Ben Bernanke is a noted expert on the Fed’s monetary history, especially in the 1930s. When the FOMC meets on Tuesday, he may spare a moment to remember that this week sees the 80th birthday of a fateful Fed decision in 1932, a decision which some scholars believe led inexorably to the bank failures of early 1933, and the suspension of US membership of the Gold Standard. That decision was to end the only period of aggressive quantitative easing which was attempted by the Fed during the worst period of the Great Depression between 1929 and 1933.
The conditions the Fed faced in July 1932 do not represent a close parallel with the conditions they face this week. Far from it. Yet some of the arguments are uncannily similar, and the episode tells us what might have happened after 2008 if the Fed had adopted the same approach as it did in 1932. The lessons for the ECB this week may be more pertinent. Read more
The last few weeks have seen a further collapse in government bond yields, especially at the front end of some European yield curves, where the ECB’s decision to cut deposit rates to zero has clearly had important effects on interest rates. How low can bond yields now go? ECB board member Benoit Coeure said on Friday that the ECB might cut rates to below zero. He said that the central bank is closely observing events in Denmark, where two year yields have dropped into negative territory, as they have in Switzerland.
Despite the fact that policy rates might drop below zero, it is common to hear in the financial markets that government bond markets are in bubble territory, with equities being “so cheap” relative to bonds that equities are virtually certain to out-perform bonds by a wide margin in the years ahead. Although I have said this myself on many occasions, I am now beginning to wonder whether it is true. Read more
The fall in US unemployment remains slow but with no clear deflationary threat the US Federal Reserve is in a quandary regarding the next steps in its monetary policy. John Authers, Long View columnist, asks Gavyn Davies, chairman of Fulcrum Asset Management, what Ben Bernanke, chairman of the Fed, is most likely to do next.
Three large downside risks continue to undermine confidence in global asset markets: the eurozone crisis, fading growth in the US and a possible hard landing in China. Of these, the last is the hardest to read, because of doubts about the accuracy of economic data and the impenetrability of the true intentions of policy makers (at least to this outside observer). Nevertheless, investors are forced to come to a view on inflexions in the Chinese cycle, because global markets have become extremely sensitive to them.
The Chinese data for economic activity which were published last week seem consistent with a softish landing rather than anything worse. While there is no definitive evidence yet of a turning point in the cycle, downward momentum has abated. The authorities are once again relying on investment spending to dig the economy out of a hole. This should work in the period immediately ahead, but the longer term consequences could be less benign. Read more
The minutes of the Fed’s FOMC meeting on 18th and 19th June were published on Wednesday, but the markets remain confused and divided about the central bank’s true intentions on the stance of monetary policy. Surveys of market participants show that they are almost evenly split between those who expect QE3 to come this year, and those who do not. And usually highly informed commentators have differed sharply about the hidden meaning in this set of minutes.
Robin Harding of the FT concluded that the tone was dovish, heralding the likely arrival of QE3 if the economy remains weak. Tim Duy, in his excellent Fed watch blog, says that Ben Bernanke is sceptical about the efficacy of a further increase in the balance sheet, and is looking for different options to ease. That could take a while. Jon Hilsenrath at the Wall Street Journal said that the Fed is in a state of “high alert” about the economy, but has not yet decided to pull the trigger, partly because “many Fed officials are uncomfortable with the mix of unconventional tools that they have to address the soft economy”. In particular, there are growing concerns that further purchases of treasury securities will damage the workings of the market in government debt. The Fed staff has been asked to report back on this in future meetings. Read more
The past week has seen the publication of generally weak economic data which suggest that the global GDP growth rate in 2012 Q2 will be the lowest recorded since the “recovery” began three years ago. Many of these data were analysed here on Friday. Since then, the US jobs data for June were anaemic at best, indicating that American business spending is now slowing in both capital expenditure and job creation.
Furthermore, the eurozone crisis has moved in the wrong direction in the past week. The ECB cut interest rates on Thursday, but Mario Draghi poured cold water over the idea that the central bank balance sheet could be used to purchase significant quantities of Italian and Spanish debt, or to leverage the inadequate balance sheet of the ESM. Even more worrying, the Wall Street Journal reports that last week’s summit did not, after all, agree that bank capital injections should by-pass the balance sheets of sovereign governments. Instead, governments will reportedly be expected to guarantee these capital injections, which greatly waters down the force of the statement made after the summit.
European activity data stabilised somewhat in June, but the absence of a genuine resolution to the crisis will hang over the region’s economies for many more months. The key near term question for the global economy is whether the serious effects of the eurozone shock can be mitigated by the renewed operation of the oil stabiliser, which has been growing in importance in the last few years. Here lies the silver lining, if there is one. Read more
The growth rate of the global economy is experiencing its weakest patch since the “upswing” in the cycle began in 2009. Of course, it has never been much of an “upswing”, given the depth of the recession which followed the financial crisis at the end of 2008. Still, the big picture seemed to suggest that global GDP was slowly on the mend, if not at a pace which could reduce global unemployment very rapidly. Now, even that modest recovery seems to be at risk.
Markets have not been oblivious to this renewed round of easing: since the end of May, global equities have risen by 8 per cent and commodity prices have recently rebounded from their lows in spectacular fashion. Although ”shock and awe” from the central banks seems to have been replaced by a sense of rather tiresome routine, the impact of QE on market psychology has not entirely lost its traction.
That will only last, however, if the current global slowdown proves to be just another mid-year lull in a generally recovering world economy. So what are we to make of recent data? Read more
Gavyn Davies is a macroeconomist who is now chairman of Fulcrum Asset Management and co-founder of Prisma Capital Partners. He was the head of the global economics department at Goldman Sachs from 1987-2001, and was chairman of the BBC from 2001-2004.
He has also served as an economic policy adviser in No 10 Downing Street, an external adviser to the British Treasury, and as a visiting professor at the London School of Economics.
Gavyn Davies is an active investor and may have financial interests and holdings in any of the topics about which he writes. The views expressed are solely those of Mr Davies and in no way reflect the views of Prisma Capital Partners LP, Fulcrum Asset Management LLP, their respective affiliates or representatives. This material is not intended to provide, and should not be relied upon for, investment advice or recommendations. Readers are urged to seek professional advice before making any investments.