Thursday, December 27, 2007
It is a staple of financial commentary that near the end of December, one offers up pearls of wisdom for the ensuing year. This can take the form of "top trades", "surprises", or even "Christmas presents." Regular readers should know by now that Macro Man marches to the beat of a different drummer, and as such his powers of prognostication, insofar as they exist, yield a harvest unlike any other. So rather then tell you what will happen in 2008, herewith is a list of eleven things that WON'T happen next year:
1) Oil will NOT rise 60% in calendar year 2008, or 100% peak-to-trough during the year. Remarkably, both of those things occured in 2007. But with global growth on a downward trajectory, demand growth for the gooey black stuff should recede a bit. Importantly, we now know that gas prices of roughly $3.00-$3.25 per gallon represent a "possum point" for the US consumer; i.e., the point at which (s)he rolls over and plays dead. $150 oil at current refining margins would send the USD into recession, thereby eliminating some demand for crude; $150 oil at current gasoline prices would kill the refining industry. The obvious conclusion is tht $150 oil ain't happening next year.
2) VIX will NOT hit single digits again. Regular readers will be familiar with Macro Man's high-conviction thesis that tightening global liquidity conditions and greater macroeconomic volatility imply greater financial market volatility moving forwards than we've seen in the past. For those who enjoy historical parallels, consider the analogy that 2007 = 1997, wherein there is a brutal localized shock that sends ripples but not catastrophe throughout the rest of the world economy. The follow on is that the aftershocks hit the next year, once growth slows. If you see VIX hit low teens or below in 2008, buy all the index options you can.
3) Inflation will NOT die as a macroeconomic issue. It may well be the case that commodity price inflation eases next year, particularly on the energy side. But the inflation story is secular, particularly in emerging markets that for much of this decade have exported deflation, rather than inflation. However, as price expectations in these countries shift and wages adjust, this should produce an upward bias to global goods prices next year. Just as the plankton population dictates the availability of sustenance across the remainder of the global food chain, so too should the inflation dynamic in the low cost producers of the world dictate inflation rates elsewhere.
4) China will NOT step-reval the RMB. The rationale is simple; they'll simply allow a faster pace of appreciation while accruing fewer official foreign currency assets next year. Macro Man has long observed that domestic inflation amongst BWII peggers would be the ultimate death knell of the system, and the recent increase in the pace of the USD/RMB decline (a "whopping" 1.1% decline this month!) suggest that the Mandarins in Beijing have reached the same conclusion.
5) The BOJ will NOT hike rates in 2008. OK, this one's hardly going out on a limb, is it? But given that markets have sort of lazily expected further tightening in the pipeline all year, it's worth pointing out directly. Japan's economic performance in 2007 will have to go down as the biggest disappointment since Waterworld.
6) GBP/USD will NOT make a new high in 2008. Sure, the dollar may continue on the back foot, particularly if the Fed keeps easing rates during a period of "muddle-through" economic growth. But why in the world would anyone want to hold sterling, the currency of a country that looks a lot like the US did six or twelve months ago? We have a pretty good idea of how the UK story will end (hint: it bears a strong resemblance to the results of the England football team for the last forty years.)
7) We will NOT see an honourably fought US presidential election with the outcome determined by the issues. Macro Man was last resident in the United States for a presidential election in 1988, the year that Bush Sr. defeated Michael Dukakis. That election was fought on soundbites and slurs, at least judging by Macro Man's enduring memories of the campaign ("Where was George?", Willie Horton, and "You're no Jack Kennedy".) From what he can see, it's gone steadily downhill ever since. Macro Man tries very hard to avoid talking US politics both in this space and in real life, given the appalling caliber of the individuals who typically contest major elections.
8) We will NOT see a US recession in 2008, as defined by the NBER. This one's a bit more contentious. But Macro Man's reading of the key drivers of the business cycle, particularly inventories, continue to suggest a "muddle through" scenario while housing remains weak. While it is likely to be the case that global demand growth will recede somewhat in 2008, the dollar remains uber-competitive against many of America's trading partners and competitors, which could/should allow US firms to gain international market share. And as Macro Man has observed recently, leading indicators are suggesting that the current slowdown is just that- a slowdown. That official and govvy rates have already tumbled should also support activity if and when credit conditions normalize to a degree (albeit with wider spreads than in 2004-06.)
9) Japan's MOF will NOT intervene in currency markets in 2008. Of all the non-predictions on this list, Macro Man is probably least confident of this one. Yet it would truly be remarkable for the yen to experience 22 year trade weighted lows in 2007, and for the MOF to intentionally weaken the currency in 2008. All the more so given the inflated levels of EUR/JPY and, more crucially, the fact that Japan has put her name to G7 statements calling out China for currency piss-taking. One can only hope that if Macro Man is wrong on this one and the MOF does decide to buy USD/JPY, that both the US and Europe abandon their recent policies of non-intervention and say "200 billion yours, at best" to the market.
10) The Shanghai Composite will NOT rise another 100% in 2008. Shanghai rose 130% in 2006 and another 100% this year. It ain't happening next year, though. Why? Two reasons. First, the Olympics represent a turning point with regards to sentiment. There are many who believe that the authorities will change their attitude towards rampant speculation after the Olympiad, but are unwilling to do so beforehand in case of domestic unrest. We are likely to see some selling after, during, and prehaps before the Olympics as a result, which could then turn a market rout into a self-fulfilling prophecy. More concretely, the monetary policy stance has already moved to "tight" for the first time in four years; in 2004, the Shanghai Comp shed 15%.
11) Macro Man will NOT find himself in this situation in 2008. Or, despite initial appearances, in any other year, for that matter.