Yearly Archives: 2013

As we enter 2014, the five-year bull market in developed market equities remains in full swing. Recently, I argued that equities now look overvalued, but not egregiously so, and that the future of the bull market could depend on when the level of global GDP started to bump up against supply side constraints, forcing a genuine tightening in global monetary conditions.

Today, this blog offers a year end assessment of three crucial issues that relate to this: the supply side in the US; China’s attempt to control its credit bubble; and the ECB’s belief that there is no deflation threat in the euro area. At least one of these questions is likely to be the defining macro issue of 2014 and beyond. Read more

The long farewell to quantitative easing, one of the most remarkable experiments in the history of macroeconomic policy, starts now. In the wake of the strong US employment data in recent months, the Federal Reserve finally announced that it will taper its asset purchases from January onwards. The Fed’s balance sheet will stabilise in 2014, but will not begin to decline for several more years.

Variously described as the saviour of the global economy, totally irrelevant, a drug for the financial system or the harbinger of future inflation, QE is still controversial and insufficiently understood. Macro-economists are destined to be studying its effects for decades to come. Here are some early reflections. Read more

For all type of investors, one question for 2014 dominates all others: can the great bull market in risk assets, especially in US equities, continue for another year? John Authers points out that there is an unusually strong consensus in analysts’ forecasts for next year, with almost everyone expecting stronger global GDP growth, dovish central banks and further rises in equity markets. As John says, this “cozy consensus” borders on complacency.

Investor psychology usually reflects the recent past. The year just ending has seen the best performance by US equities in the past four decades, with the single exception of the calendar year 1995. The word “best” in this case does not refer to the highest absolute return, but to the highest Sharpe ratio, which measures the risk-adjusted return.

Strongly positive returns, with very low volatility, is a dream scenario for investors, especially since the stellar performance of 2013 comes on top of several previous years in which equities also rose markedly, though with much greater volatility than seen this year. So is all this simply too good to last? Read more

In recent months, inflation has again reared its head as a problem in the developed economies. But this is not because it is too high. In most countries, headline CPI inflation has been falling significantly since the end of 2011, and it has now dropped to less than 1 per cent in both the US and the euro area.

Furthermore, the pervasive decline in headline inflation has been accompanied by a similar decline in core inflation rates, which are also hovering at worryingly low levels in most countries. In fact, out of the 25 developed economies that publish regular data on Haver Analytics, only Iceland is currently experiencing an inflation rate that could be considered markedly too high by any of these measures. Read more

When George Osborne, the UK chancellor of the exchequer, stands up to deliver his Autumn Statement on Thursday, he will be able to talk about good economic news for the first time since 2010. The speed of recovery in the economy in the past six months has been little short of astonishing. This will certainly have persuaded the Office for Budget Responsibility to increase its gross domestic product growth forecast for 2014, causing an automatic reduction in government deficit and debt projections.

The vicious circle linking low growth and high budget deficits, so prominent in Mr Osborne’s first three years, has been transformed into a virtuous circle — for now, at least. It will take a Herculean effort of self-control for Mr Osborne to resist claiming: “Austerity works”.

The acceleration in UK GDP growth during 2013 has far out-stripped that in any other leading economy, following a period of several successive years in which the opposite was the case. According to “nowcasts” for economic activity (see graph below), UK growth has been running at above 5 per cent annualised for several months, compared to about 1.5 per cent at the start of the year. For a while, sceptics argued that these nowcasts were being over-influenced by buoyant survey data, but there is now evidence from hard economic data that the take-off in activity is genuine. Read more

International investors often complain that they have a hard time understanding the actions of the People’s Bank of China. The PBOC still seems to pride itself on the inscrutable nature of its policy pronouncements, rather in the style of the Fed until the mid 1990s. In order to judge what the Chinese monetary authorities are doing, it is necessary to watch their actions more than their words, and even then there is plenty of room for misinterpretation. As in other areas of Chinese public administration, power resides in secrecy.

The fact that Chinese monetary policy can seem obscure to outside observers does nothing to diminish its importance. In fact, the ongoing attempt to deflate the 2010-13 credit bubble in China is more important for the global economy than the Fed’s tapering plan, or the ECB’s thinking on negative deposit rates. A collision is developing between a progressive tightening in monetary conditions, and the inflationary psychology of the housing and land markets. No-one can be certain how this will end. Read more

Mark Carney’s announcements today about the UK housing market represent the first blast from a major country of a new policy weapon that is increasingly available to the global central banks, a weapon known as macro prudential regulation. Because this weapon is seen as an alternative to raising short rates, not as a prelude to raising them, the Carney intervention should logically under-pin the lower-for-longer path for short rates discussed in his evidence to the Treasury Select Committee earlier this week. Mr Carney has turned more hawkish today, but not more hawkish about interest rates or sterling.

The Carney announcement will represent an important restraint on the UK housing market, which was showing distinct signs of getting too ebullient in the south east of the country. By acting early, and using methods that are distinct from the short term interest rate, this action may well make the economic recovery in the UK more durable than otherwise, though it may slow down some parts of the consumer sector in the immediate future. Read more

The past week has been another important one for Fed watchers, a group which nowadays seems to include almost every active investor in the financial markets. Following the decision of the Senate on Thursday to ban filibustering on Presidential nominations to many important federal posts, it has been suggested by Morgan Stanley that Ms Yellen might take up her position as Chair in time for the next meeting of the FOMC on 17-18 December, two meetings earlier than previously expected.

Furthermore, according to Neil Irwin, President Obama will now find it easier to appoint at least two new monetary doves to support Ms Yellen on the Board of Governors next year. This will offset what might otherwise have been a shift towards hawkishness on the FOMC, since regional Presidents Fisher and Plosser (both hawks) are rotating into voting status, and the unannounced new President of the Cleveland Fed may turn out to be “on the hawkish end”, according to J.P. Morgan.

These personnel changes will create their own uncertainty. But, in addition, the Fed’s monetary strategy is clearly in a state of flux, with its approach to tapering having developed markedly in recent weeks. A new “separation principle” seems to be emerging, and it explains why the FOMC seems eager to begin winding down its asset purchases in the near future, while relying even more heavily than before on “lower for longer” guidance on forward short rates. This could have important ramifications for markets. Read more

One week ago at the IMF Research Conference, Larry Summers delivered a remarkable speech about secular stagnation, which he suggested might be the defining issue of our age. The term secular stagnation, coined by American Keynesian Alvin Hansen in the late 1930s, has always had a polarising effect among economists, and the same will certainly be true again this time. But whatever one thinks about the argument, the Summers speech, at 16 minutes long, is a tour de force that demands to be watched. Read more

Investors will be paying rapt attention to Janet Yellen’s verbal evidence in her confirmation hearing at the Senate Banking Committee on Thursday. With December tapering of asset purchases possibly back on the agenda after the stronger US jobs data in October, her take on the strength of the economy will be critical, especially since she has not opined on this or any other contentious matter since the spring.

But tapering is going to happen fairly soon in any event, and in the longer term investors should pay more attention to what she says about the framework which she will be using to determine policy during her five year term. In particular, will she be using an “optimal control” framework, which she adopted last year and which was at the centre of two Fed research papers published last week? Read more

While the markets have become obsessively focused on the date at which the Fed will start to taper its asset purchases, the Fed itself, in the shape of its senior economics staff, has been thinking deeply about what the stance of monetary policy should be after tapering has ended. This is reflected in two papers to be presented to the annual IMF research conference this week by William English and David Wilcox, who have been described as two of the most important macro-economists working for the FOMC at present. At the very least, these papers warn us what the FOMC will be hearing from their staff economists in forthcoming meetings.

Jan Hatzius of Goldman Sachs goes further, arguing that the papers would only have been published if their content had been broadly approved by both Chairman Ben Bernanke and by Janet Yellen. The new works take the Fed’s mainstream thinking into controversial areas which have certainly not been formally approved by the majority of the FOMC. Read more

The sharp decline in inflation in the euro area to only 0.7 per cent in October has focused attention squarely on the monetary strategy of the ECB, ahead of its policy meeting next Thursday. In 2012, the Governing Council was willing to introduce very unconventional measures in order to keep the single currency together, dampen crises in sovereign debt and repair the fragmentation of interest rates between member states. Most people now concede that, without these measures, the eurozone would have fallen apart.

The startling success of this action has tended to shift attention away from more mundane matters, such as the overall stance of monetary conditions for the euro area as a whole. But the recent decline in inflation has raised serious questions about whether the monetary stance is anywhere near appropriate for an economy in such a depressed state.

This is problematic for the ECB, since it has already fired almost all of the conventional monetary ammunition available to it. And it has never followed the example of other major central banks in considering that quantitative easing is needed to ease policy at the zero lower bound for interest rates. It may soon have to face up to this issue. Read more

The recent buoyancy in global equities has raised fears that the markets have entered a major bubble, driven by the unprecedented expansion in central bank balance sheets.

To the extent central bank asset purchases have reduced government bond yields, they have certainly brought forward returns from the future into the present, thus reducing expected returns on both equities and bonds. But this is normal in a period of monetary easing, and it does not automatically mean that markets are in a bubble. Read more

Exactly a year ago this week, the markets woke up to the fact that Shinzo Abe would become the next Prime Minister of Japan, and would introduce the most far reaching set of economic reforms seen in that country since the similarly audacious Takahashi reforms in the 1930s. A year later, some progress has been made, but crucial issues have been ducked and much greater challenges lie ahead.

The new administration under Mr Abe immediately fired the first and easiest of his three “arrows” (see David Pilling), a dramatic expansion in the BoJ balance sheet that will be maintained until inflation reaches 2 per cent. The second arrow, a temporary fiscal support programme, has also been implemented. Read more

The Federal Reserve told us in December last year that it would maintain its asset purchases until the outlook for the US labour market had improved substantially. Does Tuesday’s rather anaemic jobs data release meet this criterion any more than it did last month, when the Fed decided not to taper its asset purchases? Not really.

The underlying pace of job gains is certainly not rising, and may even have fallen slightly. But the unemployment rate dropped to 7.2 per cent, and the pace of decline suggests that the 6.5 per cent threshold for considering interest rate rises could be reached in mid-2014, ie before the balance sheet tapering has ended! This gives Janet Yellen, the incoming Fed chairman, an early problem: she will surely have to reduce that 6.5 per cent threshold soon.

In this blog, we use some statistical tools which have been developed by the regional districts of the Fed to frame a judgment about the underlying state of the labour market, updated to include this week’s new information [1]. Read more

The award of the Nobel Prize last week to three academics who have specialized in the empirical modelling of asset prices has focused attention on what academic research can tell us about a highly topical question: could the US equity or credit markets currently be in a bubble? It goes without saying that this is of great interest to investors, who have seen the US equity market rise by 131 per cent since February 2009, and are asking when the bull market might end.

It is also of relevance to the likely next Chair of the Fed, Janet Yellen, who will be closely examined about bubbles in her confirmation process. In the past, she has strongly argued that the Fed should not use standard monetary policy to deal with bubbles [1]. Read more

Global trade growth has stopped. Gavyn argues that this undermines global GDP growth, but The New York Times’s Paul Krugman disagrees. Mr Davies replies to Mr Krugman’s points in an interview with John Authers:

When Ben Bernanke became Fed Chairman in 2006, his collection of speeches and academic papers turned out to be extremely relevant to the decisions he would take in office, especially after 2008. The same is likely to be true of his nominated successor who, pending her confirmation by the Senate, has now become the de facto voice of the Fed.

Google Scholar lists dozens of entries under the name Janet L. Yellen. These citations outline an extremely well considered economic philosophy that has developed along a consistent path since the early 1980s. A 67-year old leopard is unlikely to change its spots. Read more

Janet Yellen has been nominated to take over as Fed chairman when Ben Bernanke steps down. Gavyn discusses with John Authers what a Fed led by Ms Yellen would mean for tapering and interest rate policy

In the endless saga over US fiscal policy, attention has shifted from the closure of some parts of the government (which happened on Tuesday) to the possibility that the Treasury Department will reach the limit of its extraordinary measures to work around the debt ceiling on or around 17 October.

The negotiating tactics of the White House are now clear. They are painting the scenario in which the debt ceiling remains frozen as completely catastrophic, perhaps hoping that market disruptions will increase pressure on the Republicans to waive through the necessary legislation. Markets, however, have so far been reluctant to co-operate. (See this earlier blog.)

In a letter to Congress on 25 September, Treasury Secretary Jack Lew described the ensuing situation as “default by another name”, and Goldman Sachs CEO Lloyd Blankfein has said that “there is no precedent for a default”.

Investors hate the word “default” but they need to be careful about its exact meaning here. Most observers, including the major investment banks, think it very unlikely that the US would ever choose to default on any payments due on its sovereign debt, even if the debt ceiling is left permanently unchanged after 17 October.

The government could, however, go into arrears on many of its normal payments after that date. This would have serious contractionary effects on the economy, and might lead credit agencies to downgrade their ratings on US sovereign debt. Read more