A Different Perspective
Asking the Right Questions
ECB meeting in focus
The main event this week is without doubt the monetary policy meeting at the European Central Bank (ECB). There is no room to move on interest rates because we are at the lower bound but we can expect the so-called “detailed modalities” of Draghi’s plan to buy “simple and transparent asset-backed securities (ABSs)”. In his press conference following the announcement Draghi can expect to be grilled on whether his package of measures will really be enough to boost the ailing Eurozone economy. In particular focus will be the failure of the first of his “targeted longer-term refinancing operations (TLTROs)” with banks only taking up €83 billion of a €400 billion allotment of 4 year funding at 0.15%. The poor take-up of almost free money is either a damning reflection of the lack of demand in the Eurozone economy or a banking system that is still on life support. Those hoping for the immediate answer from Super Mario will be disappointed.
Market Recap: Week of September 29th
Global equity markets struggled again last week as volatility picked up while demand for government bonds saw yields move lower. Of the major indices, Germany’s DAX equity index suffered the steepest decline, down 3.15%. In the US, the tech-heavy NASDAQ fell 1.48%. In Asia, the Hang Seng Index of Hong Kong listed shares fell 2.58% amidst protests against Beijing’s interference in the election process of the autonomous region.
Government bonds were in demand last week with the German 10-Year bond yield closing 7bps lower at 0.97%. This compares to the US Government 10-year bond yield of 2.54%, with the spread over Germany the widest since 1990, drawing further attention to the theme of diverging monetary policy at the US Federal Reserve and the ECB.
This divergence theme has played out in currency markets in recent months with the US dollar moving higher across the board. Meanwhile, the Euro has weakened considerably finishing the week at $1.27 USD, after almost hitting $1.40 earlier in the summer.
Essentially, the US dollar is strengthening on the view that the US economy has reached a sustainable momentum that will allow rates to rise. However, a negative feedback loop could develop whereby the USD strength hurts the economy via weaker exports and thereby delays monetary policy normalisation. The global economic recovery still remains delicately poised!
Outlook
Key macro data includes the final estimate of second quarter GDP growth from the UK and Euro area. However, the purchasing manager index (PMI) reports and confidence surveys from around the globe will provide a more useful indication of the momentum behind the global economic recovery. There are also reports on unemployment and retail sales from the Euro area for August, while on Tuesday the release of the flash estimate of inflation for September will garner significant attention ahead of the European monetary policy meeting on Thursday.
In the US, the employment situation report will be in focus on Thursday after the worse than expected payrolls data last month and the Fed reiterating that “there remains significant underutilization of labour resources”. In Japan, there are reports on retail sales, industrial production and unemployment on Tuesday while the Bank of Japan’s quarterly Tankan survey, an important indicator of business sentiment used in formulating monetary policy, will be released on Wednesday.
The ‘Bond King’ departs; no player is bigger than the Club?
In football you’ll often hear managers throw out the cliché ‘no player is bigger than the club’. In truth they will bend this rule for players blessed with exceptional talent; Eric Cantona and Luis Suarez would have been turfed out of Manchester United and Liverpool respectively had it not been for their genius. But when a player’s powers begin to wane managers are much less forgiving. Alex Ferguson comes to mind and his acrimonious split with the legendary Roy Keane. Keano had acquired cult status at Old Trafford, and rightly so, epitomising the winning mentality at United. But in 2005 he ‘overstepped the mark’, according to Fergie, lambasting his teammates in the infamous ‘MUTV rant’. However, I have no doubt if it had been five years earlier, Fergie would have covered up the interview instead of using it to part company with a club icon while keeping the United faithful onside.
This brings me to the departure of the legendary Bill Gross from PIMCO last week, a company he co-founded and where he enjoyed an illustrious career of outperformance, earning the title ‘Bond King’ as he rode the wave of a 30 year bond bull market. Like Keano at United, Gross had become synonymous with PIMCO but in recent years there were signs he was losing his magic. Some big calls he made publicly turned out to be horribly wrong as the major central banks began to call the shots in bond markets, defying the old money supply rules. For once Gross began to underperform his peers which manifested in consistent outflows from PIMCO as investors lost faith in his skills. Suddenly the firm’s leadership began to see Gross’s personality as less ‘quirky’ and more ‘jerky’.
It is clear Bill Gross jumped before he was pushed, with management claiming that “over the course of this year it became increasingly clear that the firm’s leadership and Bill have fundamental differences about how to take Pimco forward”. Janus, another firm familiar with outflows, signed the ageing superstar with their shares jumping over 33% on the prospect of Gross attracting fund flows. However, like Keano, whose best days were behind him after United, Janus may be just signing a big name struggling to adapt to a world dominated by central bank monetary stimulus. For PIMCO, their job will be to convince investors that no player is bigger than the club!
“We need balance. Its absence can have serious consequences”
In a recent speech Bank of England governor Mark Carney said the challenge now facing the Bank is turning the UK economic recovery into a “durable expansion”. He emphasised: “To do so, we need balance. Its absence can have serious consequences”. Balance is just as crucial in football as Louis Van Gaal found out over the weekend with his ‘new galacticos’. The overpaid ‘superstars’ at Liverpool were no better though. If the legendary Bill Shankly was alive he would have them “put in jail”. Still it was all about the grassroots football yesterday, with my own Straffan AFC in the Kildare Division 1 cup final against Newbridge Hotspurs. After going behind early on, and with a two man disadvantage for the last half hour following two red cards, we defied the odds with a heroic victory. At 1-1 and six minutes left, I got on to a sublime defence splitting through ball. One chance……goal! Champions!
Market Recap: Week of September 22nd
Most major equity indices moved higher last week with markets buoyed by the monetary policy statement from the US Federal Reserve and also the news that the Kingdom would remain United, for now! The S&P 500 closed up 1.25%, while the yield on the US 10-Year Treasury barely reacted to the FOMC’s projections of a steeper expected path of interest rates, up just 0.01% over the week to 2.62%. The Nikkei 225 Index was the strongest performer of the major bourses, up 2.34%, boosted by a weaker Yen.
The Scottish referendum dominated news in Europe, with financial markets nervously awaiting the outcome of the vote. The triumph of the “Better Together” campaign eased concerns shown in recent weeks. However, it was clear from the result that this is a country divided; just 55% voted to retain the status quo with strong support shown mainly from the elderly voters and the more affluent areas of the country.
The first of the ECB’s targeted longer-term refinancing operations (TLTROs), 4 year funding at 0.15%, was deemed a failure with banks borrowing just €83 billion. This was well below market expectations, making the “detailed modalities” of Draghi’s ABS purchase programme even more important.
Outlook
European equity markets have opened lower this morning after a weak session in Asia overnight. On the macro front this week we have the final estimate of second quarter GDP from the US along with reports on durable goods orders and housing. There are a host of Purchasing Managers Index (PMI) surveys from around the globe as well as consumer and business confidence surveys which should provide a useful update on the momentum behind the economic recovery. The Bank of Japan will report the August inflation data on Friday.
US Federal Reserve Meeting: Key Takeaways
FOMC Statement Wording. Janet Yellen kept markets sweet by maintaining the wording used in her previous statement, “significant under-utilization” to describe the labour market and “considerable time” for the length of the period after the asset purchase program ends before the first rate hike.
When will the program end? As expected the Fed cut the current rate of monthly bond purchases, conducted under their third round of quantitative easing (QE3), by $10 billion to $15 billion. While the Committee will end this program next month, it does not mean an end to their bond purchases.
How long is “considerable”? In her first ever post FOMC press conference last year, Janet Yellen made an off-script remark “something in the order of six months”. She later backed away from this, even though the market hasn’t forgotten, since emphasising that there is no “mechanical interpretation” of what the term means. The truth is that it is however long they want it to be.
“Contingent on the Economic Outlook”. As for the Fed’s own economic outlook, three months is a long time in forecasting – “There has been a little bit of downgrading”. The Fed’s central tendency of the projections for real GDP growth in 2014 is now 2.0 to 2.2 percent, down from 2.1 to 2.3 percent. However, this compares to their forecast of 2.8 to 3.0 percent in March!
Follow the dots. There has been much focus on the Fed’s so-called dot plot, the graphic that plots each FOMC participant’s appropriate level of the target federal funds rate at the end of the specified calendar year or over the longer run. The expected rate path now appears to be steeper. However, these individual projections carry their own uncertainty and even then the dispersion of the ‘dots’ alone does not give us any statistical confidence in the path of interest rates derived from the mean of these dots. Janet pleaded the fifth on her dot – “I don’t want to identify myself”.
Fed Balance Sheet Reduction: While QE3 will end next month, the Fed will still be buying bonds through the reinvesting of proceeds from maturing Treasury securities and principal payments from holdings of agency debt and MBS. Their balance sheet now stands at circa $4.5 trillion, up from the pre-crisis level of circa $860 billion. The Fed ‘will only taper and eventually cease the reinvestment policy once they are sure normalisation is successfully underway’. On returning the balance sheet to pre-crisis levels, “it could take to the end of the decade to achieve those levels”.
Impact on the US Treasury: If the Fed ends their reinvestment policy it will, in effect, end a funding source for the US government. When the Fed’s treasury security holdings mature, the issuer (the US government) would then be required to repay the principal. A balance sheet reduction of $3.7 trillion by the end of the decade is therefore inconceivable without debt monetisation. This would of course erode the credibility of the central bank, the US dollar and the confidence in the system. In truth, they are already getting this benefit because interest income is remitted to the Treasury.
Uncertainty: “Things will depend on how the economy evolves. That will change over time and there’s a good deal of uncertainty associated with it.” The Fed has already conceded that the recovery has been slower than they expected given their unprecedented level of monetary stimulus. Therefore markets might be overplaying the Fed’s confidence in being able to normalise monetary policy without significant market dislocation.
Scottish Independence Vote – What have the British ever done for us?
As the Scottish vote on Independence fast approaches I can’t help but be reminded by the famous “what have the Romans ever done for us” scene in Monty Python’s Life of Brian when Reg (John Cleese), leader of the “People’s Front of Judea”, tries to rally his fellow PFJ revolutionaries against the imperialist Romans, exclaiming “they’ve taken everything we had….and what have they ever given us in return?!”, to which his followers respond with all the good things Roman occupation has brought. After begrudgingly accepting the positives, Reg concludes: “All right, but apart from the sanitation, medicine, education…….what have the Romans ever done for us?”.
It is classic Monty Python but the reason I draw the parallel is because I believe the undecided Scots, who will ultimately decide the result, are more likely to err on the side of all the good things that have come with being British. I’m not Scottish so I can’t frame how a nation thinks, nor am I saying which way I would vote if I had the choice. I’m simply basing this on the fear of the unknown, the prevailing force that limits people. It is often why people don’t quit the job they dislike, why they stay in bad relationships, or why they rarely move outside their comfort zone in general. So I believe the undecided will sway in favour of the NO campaign, because what these people actually have under the current system will outweigh the uncertainty and inability to quantify the economic and social consequences that comes with the patriotic idea of a free Scotland.
While the market speculates on the impact of a Yes vote – consensus view being a weaker pound forcing the Bank of England to keep rates lower for longer – the biggest implication is that a stronger conservative government in England could pave the way for their own exit from the European Union. It is ironic given the rhetoric against the treacherous Scots looking to break away from another union. Ultimately though, it does raise questions about the fragility of our society, our economic and financial systems, if a nation of 5 million people choosing the right to self-govern can have the ‘cataclysmic’ impact on the world that is being foretold.
There is one warning that perhaps the Scots should heed. Legendary investor (speculator) George Soros, known as the “man who broke the Bank of England”, (he made a reported $1 billion profit in 1992 betting against Sterling as the UK government was forced to abandon the European Exchange Rate Mechanism) warned in the Financial Times last week against the break-up, reminding Scotland that “divorce is always messy”. The 84 year old does have some pedigree in this department, moving on to wife number three last year. In fairness though, George maybe should have added that divorce can sometimes bring benefits, like a Californian half his age. I’m sure it’s his personality and not his reported net worth of $24 billion!
Away from the market noise and the fear that Scotland may self-combust, the Champions League kicks off this week, easing the pain from Liverpool’s miserable display Saturday and the “new beginning” hype in Manchester. Luis Van Gaal has morphed back from devil to King, talking about the title after one win against a promoted team, akin to the Greek finance minister telling us to now “bet on Greece”. Still, King Luis has a week off to rejoice in his first premier league win as he watches the big clubs from his couch!
What have the British ever done for us?
As the Scottish vote on Independence fast approaches I can’t help but be reminded by the famous “what have the Romans ever done for us” scene in Monty Python’s Life of Brian when Reg (John Cleese), leader of the “People’s Front of Judea”, tries to rally his fellow PFJ revolutionaries against the imperialist Romans, exclaiming “they’ve taken everything we had….and what have they ever given us in return?!”, to which his followers respond with all the good things Roman occupation has brought. After begrudgingly accepting the positives, Reg concludes: “All right, but apart from the sanitation, medicine, education…….what have the Romans ever done for us?”.
It is classic Monty Python but the reason I draw the parallel is because I believe the undecided Scots, who will ultimately decide the result, are more likely to err on the side of all the good things that have come with being British. I’m not Scottish so I can’t frame how a nation thinks, nor am I saying which way I would vote if I had the choice. I’m simply basing this on the fear of the unknown, the prevailing force that limits people. It is often why people don’t quit the job they dislike, why they stay in bad relationships, or why they rarely move outside their comfort zone in general. So I believe the undecided will sway in favour of the NO campaign, because what these people actually have under the current system will outweigh the uncertainty and inability to quantify the economic and social consequences that comes with the patriotic idea of a free Scotland.
While the market speculates on the impact of a Yes vote – consensus view being a weaker pound forcing the Bank of England to keep rates lower for longer – the biggest implication is that a stronger conservative government in England could pave the way for their own exit from the European Union. It is ironic given the rhetoric against the treacherous Scots looking to break away from another union. Ultimately though, it does raise questions about the fragility of our society, our economic and financial systems, if a nation of 5 million people choosing the right to self-govern can have the ‘cataclysmic’ impact on the world that is being foretold.
There is one warning that perhaps the Scots should heed. Legendary investor (speculator) George Soros, known as the “man who broke the Bank of England”, (he made a reported $1 billion profit in 1992 betting against Sterling as the UK government was forced to abandon the European Exchange Rate Mechanism) warned in the Financial Times last week against the break-up, reminding Scotland that “divorce is always messy”. The 84 year old does have some pedigree in this department, moving on to wife number three last year. In fairness though, George maybe should have added that divorce can sometimes bring benefits, like a Californian half his age. I’m sure it’s his personality and not his reported net worth of $24 billion!
Market Recap: September 15th 2014
Global equity markets moved lower last week with the main headlines assigning blame to better than expected US economic data, retail sales moved higher and consumer sentiment hit a 14-month high. Yes that’s right, we live in a perverse central bank led world where financial markets fret that stronger than expected economic data will bring forward the timing of rate hikes. The previous week, they revelled in the ‘good news’ that US employment was weaker than expected as fewer payroll jobs were added in August, hence prolonging the timing of rate hikes. It’s bizarro world, where stronger than expected is bad and weaker than expected is good!
The major equity indices in the US and Europe fell in the region of 1%, while emerging markets, which have become increasingly sensitive to US monetary policy, suffered much bigger losses. The MSCI Emerging Markets Index fell 3.2%, the largest weekly drop since the ‘taper tantrum’ of June 2013 when the Fed intimated the coming end of their bond purchase program. The prospect of the US Federal Reserve raising rates sooner than expected also hit the bond markets, with the US 10 Year government bond yield jumping 18bps to 2.61%, the largest weekly increase since mid-August last year.
Beyond the equity and bond markets the performance of some of the major commodities in recent months, in particular the price of oil, paints a more subdued picture of the outlook for global economic growth. Brent crude oil is down 15% since June 19th on lower demand but also increased supply, to the lowest level in over two years. I have read that there may be certain interests, on the opposite side of the standoff with Russia, who are driving increased supply to push the price lower. It wouldn’t be surprising.
Week Ahead
European equity markets have opened lower this morning ahead of a busy week on the economic front. There was also some weaker than expected data from China over the weekend, with industrial output rising at the slowest rate since the global financial crisis. Speculation has already begun that the Chinese government will ramp up stimulus to meet their GDP target growth rate of 7.5%. In Europe there are reports on the balance of trade, inflation and the latest ZEW Economic survey from Germany, which in August hit the lowest level since December 2012. The ECB will initiate their Targeted LTRO facility this week with the focus on the level of participation from the banks.
There is a host of data released from the UK including inflation, retail sales and the labour market, as well as the minutes from the Bank of England’s most recent monetary policy meeting. Bank of Japan Governor Haruhiko Kuroda will give a speech on Tuesday which investors will watch for clues that they might be preparing further stimulus measures. In the US we have updates on industrial production, inflation and housing while the Federal Reserve’s monetary policy meeting will be centre stage. The Fed are expected to further cut their monthly bond purchases by $10 billion, but the focus is on their statement and whether they keep the wording previously used to describe the labour market (“significant under-utilization”) and the timing of rate hikes (“considerable time”) for a read on forward guidance.
Away from the market noise and the fear that Scotland may self-combust, the Champions League kicks off this week, easing the pain from Liverpool’s miserable display Saturday and the “new beginning” hype in Manchester. Luis Van Gaal has morphed back from devil to King, talking about the title after one win against a promoted team, akin to the Greek finance minister telling us to now “bet on Greece”. Still, King Luis has a week off to rejoice in his first premier league win as he watches the big clubs from his couch!
Eurozone Inflation Falls Further in August
ECB president Mario Draghi must be thinking “why always me” as the latest economic data heaped more pressure on Draghi to wave his magic wand (perceived to be quantitative easing through the eyes of financial markets) and fix the ailing Eurozone economy. In particular, inflation just won’t give him a break, falling to 0.3% in August, according to the flash estimate from Eurostat. The decline in inflation is proving to be less “temporary” than Draghi expected, but he is unlikely to announce any new measures at the ECB’s monetary policy meeting this week.
As I have repeatedly written about, the priority for the ECB is fixing the banking channel and hence the monetary policy transmission mechanism. Therefore, I suspect Draghi will focus on the targeted long term refinancing operations (TLTRO’s) and their preparatory work for the outright purchases of asset-backed securities (ABS). The TLTRO’s, announced in June, come into effect this month and are aimed at improving bank lending to the non-financial sector. Also, I would expect Draghi to have some material news on their ABS purchase program, beyond just the name of the consultant he hired! He will again stress the importance of structural reform and the role of fiscal policy in sharing the burden of boosting the Eurozone economy.
