What’s going on in the global economy?

There’s a massive shakeup going on in the global money markets. Its ripples are extending to the international bond price, the value of the euro and deep into Eastern European domestic markets where many low-interest mortgages and loans have been made in Swiss francs over the past few years.

In a surprise move, the Swiss franc rocketed nearly 28% against the dollar on January 15th 2015, when Switzerland’s central bank (SNB) dumped a three-year-old cap on the franc’s value against the euro.

The euro dropped nearly 30% below the 1.20 cap to a record low of 0.8500 francs per euro before bouncing off its session low. The dollar plummeted to 0.736 francs, its lowest since 2011, before also clawing back losses

These swings in the franc are the biggest since most major currencies moved to free-floating regimes in the 1970s. Dealers said they had seen a number of major investors lose as much as 20% before managing to complete trades to close their bets on a stronger dollar against the franc.

The Swiss National Bank has been resisting pressure for months to abandon the euro/franc cap it set when investors made Switzerland their financial haven of choice following the 2010 and 2011 Eurozone economic and political woes. Switzerland is a heavily export-oriented economy, and its believed the SNB was worried that an overly strong franc would threaten economic growth.

In the immediate aftermath, the euro was down against the dollar 1.5 percent at $1.16180. The euro earlier hit $1.15675, its lowest level against the dollar since November 2003. The dollar index, which measures the US$ against a basket of six major currencies, was last up 0.2 percent at 92.355, and earlier touched an intraday high not seen since November 2003. The dollar was last down 0.78 percent against the safe-haven Japanese yen at 116.430 yen.

And then the bond market reacted…

The government bond market immediately began to act oddly. Interest rates seem to be pricing for a “debt-deflation cataclysm”.

That’s a conclusion to draw from the fact that the yield on the U.S. 30-year bond hit a record low of 2.4% percent — also on the 15th January. Meanwhile, Japanese and German 10-year yields are plumbing record lows, and five-year yields on bonds issued in Eurozone safe havens Finland, Germany and Switzerland have dropped into negative territory?

Something is very wrong here. And it looks like bonds are signaling the fall.

According to Anthony Mirhaydari, of the Fiscal Times, the prognosis is grim.

  • The evidence is building that the global economy is slowing, led by weakness in Asia and Europe. The JPMorgan Global Manufacturing PMI, which measures factory activity, last month dropped to its lowest level since August 2013. Activity is declining outright on a month-over-month basis in China, Greece, Austria, Italy and France.
  • This comes as the developed world governments, reacting to the blowup of private sector debts (mostly real estate), recession and the risk to the financial system in 2008-2009, have piled on public debt. China is in the mix here too, with local government and private credit exploding higher, fueling fixed-asset investment bubbles, overcapacity and now an unresolved bad debt problem that we got a quick taste of in early 2014. In Italy, the government debt-to-GDP ratio has grown from 104 percent in 2008 to 133 percent, with no signs of slowing.
  • All this is occurring at a time of low global inflation, tipping into outright deflation in some areas. Prices at Chinese factory gates have been dropping for months. The Eurozone is expected to have fallen into outright deflation in December. Capital Economics expects consumer price deflation in the United States for January.

Boiling it all down, these market moves are due to Chinese factory overcapacity, Japanese exchange rate mercantilism and Eurozone fiscal austerity. They’ve been accelerated by the collapse in energy prices, which looks set to continue.

The combination of all three trends forms a potent economic poison that has ensnared Japan for decades: A debt-deflation depression.