Interest rates: A useful reminder
Normally, "decoupling" is discussed in the context of stock markets. Thus, for many a moon, people have argued that the markets of the East are decoupling from those in the West - a little bit like two train cars decoupling and going their separate ways.
We disagree with this view of decoupling. More recent history has vindicated us. Shanghai (read: Hong Kong) has fallen, and Europe, along with Wall Street, followed suit. Then Wall Street fell thanks to another screech from the economics data department, and Europe along with Shanghai fell. The only exception to this rule is Estonia: even though other markets have tumbled, this one has rocketed by 40% this year alone - albeit off the back of a miserable 2009.
But we agree with "decoupling" to an extent when it comes to interest rates. As we pointed out in our recent CNBC interview, different ends of the yield curve already are wiggling:
- In the EAST, it is the short end of the yield curve that already is showing signs of movement. For instance, the Central Banks of India and of China already have begun raising rates, or in our diction of the Economic Clock®: they have started to lay the groundwork for an excess demand for money. This is because they are worried about the return of inflation.
- in the WEST, it is the long end of the yield curve that is already showing signs of movement. Here, Central Banks are holding-off the raising of rates in a meaningful manner, because they know that the Economic Time® in Europe and in the U.S. is just too fragile to kill a recovery of sorts. Thus, Central Banks are worried about the persistence of deflation. But, this fear of Central Banks - killing a nascent recovery - is reflected in the long end of the curve: people are getting worried, increasingly, about the level of sovereign debt. Or, to put it in Oswald Spengler's framework: politicians have promised so much spending over the years that now, governments are going broke.
In a nutshell, then,
- in the EAST, policy makers are going to raise SHORT rates because of inflation fears, while
- in the WEST, policy makers not going to raise short rates because of deflation fears. Instead, investors will exit sovereign debt, pushing up the long end of the yield curve.
Next to the decoupling of interest rate movements, watch for another hidden subtlety:
- in the EAST, "real", i.e. inflation - adjusted short rates will fall (i.e. rising nominal rates are mitigated by rising inflation), while
- in the WEST, "real" short as well as long rates will rise - precisely because of the persistence of deflation.
These thoughts should reveal to you that in the East, you want to be long of sectors that are impervious to higher, real short-term interest rates; meanwhile, in the WEST, you want to be long of sectors that will benefit off falling, real long-term rates.
Just food for thought. Comments would be welcome.
