February, and a 0.6% decline in January. The last gain was 0.3% in December.

This, of course, is the opposite of consensus thinking at New Year, when most commentators were confident that a “synchronised global recovery” was underway. It is therefore becoming more and more likely, as I warned in January, that policymakers have been fooled once again by the activities of the hedge funds in boosting “apparent demand”:

“For the last 6 months, everyone who buys oil or other commodity-related products has been busy building as much inventory as they could afford. In turn, of course, this has made it appear that demand has suddenly begun to recover. At last, it seems, the “synchronised global recovery” has arrived.

Except, of course, that it hasn’t. The hedge funds didn’t buy 15 days-worth of oil to use it. They bought it to speculate, with the OPEC-Russia deal providing the essential “story” to support their buying binge.”

This downturn is worrying not only because it contradicts policymakers’ hopes, but also because Q1 volumes should be seasonally strong:

  • Western companies should be restocking to meet the surge of spring demand
  • Similarly, China and the Asian markets should now be at peak rates after the Lunar New Year

HIGHER OIL AND COMMODITY PRICES ARE CAUSING DEMAND DESTRUCTION
The problem is that most central bankers and economists don’t live in the real world, where purchasing managers and sales people have bonuses to achieve.  As one professor told me in January:

“Economists would tend to be skeptical about concepts such as “apparent demand”. Unless this a secret concept (and it doesn’t seem like it is), other investors should also use it, and then the oil price should already reflect it. Thus, there wouldn’t be gains to be made (unless you’re quicker than everyone else or have inside information)…”

But in the real world, H2’s inventory build has now been replaced by destocking – whilst today’s higher oil prices are also causing demand destruction.  We have seen this many times before when prices have risen sharply:

  • Consumers only have limited amounts of spare cash
  • When oil prices jump, they have to cut back in other areas
  • But, of course, this is only confirmed afterwards, when the spending data is reported
  • Essentially, this means that policymakers today are effectively driving by looking in the rear-view mirror

RISING DEBT LEVELS CREATE FURTHER HEADWINDS FOR GROWTHNew data from the US Federal Reserve Bank of St Louis also highlights the headwinds for demand created by the debt build-up that I discussed last week.  As the chart shows:

  • US borrowing was very low between 1966-79, and $1 of debt created $4.49 in GDP growth
  • Borrowing rose sharply in the Boomer-led SuperCycle, but $1 of debt still created $1.15 in GDP growth
  • Since stimulus programmes began in 2000, however, $1 of debt has created just $0.36 of GDP growth

In other words, value destruction has been taking place since 2000.  The red shading tells the story very clearly, showing how public debt has risen out of control as the Fed’s stimulus programmes have multiplied – first with sub-prime until 2008, and since then with money-printing.

RISING INTEREST RATES CREATE FURTHER RISKS
Last week saw the yield on the benchmark US 10-year Treasury Bond reach 3%, double its low in June 2016.  It has risen sharply since breaking out of its 30-year downtrend in January, and is heading towards my forecast level of 4%.

Higher interest rates will further slow demand, particularly in key sectors such as housing and autos.  And in combination with high oil and commodity prices, it will be no surprise if the global economy moves into recession.

Chemicals is providing the vital early warning of the risks ahead.  But as usual, it seems policymakers prefer to wear their rose-coloured spectacles.  And then, of course, as with subprime, they will all loudly declare “Nobody could have seen this coming”.

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Economy faces slowdown as oil/commodity prices slide


Oil and commodity markets long ago lost contact with the real world of supply and demand. Instead, they have been dominated by financial speculation, fuelled by the vast amounts of liquidity pumped out by the central banks.  The chart above from John Kemp at Reuters gives the speculative positioning in the oil complex as published last Monday:

  • It shows hedge fund positioning in terms of the ratio of long to short positions across the complex
  • The ratio had been at a near-record low of 1.55x back in June last year, before the rally took off
  • On 30 January it had risen to a record 11.9x – far above even the 2014 and 2017 peaks

The size of the rally has also been extraordinary, as I noted 2 weeks ago.  At its peak, the funds owned 1.5bn barrels of oil and products – equivalent to an astonishing 16 days of global oil demand.  They had bought 1.2bn barrels since June, creating the illusion of very strong demand.  But, of course, hedge funds don’t actually use oil, they only trade it.

The funds also don’t normally hang around when the selling starts. And so last week, as the second chart shows, they began to sell their positions and take profits.  The rally peaked at $71/bbl at the end of January, and then topped out on 2 February at $70/bbl.  By last Friday, only a week later, Brent was at $63/bbl, having fallen 11% in just one week.

Of course, nothing had changed in the outlook for supply/demand, or for the global economy, during the week.  And this simple fact confirms how the speculative cash has come to dominate real-world markets.  The selling was due to nervous traders, who could see prices were challenging a critical “technical” point on the chart:

  • Most commodity trading is done in relation to charts, as it is momentum-based
  • The 200 day exponential moving average (EMA) is used to chart the trend’s strength
  • When the oil price reached the 200-day EMA (red line), many traders got nervous
  • And as they began to sell, so others began to follow them as momentum switched

The main sellers were the legal highwaymen, otherwise known as the high-frequency traders.  Their algorithm-based machines do more than half of all daily trading, and simply want a trend to follow, milli-second by milli-second.  As the Financial Times warned in June:

“The stock market has become a battlefield of algorithms, ranging from the simple – ETFs bought by retirees that may invest in the entire market, an industry, a specific factor or even themes like obesity – to the complex, commanded by multi-billion dollar “quantitative” hedge funds staffed by mathematicians, coders and data scientists.”

JP Morgan even estimates that only 10% of all trading is done by “real investors”:

“Passive and quantitative investors now account for about 60% of the US equity asset management industry, up from under 30% a decade ago, and reckons that only roughly 10% of trading is done by traditional, “discretionary” traders, as opposed to systematic rules-based ones.”

Probably prices will now attempt to stabilise again before resuming their downward movement.  But clearly the upward trend, which took prices up by 60% since June, has been broken.  Similar collapses have occurred across the commodity complex, with the CRB Index showing a 6% price fall across major commodities:

  • Typically, inventory build ahead of price rises can add an extra month of “apparent demand” to real demand
  • This inventory will now have to be run down as buyers destock to more normal levels again
  • This means we can expect demand to slow along all the major value chains
  • Western companies will now see slow demand through Easter: Asia will see slow demand after Lunar New Year

This disappointment will end the myth that the world is in the middle of a synchronised global recovery. In turn, it will cause estimates of oil demand growth to be reduced, further weakening prices.  It will also cause markets to re-examine current myths about the costs of US shale oil production:

  • As the charts from Pioneer Natural Resources confirm, most shale oil breakeven costs are below $30/bbl
  • Pioneer’s own operating costs, typical of most of the major players, are below $10/bbl
  • So the belief that shale oil needs a price of $50/bbl to support future production is simply wrong

PREPARE FOR PROFIT WARNINGS AND POTENTIAL BANKRUPTCIES BY THE SUMMER
Over the summer, therefore, many industrial companies will likely need to start issuing profit warnings, as it becomes clear that demand has failed meet expectations.  This will put stock markets under major pressure, especially if interest rates keep rising as I discussed last month.

Smart CEOs will now start to prepare contingency plans, in case this should happen.  We can all hope the recent downturn in global financial markets is just a blip.  But hope is not a strategy.  And the risk of profit warnings turning into major bankruptcies is extremely high, given that global debt now totals $233tn, more than 3x global GDP.

 

FORECAST MONITORING
I strongly believe that forecasts should be monitored, which is why I always review the previous Annual Budget forecast before issuing the next Outlook, and always publish the complete list of Annual Budget Outlooks.

Since January, I have also been monitoring my blog forecasts, using the percentage mechanism highlighted in Philip Tetlock’s masterly “Superforecasting” book. Today’s forecast for oil prices to fall initially to $50/bbl is therefore now added to those on ethylene/polyethylene and the US 10-year interest rate. I am also increasing the confidence level for the interest rate forecast to 70%, and will continue to update these levels when circumstances change.

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US Treasury benchmark yield heads to 4% as 30-year downtrend ends


The US 10-year Treasury bond is the benchmark for global interest rates and stock markets.  And for the past 30 years it has been heading steadily downwards as the chart shows:

  • US inflation rates finally peaked at 13.6% in 1980 (having been just 1.3% in 1960) as the BabyBoomers began to move en masse into the Wealth Creator 25 – 54 age group
  • Instead of simply boosting demand, as during the 1960s-1970s, they began to work and create new supply
  • This meant supply/demand began to rebalance and interest rates then peaked at 16% in 1981

By 1983, the average Western Boomer (born between 1946-1970) had arrived in the Wealth Creator cohort, which dominates consumer spending, and the economy really began to hum.  There was a final inflation scare in 1984, when US inflation suddenly jumped from 3% to 5%, but after that the trend was downwards all the way.

The Boomers were the largest and wealthiest generation that the world had ever seen.  Their move to become Wealth Creators completely transformed the inflation outlook, as more and more Boomers joined the workforce.  And they transformed the economy by moving it into the NICE era of Non-Inflationary Constant Expansion.

Central bankers took credit for this move, claiming it was due to monetary policy.  But in reality, people are the key element in an economy, not monetary policy.  You can’t have an economy without people.  And sadly, the idea that the US Fed Chairman Alan Greenspan had somehow become a Maestro, blinded everyone to 2 key issues for the future:

  • Life expectancy was rising rapidly, meaning that the Boomers would not normally die just after retirement.  Instead, they would likely live for another 15 – 20 years after reaching age 65
  • From 1970, fertility rates had fallen below replacement level (2.1 babies/woman) across the Western world

This combination of a rise in life expectancy and a collapse in fertility rates was creating a timebomb for the economy.

THE RISE IN LIFE EXPECTANCY AND COLLAPSE OF FERTILITY RATES CREATED AN ECONOMIC TIMEBOMB

Western economies are based on consumer spending.  And spending declines once people reach the age of 55 – they already own most of what they need, and their incomes decline as they approach retirement, as the second chart shows:

  • There were 65m US Wealth Creator households in 2000, who spent an average of $62k ($2017)
  • There were only 36m in the 55+ cohort, who spent just $45k each
  • In 2017, there were 66m Wealth Creators (almost the same as in 2000) who spent $64k each
  • But there were now 56m in the 55+ cohort, who spent just $51k each

The rise in 55+ spending was also only temporary, as large numbers of Boomers have just reached 55+ and have not yet retired.  Spending by those aged 74+ was down by nearly 50% versus the peak spending 45-54 age group.

BELIEF IN MONETARISM LED TO THE DOTCOM AND SUBPRIME DISASTERS 
The dot-com crash in 2000 should have been a wake-up call for the failure of monetarism.  It also, after all, marked the moment when the oldest Boomers began to join the 55+ cohort.  But instead, policymakers thought monetarism could solve “the problem” and cut interest rates to boost the housing market – causing the subprime crash in 2008.

One might have thought – as we wrote in Boom, Gloom and the New Normal in 2011 – that this disaster would have destroyed the monetarism myth.  But no.  Abandoning monetarism would have led to a difficult conversation with voters about the need for everyone to retrain in their 50s, and prepare to take on new, and less physically demanding, roles.

Instead, policymakers tried to replace lost BabyBoomer demand by printing vast amounts of free money via the Quantitative Easing and Zero Interest Rate Policies.  Their aim was to avoid deflation, as inflation had fallen to just 0.6% in 2010 – although why this was a “bad thing” was never explained.  But in reality, they were running uphill, and the pace of the climb was becoming more vertical, as the average Western Boomer joined the 55+ cohort in 2013.

Of course, flooding the market with cheap money boosted asset prices, as they intended.  Stock markets and house prices soared for a second time. But it also created a major new risk.  More and more investors began to panic as they hunted through the markets, trying to obtain a decent “return on capital”.  They assumed central banks would never let markets fall, and so gave up worrying about the risk of making a dud investment.

INTEREST RATES ARE NOW HEADED HIGHER AS PEOPLE WORRY ABOUT RETURN OF CAPITAL
The end of the Bitcoin bubble has highlighted the fact that that risk and reward are normally related.  Most investments that offer potentially high rewards are also high risk – a lot has to go right, for them to make the possible return.  This process of price discovery – the balance of risk and reward – is the key role of markets.

Left to themselves, markets will price risk properly.  But they have been swamped for the past decade by central bank liquidity and their crucial role has been temporarily destroyed.  Now, the fact that the US 10-year bond has broken out of its 30-year downtrend tells us that markets they are finally starting to regain their role.

How high will interest rates now go?  We cannot yet know, and we can also be sure they will not move in a straight line as central banks will continue to intervene.  But as more and more investments, like Bitcoin, prove to be duds, so more and more investors will start to worry about return of capital when they invest.

4% therefore looks like the next level for rates, as we are now trading within the blue bars on the chart.  It may not take very long for this level to be reached, given the fact that the world now has a record $233tn of debt – 3x the size of the global economy.  After that, we shall have to wait and see.

 

FORECAST MONITORING
I strongly believe that forecasts should be monitored, which is why I always review the previous Annual Budget forecast before issuing the next Outlook, and always publish the complete list of Annual Budget Outlooks.

I now plan to begin monitoring my blog forecasts, using the percentage mechanism highlighted in Philip Tetlock’s masterly “Superforecasting” book.  The first forecasts relate to last week’s post on US polyethylene exports and today’s forecast for the US 10-year Treasury bond.  I will change confidence levels as and when circumstances change.

 

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