Broken Records

The past year has been remarkable with political precedents set in the US, UK and France, still record-low central bank policy rates in most developed economies and financial markets and macro data at all-time or multi-year highs (and lows).

The US presidency is fraught with problems but markets are turning a blind eye…for now. The UK is still on course to be the first ever member state to leave the European Union come 29th March 2019, at least on paper. French elections have repainted the political landscape and present many opportunities but old (fiscal) hurdles still need to be cleared.

Central bank policy rates remain at record lows in the majority of developed economies, including the Eurozone, UK, Japan, Australia and New Zealand and I expect this to remain the case for the remainder of the year. Loose global monetary policy is likely to continue providing a floor to risky assets, including equities and emerging market currencies.

A number of central banks have hiked 25bp in recent months, including the Fed, BoC and CNB, in line with my year-old view that rate hikes would gradually replace rate cuts. But in aggregate the turnaround in developed central bank monetary policy is proceeding at a glacial pace and I see few reasons why this should change.

The Bank of England has not hiked its policy rate for 526 weeks – a domestic record – and I continue to believe that this stretch will extend into 2018.

In contrast to the Dollar and Sterling, the Euro – by far the most stable major currency in the past seven years – has appreciated over 7% since early April.

While the ECB may want to slow the current rapid pace of Euro appreciation, it is unlikely to stop, let alone reverse, the Euro’s upward path at this stage. For starters, Eurozone growth and labour markets continue to strengthen. The German IFO business climate index hit three consecutive record highs in June-August.

Perhaps the most obvious record which financial markets have broken is the continued climb in US equities to new highs and volatility’s fall to near-record lows.

Emerging market rates continue to edge lower in the face of receding inflationary risks and I see room for further rate cuts, particularly in Brazil given the pace of Real appreciation.

Non-Japan Asian (NJA) currencies continue to broadly tread water, in line with my core view that NJA central banks have little incentive to materially alter their currencies’ paths.

Year-to-date emerging market equities have rallied 24%, twice as fast as the Dow Jones (12%) which has rallied twice as fast as EM currencies versus the Dollar (6%). Read more

Politics suspected of interfering with economics and markets

In the US, political intrigue, seemingly lifted straight out of a John Le Carré novel, has reached a crescendo and there are now multiple investigations running concurrently.

If we assume these investigations will run over weeks/months, the question is whether and to what extent this political backdrop is likely to impact financial markets, US government policy-making, the US and global economy and Federal Reserve monetary policy.

US equities have corrected lower, volatility has spiked and markets are seemingly ignoring positive data surprises

It has all been rather orderly so far but it is difficult to see how at this juncture, with major policy initiatives likely kicked down the road, US equities can launch another meaningful rally. If anything big data misses are likely to further pressure stocks. 

The Dollar’s performance has been mixed in the past month, posting its biggest loss against the euro in line with the fundamentally bullish euro view I expressed in December and April.

Capital inflows into the eurozone allied to a 2% of GDP current account surplus, a pick-up in economic activity and receding political risks following the French presidential elections are likely to extend the euro’s current rally near-term.

However, the ECB’s stance on its quantitative easing program will be key in shaping the euro’s medium-term path.

US economic indicators paint a blurry picture while solid global GDP growth is seemingly struggling to make further gains.

The Fed and US rates market have the unenviable task of making sense of these macro trends and a quickly changing political landscape.

The apolitical Fed will of course stay above the political fray, even if markets do not with pricing for the probability of a 25bp hike at the 14th June policy meeting continuing to oscillate between 60% and 75%.

My core scenario is that the Fed will hike rates only once more in 2017 although I acknowledge that this is not a high conviction call. The market seems still on the fence, pricing in a further 32bp of hikes in the remainder of the year.
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Global Central Bank Easing Nearing Important Inflexion Point

Recent comments from the Fed, ECB and BoJ have rattled financial markets after a summer of relatively low volatility.

The correction in financial markets has so far been relatively modest, particularly for equities and the dollar. But the questions remain where global monetary policy goes from here, the implications for asset valuations and ultimately whether elevated global risk appetite will correct more forcefully.

My core view is that eight years of ultra-low (and in some cases negative) central bank policy rates and expansive bond-buying programs have helped stabilise global growth and inflation, albeit at low levels.

At the same time, the costs of ultra-loose monetary policy, including asset price bubbles, distortions in bond markets, pressure on the banking sector and even rising inequality, may be starting to outweigh the benefits.

Therefore, major central banks, with the exception of the BoJ, may refrain from loosening monetary policy further near-term.

I would certainly expect central bank policy rate cuts to become increasingly less frequent than in the past and the ECB and BoE to keep the modalities of their current QE programs broadly unchanged for now.

At the very least, the world’s most influential central bankers may going forward tweak a discourse which has in recent years largely focused on doing “whatever it takes”.

To be clear, the risk near-term remains biased towards more central bank monetary policy easing. Bar the Fed and possibly a handful of EM central banks still fighting weak currencies and high inflation, no major central bank is likely to hike policy rates or tighten monetary policy this year, in my view. That’s a story for 2017, at the earliest.

But if we have indeed reached an inflection point in global central bank monetary policy, if anything financial markets will become more sensitive to any downturns in still tepid global growth and inflation and to the negative side-effects of loose monetary policy.

In this context higher volatility is likely to prevail and global risk appetite may struggle to forcefully regain traction for now. Read more

Global growth – Down but not out

While equity and commodity markets have recovered, it is an almost consensus view that already tepid global economic growth in H2 2015 likely weakened furthered in Q3 and shows few signs of recovering near-term,

Governments, lacking in both leadership and fiscal-reflation headroom, have passed the buck to central banks struggling to hit multiple growth, inflation and financial stability targets.

However, talk of global recession let alone economic collapse is somewhat overdone and I reiterate my long-held view that the global growth story is a cause for concern, not panic (17 December 2014).

Global GDP growth has been mediocre but pretty stable in the past three years at around 2.4 and 3.2%, according to respectively World Bank and IMF estimates, so perhaps it is the expectation of a return to pre-2008 growth rates which is unfounded.

International institutions have revised down their global GDP growth forecasts for 2015 but history suggests that the IMF’s 2015 forecast of 3.1% growth may prove a tad too pessimistic.

The focus on China’s ill-defined “hard-landing” and “true” growth rate has obscured the fact that growth in US, still the world’s largest economy, is back to its long-term average. 

Finally, while policy-makers are running out of tools to spur their economies, a number of emerging market central banks, including in China and India, still have room to cut policy rates further.

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Deflation, what deflation?

Four themes have hogged the headlines this year – Greece, China, the Fed and linking these three topics…the risk of deflation and associated damage to the global economy.

At the risk of over-simplifying a complex picture, what is striking is that global headline and core inflation have actually been pretty well behaved (see Figure 1). Further analysis shows that headline and core inflation have evolved in reasonably narrow ranges since early 2013 in the world’s largest developed economies as well as China and Mexico. The fact these inflation data series are a little boring is in itself noteworthy given that central banks typically favour low and stable inflation. Read more