Economic Insights – All the Davos horses and all the Davos men

The great and not really that good are convening in Davos this week to be confronted yet again with the uncomfortable (to them) reality that markets cannot be manipulated indefinitely by politicians, investment bankers or even central bankers, even when they try to act in concert.

In this ‘express’ edition of Economic Insights I offer just two simple headlines:

The global economy is slowing not collapsing

This may disappoint some but is actually quite good news. Most attention this week will be paid to the latest batch of fiddled data ‘outta’ China and the irony is its economy may well be on track but just only at half the speed of official numbers. There will not be much significant data out of the US (after last week’s disappointing Retail Sales and Industrial Production) while that from the EZ will be mainly survey data and at best inconclusive. That will not stop Mario Draghi telling us all on Thursday how effective his policies are proving to be and will be even more so once he has outmanoeuvred the awkward squad led by the Bundesbank. From the UK will come a raft of numbers on Inflation, Unemployment, Average Earnings and Public Sector Borrowing (probably mostly from middling to quite good) but the main interest should be Retail Sales. Evidence so far suggests the Brits were shopping online and on foot in December and they certainly need to stick at it if the UK economy is to keep outperforming the rest of the world.

Investors need to calm down

The main consequences of a global slowdown are that corporate earnings will be lower and interest rates and commodity prices will stay very low.  The Big Bucks investors are…er… just too big to buy most individual stocks or bonds and so have to rely on derivatives, which are, of course, what ETFs and other passive funds are all about too. As sophisticated as algorithmic programmes have become they seem to end up in rather simple trading strategies: sell until prices stop falling and buy until they stop rising. Needless to say, things can go wrong without necessarily being ‘Black Swan’ events. The programmes are written by humans just as frail as even the most experienced traders. Right now, selling and/or shorting equities seems to be both a herd instinct and a hedge against scary trades in Oil, commodities and currencies. The selling will have to stop sooner rather than later.

The most dangerous scenario, albeit still somewhat unlikely, is if investors collectively stampede into a crash that provokes a genuine global recession. There are really no policy weapons left if this happens, apart from old fashioned Keynesian public spending and even that is easier said than done. So, if the global economy really were to ‘have a great fall, all the Davos’ horses and all the Davos’ men’ would struggle to put it together again.   Meanwhile, somewhere and somehow, some companies will find a way to grow, which happens to echo our own motto: ‘Incrementum inveniendum est’. Amen to that!

Economic Insights – Week ahead 11/01/2016


  • First week hangover: don’t blame it all on China

  • Coming up: more slowdown evidence

  • L’Europe en danger! Et ses femmes!

  • Brexit is hard to do

  • Markets: sauve qui peut! Every stock for itself!


First week hangover

2016 has got off to what can only be described as a rather poor start but I am sticking to my headline last week that we may well all be ‘doomed but just not yet’.  China is currently getting most of the blame but, in fact, the real causes are problems carried over from last year:

  • The slowdown in growth is global and not only the fault of China’s manufacturing
  • The central bank with most clout remains the US Fed even if others are more deluded.
  • China has almost nothing to do with the Syrian crisis threatening Europe.
  • All markets have become fragile and exposed to stampedes

Alas, the hangover follows what was  not even that much of a party. Much of 2015 went by with the Fed’s signalling its desire to remove the proverbial punchbowl and finally doing so just as Santa was expected with his proverbial rally. So, it should really be no surprise that things look grim right now and, unfortunately, there appears to be no equivalent to PG Woodhouse’s ‘Jeeves famous hangover cure’. Hangovers are wretched but they do eventually fade and I remain convinced the major stock markets will end 2016 not so far away from where they started, albeit they are more likely to take a few nasty tumbles on the way and from which not all may recover fully by next December. Having said that, last week’s rout in equity markets included the worst ever start to the New Year in the US and has given new material to the soothsayers who routinely come out with such bonmots as ‘Santa Rallies’ and ‘Selling in May’. The latest sooth is ‘as the year starts, so it proceeds’ and this may well prolong the hangover for the more nervous. Why not take a look at Chart 1 and judge for yourself?

 Chart 1 S & P 500 in 2016?: Pick a number between -40% and +30%


Source: Pension Partners via Financial Orbit

Coming up: more slowdown evidence

Two charts from last week highlight the current challenges to the global economy and  provide a framework for assessing data to be published in the coming weeks. Chart 2 from Caixin/Markit came out on Wednesday showing China’s Manufacturing, Services and the combined Composite PMIs for December. These surveys are widely regarded to be as close to being independent as any data from China.The shock was that the Services PMI had for the first time ever fallen below the 50 level that delineates expansion and contraction.Taken to extremes, which inevitably it was (especially by the new archetype gung-ho investor, Mrs Wong), this could mean that the whole Chinese economy was contracting in December. So, forget the official GDP growth rate of 7% and the switch to Consumption! It is going to become increasingly difficult for the authorities to massage the next batches of data and so this week we can expect further softening in both Exports and Imports. Later in the month Retail Sales and Industrial Production in December may also be reported as softer but the authorities will probably try to tough it out with reporting 7% GDP growth in 2015 as a whole.

Chart 2 Caixin China Output PMI: Services pooping the Party


In contrast, at first sight the December US Labor Market numbers seemed very encouraging when they first came out on Friday: 292K new hires in the month, previous months revised higher, another nudge higher in the Participation Rate and also in Average Hourly Earnings. However, the doomsters have since been busy deconstructing the data. Chart 3 tells a similar story to the UK in so far as almost all recent new hires are in the Services sector, where many jobs are lower paid, unskilled and less productive. Indeed, average hourly earnings did not increase month on month from November. Perhaps even more worrying is that of the 292K incease in the December Non-Farm Payrolls 281K represent an annual adjustment because of the Festive Season that may or may not be accurate. This week Industrial Production is almost certain to be soft again but there may be some cheer in Retail Sales, which are due for a good month after struggling over the last few months. In other words, whether the US is even close to growing at 2% per annum depends almost entirely on shopping.

Chart 3 US cumulative new jobs by sector: low skill, lw pay


Here in the UK, Industrial Production may actually be better as the ONS seems to report good and bad numbers in alternate months but the year on year headline for Manufacturing Output is still set to show a deterioration. Also due for an uplift are British Retail Consortium sales in December (shopping again!). The MPC meets this week but the only question is whether Ian McCafferty will fall back in line with his colleagues and vote to hold Base Rates (probably not). The most interesting announcement will be the NIESR’s rolling 3-monthly GDP estimate (not a forecast) which will cover Q4. The previous two rolling estimates came out at +0.6% which suggests an estimate for Q4 of no worse than +0.5%, which sets up a potential clash with the ONS’s first cut when it is published later this month.  Chancellor Osborne will have to put up with the latter’s numbers but will not welcome any further downward revisions for previous quarters. His downbeat ‘poisonous cocktail’ speech last week, however, should be seen as a political rather than economic warning. Protocol prevents his giving hints to the MPC but Tory MPs need a wake-up call on Brexit risk and, of course, he must ensure that he gets none of the blame if his upbeat message of only one month ago turns out too optimistic. It should always be remembered that Mr Osborne is usually (but not always!) at least two moves ahead of everyone else.

Meanwhile in the EZ, mixed data suggests that although its economy is no longer getting worse significant recovery remains elusive. This week, with Italy and Spain taking centre stage, should add to this picture following last week’s Unemployment (slightly better), CPI (under pressure again), Industrial Production (stalling) and PMIs (slightly better).

L’Europe en danger! Et ses femmes!

One thing that can be said for the EZ elite is that they take holidays very seriously. Sadly, there has been no avoiding the shocking accounts of muggings and sexual assaults in parts of Germany but who would guess that all the major problems are still festering. Greece is not and, to be fair, probably cannot, comply with the bail-out conditions, Italy and France are trying to neutralise the Stability and Growth Pact, Germany is still trying to block the Single Bank Resolution, Portugal and Spain are without stable governments, Denmark wants no more integration, there is a North-South dispute over gas pipelines from Russia, the Bundesbank is trying to subvert the ECB’s monetary policies und zo weiter. The Brexit negotiation is a minor irritant by comparison.


However, there is no doubt the Syria crisis represents the greatest threat to Europe and it has already undermined the Schengen agreement on free movement and returned high wire fences to Eastern frontiers. Migration generally brings direct economic benefits to all concerned: more jobs, more public spending but tax receipts taking over from initial social benefit outlays but this time the problem is so many migrants’ arriving at once. This point is made in a most civilised way in the following extract from an article by Klaus Brinkbäumer, Editor in Chief of DER SPIEGE:

9:26 p.m. – 25 Dec 2015 · Details

No migrant leaves his or her home casually, frivolously or even with any kind of pleasure at all. It is a far-reaching decision and all who pull up roots know it, even those who are still in their formative years. The migrants who come to us merit empathy — and what choice do those people have who come from war-torn Syria? What would we do in their situation?

There is proof for everything — for almost every thesis as well as for its antithesis. Regions that have integrated many migrants in the past are prosperous today, but integration only works if the state doesn’t lose control, and Germany at present has lost control. Of course there is a basic human right to asylum, but without an upper limit — enforced, if necessary, with border controls — it will be almost impossible to find a way out of the crisis.

The political and social disruption is only just beginning and it is hard to be optimistic. Much is being made of the rise of extremist political parties but I would suggest that the most sinister long-term threat is to the status of women unless ‘multiculturalism’ is made more sympathetic to them.

Chart 4 Brexit voting intentions


Source: YouGov via The Times

Brexit is hard to do

Full disclosure: both my head and heart are in favour of the UK staying in the EU. Heart is easy to explain as my father was an immigrant, my wife and I between us have family and friends in 8 other EU countries and I spend up to 2 months every year in Italy and France. Head (from an economic stance) is slightly more difficult if the post-Brexit outcome is merely a ‘Swiss/Norway plus’ deal in a free-trade zone although I boggle at the logic of  still  being bound to most European Treaties without being able to participate in future decisions.  The extreme solution of joining some sort of ‘Anglo-Saxon’ English-speaking trade group (specifically with multiracial US, Canada, Australia and New Zealand) seems even more illogical as well as politically fanciful and economically reckless. At least our European partners value our trade!  Nevertheless, it may well be that fear of migrants from Syria, Somalia, Afghanistan and Pakistan rather than Europe itself will tilt the balance in favour of Brexit,  which would ironic in a number of ways, not least because we would need to increase trade with many such countries.

Chart 4 from pollsters YouGov shows referendum voting intentions to be very finely balanced with a narrow split between both men and women. The party political differences are as one might expect, which means people in London, the North and Scotland want to stay while those in the English shires want to leave. There is a more fundamental polarisation between those educated to ‘A’ Level and above (stay in) and those below (out) and also those aged under 30 (stay in) and over 50 (out). There is less polarisation by social class: AB and CI would prefer to stay while C2 DE want to leave. As with most referenda the onus will be on those who want a change and xenophobia as opposed to lofty superiority traditionally does not go down well in the UK. A sub-plot may well develop in which it becomes a matter of confidence in David Cameron personally, which should stay the hand of many Tory Eurosceptics. I would like to think the pointlessness of Brexit might swing the balance.

Markets: Sauve qui peut. Every stock for itself

OK, let’s get China and last week’s 10% belly flop out the way first. Foreigners are still not allowed to get much involved directly via the domestic stock exchanges and most are too smart to want to. With major shareholders subject to restrictive lock-in regulations, the wild swings are all about ‘Mrs Wong’ and the authorities clearly do not know what to do about her, given the absolute priority of keeping the Communist Party in power. The international repercussions are to undermine confidence in global growth and corporate earnings while the clumsy devaluation of the renminbi is more of an issue for China’s trading partners amongst the Developing Economies. It is all very unsettling but investors will just have to get used to it while Mr Xi decides how much he wants to ‘embrace the markets’ as The Economist mischievously put it back in July or, as now seems more likely, prop them up!

Chart 5. Xi ha!


Source: Bloomberg

Some Emerging Markets are easier to get into than others but none look attractive right now and this highlights the problem of investing in broad asset classes and geographical markets. Where to get a positive return is proving increasingly hazardous for Japanese investors who are inclined to repatriate when risk is in the air but the resulting boost to the yen is counterproductive, especially for exports to China and other Developing Economies. European equities were fashionable last year but neither exports nor domestic demand are growing fast enough to encourage hopes for much further progress, albeit earnings multiples are still relatively modest compared to the US. In the UK the FTSE 100 looks a rather unhappy cocktail of beaten-up overseas resources companies and UK standard bearers in sectors facing margin squeezes and/or enforced structural change. The FTSE 250 has so far proved to be a more solid representative of UK plc and the wider economy but even it failed to escape last week’s sell-off.

Chart 6: M & A to the rescue?


Inevitably, one has to look to the US for investment ideas but even this is not clear-cut. Valuations are historically very high especially when considering the prospects for future growth. After two soild years earnings of S & P 500 companies probably fell by at least 4% in 2015 and the outlook is still not encouraging. Share buy-backs no longer look so attractive to corporate executives nor does holding on to their stock options. There may be a silver lining in the form of M & A deals although even these may involve significant equity swap elements. It is only once one starts digging deeper that slightly more hopeful signs appear. If one strips out the energy and materials sectors, average corporate earnings turn positive with Consumer Dicretionary, Healthcare and IT topping the bill. This is yet another reason not to invest only in asset-classes and market indices.

Even better is to seek out individual companies that have a new story to tell and/or are temporarily off many investors’ radar screen. These stocks should be able to move independently of the general market or their sector but also be sufficiently liquid to enable short-term trades. This approach is applicable elsewhere but the US and the UK offer the most accessible opportunities. This ‘stockpicking plus’ strategy is the principle on which we recently launced our DAN-Trade equity product. Of course, there will always be great companies to buy and hold for the long-term but that too is becoming increasingly subjective-and risky!- in the current skittish markets.

Meanwhile some investors will continue, when all else fails, to rely on the Fed to bail us all out. Plus ça change …….

Chart 7 When you wish upon a star…….


Source: WSJ Survey of Economists via WSJ


Economic Insights – 07/01/2016

From jittery 2015 into even more unsettling 2016

Monday January 4th 2016:


  • We are all doomed but maybe just not yet
  • Bear in a China shop
  • Global growth: shop or drop
  • Central banks: classic fail


We are all doomed but maybe just not yet

One thing that can be said  about 2015 is that it was a year of abundant forecasts. Most of them wrong, of course, and often published by people talking their own book. Chart 1 from Dent Research nicely captures the increasing polarisation between the shrill doomsters (bottom right) and the determined optimists, who as the good news runs out, are having to shuffle from top left to top right. For the record, I am wobbling just below top right but still reluctant to go much lower. There certainly are big problems being carried over into 2016 as I highlighted in Economic Insights last month and also at our Private Client Forum on December 1st. My main concern dating back to 2014 and intensifying ever since remains the financial markets themselves. It is really rather scary to realise that most traders and investors have never experienced economic and market conditions such as those currently prevailing. Understanding and managing risk has never seemed more important. A cyclical downturn or even secular stagnation ought to be navigable but not if market participants panic. So, while there is as ever a need to ‘keep calm’ it would be wise not to ‘carry on’ as usual!

Chart 1 The Human Model of Forecasting


Bear in a China shop

While the arguments rage about the truthfulness of official China data it is worth remembering that the country has been fuelling global growth for much of the last 25 years, especially in the last seven when it ‘heroically’ sought to make up for recession in the decadent West. China has become the largest or second largest trading partner for most of Asia, North and South America and Africa but now both imports and exports are falling. As one might expect from a centralised one-party state, fear of losing power takes precedence over not just publishing inaccurate data but also prudently managing the economy itself. It could, of course, be argued that the task is almot impossible anyway with a population of almost 1.4bn spread unevenly over 3.7m square miles. For the last two years the government has been trumpeting a switch in emphasis from manufacturing, infrastructure investment and exports to consumption but more recently seems to have lost its nerve and reverted to type. The trouble is that so much of the new investment may well be unproductive as well as funded by debt and a rigged stock market. No doubt loss-making debt-laden state-owned enterprises will be propped up but the government is going to have to choose soon between continuing to open up the economy to market forces or battening down the hatches. Either choice will slow growth further for China and the rest of the world. Given the shamelessness of China’s leaders, we can expect throught 2016 a lot of pious waffle for international consumption and increased domestic control freakery (e.g. prominent financiers and business leaders ‘helping the authorities with their enquiries’).

Figure 2 China Matters


Shop or drop

So, while China is sorting itself out, where will global growth come from and in what form? A sudden revival in trade can be ruled out just because of China while government spending remains constrained indefinitely almost everywhere. More Business Investment would be most welcome but it depends on growth in profits and confidence and both seem at best flat in most major economies.

The spotlight has, therefore, to fall on consumption. We are doing our bit in the UK but apart from Spain retail sales in Europe are somewhat patchy and dire again in Japan. This means that US consumers have to step up and at first sight Chart 3 suggests they are. However, the headline numbers have been made ‘real’ by being adjusted for inflation (not much of that recently!) and further analysis suggests that 18% over ten years is not very exciting , even allowing for a 3% drop after the Great Financial Crisis. Over the last five years it works out at only about 2% per annum allowing for compounding and it has been wobbling a bit of late. No surprise, therefore that US GDP has been struggling to get much above 2% over the same period, including 2015.

Chart 3 can consumers continue to save the day?


The trouble is that if consumers are to spend more they will have to borrow more too, which they may  well not feel either inclined (because of low inflation on the prices of stuff) to do or, indeed sufficiently confident of their future financial position. Moreover, the banks may spoil the party through reluctance to lend because of past excesses (notably in Europe) or lending too much imprudently (in China and the US) and then repenting suddenly (as Hyman Minsky warned in the 1970’s and 1980’s). I have mentioned before the work of Professor Steve Keen on the correlation between debt and economic growth and what consumers do next is the key economic question for 2016. There may be a big boost from lower oil prices but consumers in the richer economies are increasingly worrying over healthcare and age care, which are two of the areas where inflation is picking up. Investors should worry too!

Central Banks: Classic fail

Monetary policy is not really supposed to be understood by the likes of you dear readers, and me. It requires mysterious constructs such as Dynamic Stochastic General Equilibrium and mathematical models which are so logical that economic data often requires adjusting to make the models ‘work’. The great spanner in the works is something called the ‘Liquidity Trap’, which is when businesses become reluctant to invest and consumers to spend. The ‘classical’ avoidance solution is to make everyone feel good by slashing interest rates and printing money via Quantitative easing, which also should entice investors into taking bigger risks through switching out of cash, government bonds and mortgage-backed securities. All this extra money being splashed about is supposed to reduce its value vs. goods and services: i.e. it generates inflation, which in moderation, helps to stimulate growth. Less publicised  motives for QE are to bail-out improvident banks and to devalue the national currency.

True-believers amongst central bankers argue that the lower official interest rates and the larger the QE programme the better. It is just a case of doing it for long enough and all will be well. Unfortunately, the models appear not be working any more, even if they may have at first:

  • Many companies have taken advantage of lower interest rates not to borrow for investment but to fund share buy-backs.
  • Most consumers, especially those with middle and lower incomes, have yet to be convinced that they should stop worrying about their jobs and their old age (see above)
  • Investors have been as likely to invest in foreign equities and bonds, commodities and currencies as backing domestic companies, creating large hot money flows.
  • Competitive currency devaluations have become more common.

It is proving very difficult to start tightening again either through ending new QE asset purchases or raising interest rates as financial markets have reacted unfavourably in each of 2013, 2014 and 2015. Traders and investors have become addicted to a powerful cocktail of low rates and large QE programmes. Somewhat theoretical studies at the Atlanta Fed have calculated ‘shadow’ Fed Funds rates to be as low as the equivalent of -3% (vs. the official target range of 0.00-0.25%) in May 2014 by which time the FOMC had taken fright and started the taper that it had delayed in the previous year.

Chart 4 Economic model not working, so change the facts?


Chart 4 (blue line) shows that after 7 years of zero interest rates and QE programmes totalling $4.5tn that the FOMC’s preferred measure of inflation remains close to zero after falling below the target 2% level in 2012. A quick tour of other major economies reveals headline CPI levels at similar levels, except (sigh) in China where it is currently at 1.5%, despite several years of Producer Price deflation. In my house this record wold be greeted with the lugubrious cry of ‘classic fail’.

Two points need to be made here. First, the headline PCE and CPI numbers include energy and food prices, which when stripped out leave so-called ‘core’ numbers that are considerably higher (green line on Chart 4). Naturally, the central banks now place greater emphasis on the latter even though the politicians have yet to take the hint and change the inflation mandates. Second, even the headline numbers are likely to increase sharply over the next few months as the first major slump in oil prices drop out of the calculation, which the central bankers are likely to gloss over while patting themselves on the bank.  At this stage it seems almost churlish to mention Minsky’s theory that economies are inherently unstable and periods of apparent equilibrium are always temporary. So, I won’t!

What next  from central bankers? The FOMC continues to have a credibility problem despite, or because of, months of hand-wringing over the first rate hike. Having at last proclaimed the return of economic normality, Dr Yellen et al would be damned if they faltered on the gradual tightening that they have themselves predicted. On the other hand, they will be damned if they do carry on hiking when there is no fundamental economic justification and markets are sending out alarm signals. There seems to be an unofficial truce that the FOMC will solemnly forecast three or four rate hikes in 2016 while markets will price in only one or two. Chart 5 from Bloomberg highlights how the damage inflicted by a 1% increase in interest rates has risen throughout the great bond bull market to $3tn on some $45tn investment grade issues (tracked by the BofA Merrill Global Broad Market Index). The doomsters are convinced that, faced with the threat  of a market rout and a new recession. the FOMC will reverse last month’s hike and even launch QE4 this year. For now,however, it does appear that the market’s expectation of one or two hikes is about right. Speculation will resume as soon as this week in the build up to Friday’s release of the December Labor Market numbers but these are unlikely to be conclusive.

Chart 5 Don’t do it, Janet!


Here in the UK, the MPC is subject to gentle ridicule because despite its protests to the contrary its decisions on interest rates seem beholden to the FOMC’s. If there is any substance to this it is because the UK and US  economies are experiencing similar rates of growth and inflation. It should be noted that the MPC stopped its QE programme as long ago as 2012 and has since been much more willing to debate its efficacy. Moreover, apart from some curious recent kite-flying by Chief Economist Andy Haldane, the Bank has resisted any moves towards zero or negative official rates. Having said that, the MPC will not not want to tighten faster than the FOMC and may not raise rates at all in 2016 or merely stop at one symbolic hike.

In Asia, the PBoC will have to do as it is told by the party leadership and further loosening can be expected. The bond market is growing rapidly but is not yet large enough to justify a QE programme similar to those elsewhere. There should, however, be large-scale direct bail-outs of state-owned banks and other enterprises and the private sector, especially in the shadow banking sector where retail savings are at risk, is also likely to benefit from PBoC largesse. The policy of a weaker exchange rate will continue but not so aggressively as to jeopardise its growing international status. Government pressure on the Bank of Japan is much subtler than in China but it seems its QE programme will carry on indefinitely  while inflation remains minimal and the yen does not weaken. The hunt for assets that the BoJ can buy has been quaintly extended to include ETFs that do not yet exist. All in all, more classic fails ahead!

The Super Mario image took a major hit last month when Mr Draghi ran into some stiff opposition to further substantial easing from a hard core of ‘Nothern Europeans’ and bond yields and the euro surged higher as a result. He may yet get a reprieve if the FOMC really does hike aggressively and, of course, he has since been quick to put a new spin on his ‘whatever it takes’ line. As in the US, European businesses are reluctant to invest and consumers to spend but excessive private debt is not the main reason while even those who are looking to borrow are still finding many banks rationing their lending as they cover up their non-performing loans. QE in Europe is a bit like the proverbial pushing on a string. In the most recent Financial Times survey of European economists I was in both the minority camps on pessimistic economic prospects for 2016 (1.3% max GDP growth) and on further ECB loosening (more but limited rate cuts and an indefinite time extension of asset purchases).


The most active European borrowers are, of course, governments (mainly but not only Southern) who are relieved to benefit not only from extremely low rates but also a buyer of first and last resort in the ECB. Chart 6 shows just how much of EZ sovereign debt has negative yields and there is a knock-on effect on maturities all the way out to 30 years. It is likely that the Italian and French governments, both facing important elections in 2017, are already relying on ECB funding while all the Germans can do is try to cap it. This is a conveyor belt that nobody can afford to get off without wrecking the market for EZ sovereign bonds or, indeed, threatening the Monetary Union itself. Ironically, this could provide the glue for Europe at a time when everyone is quarrelling over everything else. Luciano Pavarotti once described his spectacular singing to me as ‘ I takk beeg reesks’ and the same can surely be said of Mr Draghi and his song for Europe.

Chart 6. Draghi the Great Redeemer?




Economic Insights – 03/12/2015

Towards the turn of the year

Maybe in the greyness of late November it is normal to want to hurry on into a new year but 2016 is going to start with a raft of unresolved problems carried over from this year. On the gepolitical front, Syria looks like getting a lot more complicated while on the macroeconomic front global growth looks as fragile as ever. Central banks are still acting as if they are in charge of something more than how investors will second guess each other’s reactions to the latest announcements and pronouncements. Making money in 2016 looks like being even more difficult than in this year of skittish volatilty. There are only 23 days trading left to add to/rescue/conserve any hard-fought gains of 2015 and few trends suitable for befriending.

Chart 1:  Worth following the money?


Chart 1 is of cumulative net investment into and not between US and European equity funds. The graph on the right is consistent with the outperformance of the major European stocks indices in 2015 after a relatively lean 2014 and in anticipation of an ECB-fuelled recovery. The recovery aspect is highlighted by Milan’s leading the way (see Table 2), which has more to do with its having fallen furthest than some sort of sentimental Italian connection with Mr Draghi. It is also interesting to note that it has taken 8 years to get back to the funding levels in Europe before crisis struck, whereas the inflows into the US after two strong years of stock market performance have gone into reverse in 2015, which again is consistent with US stocks’ stuttering progress in 2015. Where the money is going instead is a very good question. Some of it will have gone to Europe and some may well have stayed in the US in cash or bonds but much that found its way to Emerging Markets will have since returned, which again is reflected in the dismal performance of most EM indices throughout 2015. Even Chinese equities, despite all the official maipulation….er….support (the patriotic China Team may now own 6% of the market) ….look like ending the year badly hit by new scandals as well as profit-taking. It seems reasonable to doubt that US equities next year can continue to get the same support from share buy-backs at the same time as corporate earnings stand still. Any weakness there or elsewhere could fuel even more  M & A deals next year, albeit they will be pressed to match the sheer size of deals in 2015.

Chart 2 Global M & A: essential market support in 2015


Source Bloomberg via Financial Orbit

Whereas the ECB has so far fuelled only hope in European equity markets it is has already made investing in Eurozone sovereign bonds a bonanza for speculators (see Table 3), especially those willing to ride the convergence in yields of so-called ‘peripheral ‘countries. In fact, Greece excepted, the riskier the country hitherto the bigger the fall in yields. Good news indeed for punters on Italy (again!), Spain and Portugal!  A different sort of speculation, on interest rate hikes, has made investing in US Treasuries and, to a lesser extent, gilts much more problematic and also means the year is ending with a surge of corporate bond issuance in the US. Corporate debt has more than doubled in the US since 2007 while the interest rate burden has risen by a third despite average interest rate levels falling by a third. Unsurprisingly, around 50% of the corporate bonds around the world are ‘junk-rated’  with yields of 8% or more. The number of defaults in 2015 has reached 101 including 62 so far in the US and 21 in Emerging Markets. This is still some way short of the heavy defaults recorded in 2008-9 but nor is it a trend that will turn benign next year.

Chart 3 Heavy borrowing can seriously damage your health


Source FT

The real disaster area has, of course, been industrial commodities but grains have suffered too and even gold has slid to six-year lows (see Table 4). It has been a second terrible year for oil, which now seems to be settling into a $40-55 price range. This has in turn hit hard Emerging Market currencies, notably the real and the rand, and also the commodity-associated Australian, Canadian and New Zealand dollars. There is already talk that these are the recovery plays for 2016 but this flies in the face of economic fundamentals and sounds more like punters talking their own book.

The US dollar is still riding the prospect of the FOMC’s hiking in two weeks and its trade-weighted index has just touched again the witching 100 level. It has seen off all major challengers with the yen and pound holding up better than most, albeit for different reasons (see Table 4). The euro is by far the main casualty against the dollar and just about everything else except the oil-beleaguered Norwegian kroner. The odds of EUR/USD reaching parity are increasing but it will not be straightforward as many traders will be tempted to cash in their profits now that Thanksgiving is past. It could well happen in thinner trading over the peak festive season (and could well take with it GBP/USD below $1.50 again after its brief flirtation on November 30th). This appears to be what Mr Draghi wants, despite his disingenuous denials, but it could for many investors take the shine off gains made in European equities and sovereign bonds.

Chart 4 EUR/USD in November: half-way to parity


And it’s not over yet!

The saddest part of Syrian Crisis is that the plight of people who live there is being increasingly subordinated to geopolitical (=Machiavellian?) intrigue and even here in the UK to the future of the Labour Party. Oil still seems to be the main motivator for many of the protagonists, both in grubby (and dangerous) local trading and in the arcane alliance between Russia and Iran. On oil the US ought to be less interested but there appears to be a division between the more pacific White House and the still powerful NeoCons (=paranoid anti-Russian) elsewhere in Washington. As recriminations reverberate, it seems possible that ISIS has at different times received support from many previously unthinkable sources. What is definite, however, is that no support for ISIS has ever come from European governments, which rightly feel themselves the major losers from the crisis. It is not the suicide bombers and gunmen who are the threat to European stability but the waves of migrants, many of whom are not even from Syria. The first tests of public opinion come with the Spanish General Election, which should mean that Mr Rajoy stays in office (albeit in coalition) and the French Regional Elections, which should make a nice Christmas present for Marine Le Pen. The internal political, economic and social challenges will go on to overshadow not only 2016 but will shake the very foundations of both EMU and EU. No wonder Mr Hollande wants to tackle the problem at its root and is willing to work with anyone in doing so. No wonder that the UK government feels obliged to help and that so many Labour MPs see it as the point beyond which Messrs Corby and McDonnell are merely an embarrassment. There will, of course, be no winners in this terrible business.

As if they had not had enough air time already this year, December is the month of central bankers. First up is the ECB on Thursday with Mr Draghi playing ‘double but not quits’ by increasing and extending monthly QE asset purchases and taking rates deeper into negative territory. So far the Bundesbank has been both disapproving and acquiescent on such looseness and Mr Draghi probably feels he can just ignore the hawks. In fact, he had better not disappoint all the punters who have already priced in something dramatic. One technical hitch could be that if the ECB cuts the rate it pays on deposits by the banks to below -0.3% then there will not be enough German bonds eligible for purchase. So, another weakening of credit quality is looming. Perhaps Mr Draghi should go the whole hog by ignoring German bonds and start buying extra Italian and French ones! After all he is already on the escalator to underwriting all EZ sovereign bonds indefinitely. It is said that investors buying so many bonds with negative rates are banking on selling them on to ‘greater fools’. Any candidates, folks?

No sooner will the ECB have headed off further in one direction than the US November Labor Market data on Friday will almost certainly confirm that the FOMC will head in the other on the 16th. Only a complete undermining of the October numbers plus a slump in November Retail Sales (due on 11th) can stop the first hike now. However, it could well be the only hike for many months thereafter as the divergence with ECB and BoJ (meeting on 18th) could take the dollar to levels where Dr Yellen will meet resistance from her more internationally-experienced colleagues.

Just about every other central bank one can think also meets in December, including our own MPC on the 10th. This may be the occasion when the Committee discusses how their ‘macro-prudential’ colleagues (who reveal the UK Bank Stress Test results on the 1st) are planning to curb reckless borrowing (and lending) of both short-term unsecured personal loans and mortgages. This could be done by raising banks’ capital requirements thereby incurring costs that they would naturally want to pass on to their borrowers. This could be a cunning way to hike rates selectively to prick bubbles while going more slowly on Base Rates. It may also explain why the pound came under some pressure last week as hitherto it has been assumed that the MPC would follow the FOMC after a dignified interval. T

There are at least two ironies in all this central bank huffing and puffing. First, the CPI index in most major economies is likely to increase by around 1% in the first few months of 2016 as the main oil price slump drops out of the calculations. Dr Yellen et al may try to claim the credit but it is simply a matter of arithmetic and does not mean that prices are going up overall (although some in the Services sector will do so). Second, the central bankers still think that what they do will make a difference when the real problem is the slowdown in global demand, led by China but with knock-on effects both internationally and domestically. It really is time to recognise that the Emerging Economies are increasingly setting the pace.

  Chart 5 Memo to Central Banks:  Emerging Economies matter


Economic Insights – 02/11/2015

Only Disconnect!

This week’s misquotation comes courtesy of EM Forster (in Howards End) but is there a better way of describing market performance during another month of mixed to poor economic data? October is typically the worst month of the year for many equity markets but 2015 turned out even better than 2011, with all those that I monitor closing higher, albeit with a few wobbles at the very end, Market sentiment appears to have improved during the month and the most likely explanation is deeply unsettling. It is not really about confidence amongst investors in central banks and classical monetary policies but rather that algorithmic programmes are trading on the assumption that most investors either have such confidence or are too scared to bet against it. This seems  unsustainable and the October cornucopia may threaten the hitherto widely expected Santa rally  There is still just about scope in the US for another push higher but portfolio investors elsewhere must be tempted to wrap up the year soon while the going is good.  There seems little prospect in the next two months of major good news to justify hanging around unless one is looking for trading opportunities.

Chart 1 – Probability of FOMC hiking rates


Source: Bloomberg

Never fight the Fed?

This maxim has stood up well over the years but, as Chart 1 shows, markets have become more sceptical that FOMC members mean what they say, not least with their famous dot diagrams forecasting their own future decisions. Last Wednesday, the Committee wrong-footed dovish investors by indicating that a rate hike in December 2015 was very possible if not a done deal. Even now, however, it appears that investors place less than a 50% probability on that happening and a 5% probability that it will still not have happened by the end of 2016.

At the risk of oversimplifying, there are three alternative ways of describing the state of mind of ‘mainstream’ Committee members, based on last week’s Statement:

Delusion: Monetary policy is working in the US and Personal Consumption is sure to push annual GDP growth back above 3%. China’s official data may be a little massaged but Consumption will come good here too.  Other central banks will do their bit to boost both growth and inflation. An early hike will create the opportunity to cut again if things go awry and especially if the dollar surges out of control.

Cynicism: the FOMC’s credibility is now on the line after months of conflicting signals. One rate rise is unlikely to do much harm and many investors will be fobbed off by a ‘wait and see’ approach to subsequent hikes. Meanwhile, the rest of the world can go hang.

Realism: no matter how successful QE and ZIRP have been hitherto, their efficacy appears to be waning in respect of business investment and hiring new workers. There is currently no macroeconomic case for a series of rate hikes but the mere possibility could help with an orderly deflating of price bubbles in equity, debt and housing markets as well as discouraging hot money leaving the US at the drop of a hat.

It would be nice to think that realism was prevailing but more likely is a combination of delusion and cynicism being outweighed, at least at the next meeting in five weeks’ time, by a new outbreak of dovishness. Accordingly, no rate hike soon in the US.

So, what of the other Masters of the Universe? Despite his occasional lapses into vanity Mr Carney and most if not all of his MPC colleagues seem generally inclined towards realism. For some time now they have accepted that the impact of QE is diminishing and apart from the sparky Andy Haldane (who may well be kite-flying with his boss’s blessing) have resisted siren calls for zero or negative interest rates. Nevertheless, it must a bit annoying that the market boxes them in to a position where they can do little other than wait for the Fed, not least that it pushes up sterling.

Alas, in their different ways the ECB, BoJ and PBoC seem seriously deluded. Mario Draghi has more reason than most to feel he can move mountains with his defence of the euro but it is hard not to believe that his hubristic pronouncements have little effect on the real economy but instead provide punting opportunities for international speculators in equities (especially the DAX) , sovereign EZ bonds and, naturalamente, the euro. Chart 2 shows how both his expected and actual interventions in January, March and October have prompted shorting EUR/USD (the lower the white line the larger net short positions) thereby driving the spot rate lower (blue line), which Mr Draghi grandly asserts is not a formal ECB goal (ahem!).

Meanwhile, Haruhiko Kuroda also wrong-footed markets last week by failing to respond to the continuing stream of soft to awful economic data in Japan. He did not come across as any less deluded than previously but maybe he now secretly believes there is not much that monetary policy can do in his patch. In contrast, central bank inaction is not permitted in China as Mr Xi puts Communist Party imperatives above everything else. A sixth interest rate cut in less than a year suggests that neither the PBoC nor the economy at large have fully understood him!

Chart 2 – Punting on Draghi EUR/USD since Nov 2014


Source: Bloomberg

Central bankers at the helm?

The term ‘secular stagnation’ suggests a prolonged period of low growth, low inflation and high unemployment but it is quite tempting to opt for a less formal definition along the lines of an economic condition during which official monetary fails to stimulate growth.

In the US, the FOMC seems increasingly divided over when to start raising interest rates but somehow still unanimous in denying that ZIRP and QE2 and 3 have all been largely futile. This denial has put Committee members in a bind. On the one hand, they are concerned about asset price bubbles but on the other are also are worried that raising interest rates could cause a stock market crash and drive businesses and households into crisis. In this rarefied world they are joined by investors who know what FOMC members think and even know that they know they know and vice versa! There are similar worlds occupied by the ECB, BoJ and PBoC. On this basis, it is possible to assume that money will remain cheap indefinitely, asset prices will keep rising and that central bankers, while nominally at the helm are unwilling and unable to steer in a new direction. This is not attractive to your typical central banker!

So what’s do be done? Almost certainly, follow the Bank of England in doing nothing for an indefinite period while opening up new lines of research on macroeconomic and monetary policy. This could well lead to the conclusion that private debt is just as relevant to growth as public debt and that it is the commercial banks that separately and cumulatively determine aggregate credit. In fact, the Bank has issued research notes that suggest it is half way there already. This is a subject for much future discussion but in the short-term it suggests that rates should not be raised until both growth and inflation look to be firmly established. In the meantime, it is probably best to let equity markets correct (the UK market does not look outrageously expensive anyway) and speculation in gilts burn itself out. More controversially, it might be worthwhile to regulate more precisely lending for speculative investment.

Selling off now assets acquired under QE programmes would represent premature tightening but allowing some to run-off without replacement might reduce ongoing distortions to market rates. Again more controversially, such a run-off might create some space for the central bank to fund directly public investment. Such controversial policies would be more fiscal and, therefore, political than monetary and would throw into question the need for an independent central bank. Don’t hold your breath!

Wakey wakey!

It is definitely time investors for investors to wake up to the unreality of the world they share with central bankers. Writing in the Financial Times George Magnus put it well:

Speculative euphoria, even when encouraged by central banks, is defined by the way it ends — not with a whimper but with a bang….. Investors are still chasing low or negative yields in bond markets, fairly or fully valued equity markets, and rising property markets. Yet, it seems increasingly that, long-term investors aside, they are playing a greater fool game.

Investors often get their timing wrong often disastrously and the following chart shows that we may be at or close to another turning point where there will not be a greater fool waiting to buy.

 1 jun 5


Sovereign bond markets have become the gaming tables of speculators as who else could justify buying assets with negative yields to sell on to an even greater fool?

1 June 6

Turning again to George Magnus:

……the persistence of low real interest rates implies an environment of low real investment returns. So any euphoric returns today will be counterbalanced as night follows day. Central banks may be going boldly to the outer limits of monetary policy to encourage investors to buy risk, but it is difficult to reconcile the appetite for risk with what those policy actions actually imply.

Should investors throw in the towel? It is a conundrum. Institutions are still buying European debt on negative yields. Investors who have missed the doubling of the Chinese stock market since mid-2014 wonder if they can afford to stay out.

At least the penny appears to be beginning to drop amongst some people as shown in a recent BofA/Merrill Lynch survey of fund managers. Increasing one’s cash holding seems a smart move even if one is too superior to go for all that ‘sell in May’ stuff.


1 june 7

Regular readers will be aware that I advocated in March last year selective selling of equities and avoiding sovereign bonds. This may have cost money but it has also saved many sleepless nights. It is still not too late to do so now. However, I remain as convinced as ever that some individual stocks will ride though any storm provided one is willing to see them drop by up to 20% before recovering again. I also believe that returns as low as 4-6% through fixed rate coupons dividends or even capital appreciation are worth considering during a period of low growth and low inflation.

Deflation arrives at last: some clouds and a silver lining

After several months cheaper food and other shop prices have finally-just- prevailed over the bounce-back in oil prices from their plunge in 2014. As I expect oil production to counter any further speculative price rises, inflation is likely to stay negative for several months and remain below 1% until well into 2016 at the earliest. Moreover, the pipeline of continuing negative Producer Input and Output prices will also help to keep the lid on the CPI. So far, so benign!

However, slowing global demand seems to driving prices lower everywhere and it is hard to see that changing soon. Even if the initially reported (and hotly debated) weakness in Q1 GDP is revised higher there is no doubt the US economy is no longer the world’s locomotive while China is struggling to replace it and Japan and Germany have long since given up. Central banks seem to be running out of ideas and there is an increasing disconnect between economic fundamentals and asset prices. There are potentially very dark clouds gathering that could prolong this deflation and make it malign.

Looking on the bright side, the fact that the prices of Services are still rising may provide some silver lining in our Services-dominated economy if they are driven by robust demand for higher value purchases. After all, Central Banks do welcome moderate inflation as a sign of growth and the UK still needs Services to carry the baton for employment during the next few years if and when the economy rebalances. This should keep average earnings moving up and, depending on which services grow the most, might even help (whisper it soft!) productivity.

The immediate implication is that the MPC will continue to sit on its collective hands until well into 2016. The so-called hawks will be outvoted if they propose rate hikes sooner. Equities have remained untroubled throughout the build-up to deflation and now it has arrived gilts and even the pound should also settle down again, the latter reacting more to news and rumours from the FOMC and ECB.

To finish on a slightly pedantic note, the BBC’s Andy Parsons and I  have shared on Twitter our disapproval of describing the latest CPI as ‘low inflation’ or ‘negative inflation’.  We are calling it deflation, for that is what it is and for good reason.

Once more unto the breach

I very much regret that I have to carry on with my recent themes with some new emphasis on the clouds gathering over the US economy, albeit that relatively little news is actually due from there this week. The latest FOMC minutes will no doubt confirm the growing gulf between hawks and doves amongst the regional Fed presidents but Chair Yellen and her fellow governors have probably again tried to say as little as possible. The April CPI is the other significant US announcement and it will likely remain close to zero but the FOMC still do not seem inclined to pay much attention to it.

US economy: not in the script

One of my acerbic correspondents in the US (@smaulgld) pointed out yesterday that ‘lowering GDP estimates is a national sport now’ and indeed he deems the economy already to be in recession. There is certainly plenty of recent data to encourage caution if not downright pessimism.  US economic headlines concentrate on monthly numbers and last week reported higher March retail sales but year on year growth’s falling further to a lowly 1.3% is rather ominous. Moreover, the monthly numbers have a history of being revised substantially lower as shown in the chart below.


Source: Zerohedge

Even more worrying from last week was a fifth consecutive monthly drop in Industrial Production, which in April was just about chugging at 1.9% year on year. The great hope remains Employment but the weight attached to the headline Non-Farm Payroll numbers is exaggerated.  Currently, a debate is carrying on both as to whether US Q1 GDP is always low and also whether there were exceptional factors at work this year. Fresh from forecasting Q1 reasonably accurately, the Atlanta Fed Nowcast is predicting that Q2 is unlikely to be much better. Since these Nowcasts started in 2011 regular technical improvements are resulting in error margins of 0.7% annualised. Accordingly, for my part I am willing to accept that the latest Nowcast of 0.7% shown in the chart below means that US GDP in Q2 is running at somewhere between flat and +1.4%. Others, coyly described as ‘Blue Chip Consensus’, seem to be veering in the same direction. This is not a happy outlook and is still not in the script for many investors.


More slow boating in China

Official China data has long been viewed, along with much else in China, as being managed to reflect Socialist Realism and conformity with Party Policy but somehow the numbers still keep getting worse. Last week it was New Loans, Fixed Asset Investment, Retail Sales, Industrial Production and even Inflation (too low). This chart courtesy of China-expert George Magnus highlights the trend in recent months, with no end in sight.

China Data 2007-15

blog 3

EMU: Better but don’t forget the deflator

Everyone loves a good headline and there plenty last week proclaiming that EZ GDP growth in Q1 outstripped that in both the US and the UK. There is no doubt that a solid recovery would represent good news for all concerned and maybe things really are looking up a bit but precious little mention was made of the boosting of the nominal numbers by the price deflator. This was negative throughout most of the EZ in Q1, notably so in Spain and Italy. Moreover, deflation persisted despite a fall in the EUR/USD exchange rate of 11.2% in Q1 and following a 12% drop in 2014 and while this previous euro weakness has certainly helped exports the sharp turnaround in Q2 will surely be a drag on each of GDP, Trade and Inflation. At the risk of seeming churlish, it should also be noted that both Industrial Production and Retail Sales are running at levels below 2% while Unemployment remains stubbornly above 11%. We must hope for more progress in Q2 but be prepared for some disappointment.


Meanwhile, Grexit has somehow managed to sneak off the front pages but a leaked internal IMF memorandum suggests its return very soon. The main points are:

  • The negotiating process may have got easier, with Prime Minister Tsipras apparently taking more interest, but it remains ‘far from ideal’ with no direct access to ministers.
  • Major concerns are deposit withdrawals (increasing dependence on the ‘Eurosystem’), non-performing loans and a deteriorating ‘payment culture’
  • There has been progress on reforms to Vat, tax collection and insolvency law
  • Loan repayments to the IMF in June, July and August cannot be funded without help from the rest of EMU but there has been no agreement, even on partial disbursement
  • IMF staff appear to believe that debt relief is needed but they are not prepared to press other EMU countries to grant this
  • The Syriza government seem determined to press on with reversing measures agreed by its predecessor on pension and labour market reforms or on laying off public sector workers.

Significantly, the memorandum seems entirely consistent with Mr Tsipras’s latest pronouncements, in particular his ‘red lines’ on pensions, wages and rehiring of public sector employees.  He may or may not still believe that other EMU governments can be shamed into coughing up but they seem more interested in passing off the blame to the IMF, ECB or better still the Greeks themselves. The IMF reckons the cash will run out in June but it probably has already.

UK: Land of Hope……

….and maybe even a modest amount of economic glory as last week yet another set of strong Employment numbers and signs of renewed growth in Manufacturing and Construction after a dull Q1. Productivity is now seen as the UK’s Achilles Heel, although it is also a problem in most other advanced economies. Chancellor Osborne is likely to have something to say on the subject in his second Budget on July 8th with a major splurge on Supply Side stuff: apprenticeships, capital allowances, seed capital for new technologies and high value sectors, funding for small business, house building and Infrastructure. His Northern Powerhouse and other offers to local authorities are still not being taken sufficiently seriously but are of huge economic and social s as well as political ignificance. On the tax and welfare fronts Mr Osborne is likely to deliver his IHT pledge to ‘ordinary’ house owners while using higher CGT on the wealthiest to pay for it but both the main pain and jam are likely to be postponed.

Meanwhile, Mr Cameron seems to have plans of his own, including for the EU referendum. Having seen off UKIP with his pledge to hold it he has now while impressed his Tory Eurosceptics by being in a position to do so. Foreign Secretary Hammond, an erstwhile Eurosceptic is clearly on board with his newly emollient approach to EU Treaty changes while other ministers have at last admitted that many of the friction points can be dealt with internally. Also helpful is Andy Burnham’s offer of support, albeit with conditions, for the negotiations: a smart move by him, helpful to Mr Cameron and in the national interest.

Election post mortems are continuing and The Spectator has run two contrasting stories of quiet confidence at Tory HQ and manic delusion at Labour’s. Even with a generous pinch of salt it is hard to argue with the description of the professional expertise of the Tories’ Lynton Crosby and the smouldering divisions within Labour, which have now come to the surface. Peter Mandelson’s spoke for many in the party with the devastating comment that what Ed Miliband most lacked was an economic policy. It is hard not to sympathise personally with Mr Miliband while also remembering that those who live by the sword often die by it.

Central Banks: running out of ideas

Nobody could ever say that central banking was easy but those who try run an economy with an interventionist monetary policy end up reaping the whirlwind, as it were.

FOMC: They clearly want to raise rates not so much to tighten per se but to get some flexibility after six and a half years of near-zero rates and various QE programmes. They have, however boxed themselves by making any change ‘data dependent’ and, of course, the numbers are starting to go the wrong way. Various committee members keep sending out conflicting signals and have managed to confuse many economists, if not themselves. The Wall Street Journal has been tracking changings views on the date of the first rate hike so far in 2015 ,as shown in the chart below. Although I do not participate in the WSJ’s surveys, I would have gone with the June consensus (red) until the March FOMC but now am blue, most likely in December 2015.

blog 4

PBoC:  It has so far eschewed both ZIRP and ‘conventional’ QE but successive cuts to both lending and deposit rates and to the Reserve Requirement Ratio for banks do not seem to be having much effect. Bailouts of local authorities, state-owned enterprises and even private sector companies look to be the next step, which will look and feel very much like QE but only using vast accumulated reserves rather just printing money. In fact, the first bailouts have already been arranged via the state-owned banks. The PBoC is, of course, under the control of the Communist Party leadership, who seem to be willing to pursue high risk policies such as encouraging booms in real estate and shares. Sound familiar?

ECB: Never a shrinking violet, Mario Draghi is already boasting about the success of his QE programme, the mere rumour of which did indeed start the depreciation of the euro. However, in the last few weeks the euro has come roaring back, bond yields have soared and many European share prices have been hit as a consequence. Supermario is, in fact, assailed on two fronts:

  • The Bundesbank (and many others) saying that QE was unnecessary and competitive currency devaluations only work in the short-term and can rebound.
  • The various EMU governments creating a new existential challenge to the euro by refusing to hand over any more money to Greece despite pressure from him, the EU Commission and the IMF. Rubbing salt into the wound, the ECB itself is facing a multi-billion hit on Greek sovereign paper it holds.

MPC: It is hard to tell when Governor Carney decided doing nothing was the best monetary policy for the UK but he is surely right to leave well alone. In retrospect, he must be grateful that previous MPCs did not cut rates to zero and continue indefinitely on the QE treadmill. The election of a majority Conservative government committed to fiscal correctitude must suit him while he keeps monetary policy loose but he is also right to argue for an early resolution to continuing membership of the EU. This means that the worst criticism he faces is over poor economic forecasting. Below is the GDP chart from the latest Quarterly Inflation Report, which shows that the MPC believe growth will be in 2-3% range for the next three years but…….it could be as low zero or as high as 5%! The other non-shock forecast was that Inflation will eventually return to the target of 2%. Well, put like that it could just happen!

blog 5

Put not your trust in princes or central bankers (Psalm 146)

This may not be an exact quote from the King James Bible but it could well become increasingly appropriate advice for those investors who have come to believe, whether out of cynicism or naivety, that the various central banks both can and will ‘see them right’.  The People’s Bank of China still appears the most obliging as it is under political orders to ease monetary policy and provide bail-outs wherever needed. In the US,  while the FOMC does seem to have abandoned altogether renewing the notorious Greenspan and Bernanke ‘puts’ for investors it remains collectively ambiguous as to when the first interest rate hikes will start. The Bank of England has been much more restrained in deed but in word has indulged in occasional kite-flying about raising Base Rates and, most recently, in cutting them. In contrast, the ECB and Bank of Japan are still ‘gung ho’ on QE, ZIRP/NIRP and competitive currency devaluation.

Last week collywobbles in most equity markets further confirmed that some investors are losing confidence both in the global economy and the ability of central banks to do much about it. In fact, US markets have been flashing hot and cold for much of the last six months in response to FOMC ambiguity while those in Europe and Japan have been either awaiting or responding to ECB and BoJ QE programmes. Since Mr Draghi fired his starting gun investment flows have been complex with some US investors eager to exploit ECB as well as BoJ largesse while some European and Japanese investors have taken the opportunity to pile into the US. Mr Draghi, presumably deliberately, has set off a feeding frenzy for European sovereign bonds and shorting the euro in favour of the dollar.

Around the world, commentators with varying degrees of shrillness are ramping up talk of asset prices bubbles and surely there will soon be more frequent alarms over Ponzi schemes and Minsky moments. Market movements and economic fundamentals rarely coincide but it is worth saying that the latter are definitely not encouraging. Whatever monetary policy has been credited with in the past it appears now not to be doing much for global demand. Accordingly, putting trust in central banks is asking too much of them. Moreover, at the risk of ending with a banality, it should be noted that the ‘sell in May’ season is already upon us.


There are two contenders for Weekly Irrational Movements in Prices

Thirty-year German bund yields: 0.48%, down 17 pips on week and 90 pips in 2015 so far. OK, so you might end up being repaid in DMarks but less than half a per cent return for 30 years?

Shanghai Composite: up 6.7% last week, 32.5% in 2015 and 111% in 12 months. Even the Chinese authorities are rattled!

Punch bowl maintained

The main story continues to be what central bankers are saying and whether investors believe them. It is evolving all the time and the more complicated it gets, the scarier it becomes. The FOMC is still the biggest actor and the minutes of its March meeting managed to sound dovish while leaving the door open to a rate hike as soon as June.  This, coupled with a string of mixed to soft economic data, has made some  US investors turn on its head the bon mot ‘good news from the economy is good and bad news even better as the FOMC will step in’.  Now, it may be that ‘good news’ from the FOMC means the economy is going bad! The minutes suggest that four or five ‘participants’ still favour a rate hike in June while ‘a couple’ want to delay until 2016. That leaves a solid block of ten or eleven, including Chair Yellen and her four fellow governors, looking at September at the earliest.

Meanwhile in Japan, the dissident Takahide Kiuchi’s modest ‘normalising’ proposals were buried by his eight colleagues at the BoJ. We shall have to wait to see if the Bank of England’s MPC are still unanimous or if Andy Haldane’s kite-flying on lowering Base Rate has won any support.

Weekly Irrational Movements in Prices (WIMPS)

Whatever investors think the central bankers will do next, many are clearly struggling with the increasing disconnect between price movements and fundamental macroeconomics and politics or even specific corporate earnings. So, rather than highlight the biggest movers why not the daftest? This could become a regular feature in Economic Insights but I am not yet sure I can aware prizes every week. There was certainly very stiff competition last week.

Ten year German bond yields: 0.16%, down 3 pips on week and 38 pips in 2015. Catch them before they go negative?

Ten-year Portuguese government bond yields: 1.64%, down 6 pips on week and 105 pips in 2015. Of course, that nice Mr Draghi will guarantee repayment in full?

Brent Crude: up 5.$% on week but only 1% in 2015. Will the Iran nukes deal affect oil supple? Or not? Who cares?

USD/RUB: down 6% on week and 12% in 2015. Hurry, hurry before all those bargains in Russia are snapped up?

Hang Seng: up 7.;9% on week, but ‘only’ 15.5% in 2015. What could go wrong trying to catch up with Shanghai? This week’s winner.