Monthly Archives: February 2014

There has been a significant weakening in China’s exchange rate in recent days. Although the spot rate against the dollar has moved by only about 1.3 per cent, this is actually a large move by the standards of this managed exchange rate. Furthermore, the move is in the opposite direction to the strengthening trend seen in the exchange rate over the past three years.

This has triggered some pain among investors holding long renminbi “carry” trades, along with much debate in the foreign exchange market about what the Chinese authorities are planning to do next. Since China does not explain its internal or external monetary policy in a transparent manner that is intelligible to outsiders, there is much scope for misunderstanding its true intentions. The key question is whether the Chinese authorities are changing their commitment to a strong exchange rate and, if so, why? Read more >>

The G20 Summit in Sydney ended on Sunday with a call to boost global growth by 0.5 per cent per annum from 2014-18, thus raising world output by over 2 per cent ($2.25 trillion) in the final year of the period. Australia, the host country, had been pushing for the adoption of a global growth target, and US treasury secretary Jack Lew said after the meeting that this target marked a profound change of tone for the G20, compared with the focus on budgetary austerity in previous years.

Others, like the ECB and the German Finance Minister, were much more sceptical, and in fact no new measures have yet been adopted to help attain the growth targets. The real test will come at the Brisbane G20 Summit in November, when concrete measures are intended to be unveiled.

Policymakers may pay lip service to the need for reforms, but in practice they seem increasingly satisfied with the rather weak economic recovery which is now underway in the developed economies. The good news is that the underlying recovery in GDP does not seem to have been significantly dented, despite the slowdown in the manufacturing sector, in recent months. Read more >>

The crisis in the emerging markets’ “fragile 8″ , which threatened to sweep all before it a few weeks back, seems to have settled down almost as quickly as it erupted onto the scene. Investors are already asking whether it is now safe to enter the undoubted attractive valuations in the emerging world.

After the latest rally, emerging assets have performed almost in line with developed equities since the beginning of the year, and there has been little sign of the sudden jump in correlations between countries with good and bad fundamentals that is the hallmark of a genuine crisis in the emerging world. After all the hype, surely that cannot be the end of it, can it? Read more >>

The leading central banks in the developed economies have, of course, been the main actors underpinning the global bull market in risk assets since 2009. For long periods their stance has been unequivocally dovish as they have deliberately tried to strengthen an anaemic global economic recovery by boosting asset prices.

In the past week, we have had major statements of intent from Janet Yellen, the new US Federal Reserve chairwoman; from the European Central Bank; and from the Bank of England. After multiple hours of fuzzy guidance about forward guidance, the clarity of previous years about the global policy stance has become much more murky. Central banks are no longer as obviously friendly to risk assets as they once were – but they have not become outright enemies, and they are unlikely to do so while they are concerned that price and wage inflation will remain too low for a protracted period.

It is now quite difficult to generalise about what central bankers think. However, a few of the necessary pieces of the jigsaw puzzle slotted into place in the past week. Read more >>

Financial markets began 2014 in an ebullient mood. Omens of economic recovery in the developed world buoyed investors across the globe. Troubles in emerging markets, it was thought, would amount only to a handful of little local difficulties.
It did not last.
In developed markets, the past three weeks have seen the steepest falls in equity prices since mid-2013, when fears that the US Federal Reserve would begin phasing out its massive bond-buying programme caused interest rates to surge. This time, however, there has been no rise in short-term interest rates in the US or Europe, and bond yields have fallen slightly. There has been no change then in the market’s reading of the Fed or the European Central Bank’s policy stance.

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The governing council of the European Central Bank meets on Thursday amid rising expectations in the market that it will signal another easing in monetary policy, either in February or March. Most ECB watchers now expect the council to cut the refinance rate by around 15 basis points before quarter end (from 0.25 per cent to 0.10 per cent), and some expect the deposit rate to be reduced into negative territory for the first time. This action would be in response to recent volatility in money market rates, and an unexpectedly low inflation rate of 0.7 per cent for the euro area in January.

If the ECB was to follow this course of action in the next couple of months, it would represent another relatively minor adjustment in its policy stance in response to surprisingly low inflation data. It is still thinking in terms of incremental changes in policy, rather than anything more dramatic. This, of course, follows from the fact that the ECB has a pessimistic view of the growth in potential output since 2008, implying that the output gap is fairly small, and that inflation in the medium term will gradually return to the target of “below but close to” 2 per cent.

This view is, however, being increasingly challenged by the data. Some forecasters now see the 12-month inflation rate falling to only 0.5 per cent in the spring, depending on the behaviour of oil prices. More importantly, core inflation also continues to drop. After the next round of interest rate cuts, the central bank will genuinely be at the zero lower bound for the first time ever. The ECB will therefore face a major problem if the inflation data confound again, and head towards zero. Read more >>

The start of 2014 has seen the global markets decisively in risk-off mode, with global equities falling, government bonds rallying and many emerging market currencies collapsing. Yet few investors currently believe that the risk-off pattern will continue in the developed markets (DM’s) for the year as a whole. The bullish consensus for developed equities remains firmly intact, for now.

Economic fundamentals in the DM’s have not really changed. There have been some mildly disappointing data releases in the US, but these have been mostly due to an excessive build-up in manufacturing inventories since mid 2013, and the prospects for final demand seem firm.

Furthermore, the Fed’s tapering of asset purchases has now been clearly separated from its intentions on short rates, which remain extremely dovish. So far, the decline in developed market equities has been very minor compared with the rises seen last year, and do not even constitute a normal pull-back in a bull market.

In the emerging markets (EM’s), however, there is much greater cause for concern. As the graph above shows, the EM crises in the late 1990s did not, in the end, prove fatal for equities in the US and Europe, but they did cause occasional air pockets, notably in 1998. This is why investors are focused on whether the current EM crises will deteriorate further, and whether they will eventually take the DM’s down with them. Read more >>