Harold Macmillan, the former British Prime Minister, famously described the main risks facing his government as “events, dear boy, events”. Investors no doubt feel the same way about the most crucial single element in their deliberations, the future actions of the Federal Reserve.
A week ago, the immediate path ahead for the Fed seemed to be well mapped out for the financial markets. There was a clear consensus that the FOMC would taper its asset purchases in its 17-18 September meeting, and would completely end its asset purchases in mid 2014. Furthermore, it seemed increasingly certain that Lawrence Summers would be nominated by the President to be the next Fed Chairman sometime in October, and that the ratification process would end in time for him to take office on 1 February. Now this timetable has been thrown into much greater doubt. Read more
Pessimism dies hard in the UK. Even so, the startling rise in sentiment in UK business surveys in recent months calls for a rethink of the downbeat view of the British economy which prevailed almost everywhere at the start of 2013. After several years of gloomy economic data, there was a strong consensus that the UK was permanently mired in a severe demand shortfall, and that none of the usual levers – monetary policy, fiscal policy or weaker sterling – were ready or able to remedy the problem.
The outlook appeared so bleak that the government imported Mark Carney from Canada to devise emergency ways of easing monetary conditions.
By the time that Mr Carney took office as governor of the Bank of England in July, however, the economy had already embarked on a completely unexpected recovery. According to Fulcrum Asset Management’s statistical system, which tracks all of the available data sources and combines them into a single composite indicator of activity, economic growth in the third quarter is running at an annualised rate of 4.5 per cent, the highest rate seen since the booms of the 2000s and the 1980s. Read more
Raghuram Rajan‘s arrival in the Governor’s office at the Reserve Bank of India on Wednesday coincides with the worst economic crisis his country has faced since the early 1990s (see this earlier blog). The rupee hit new lows in the foreign exchange markets last week, and there are signs that a gradual erosion of confidence in the currency is turning into a complete rout. The restoration of confidence in the currency is now the sine qua non for any recovery in the economy more generally.
Like 2013′s other new central bankers (Governor Kuroda in Japan, and Governor Carney in the UK), Mr Rajan now has the advantages of the new broom, providing him a brief opportunity to seize the initiative and change market perceptions about macro-economic discipline in India. But he does not, by any means, hold all of the cards in his own hand. The Fed’s likely tapering of its asset purchases in September has clearly been the catalyst for the acute phase of the crisis. And the seeds of today’s problems have been sown over many years in which an excessive budget deficit has been partly monetised by the RBI, feeding a credit bubble, and a burgeoning current account deficit. Read more
The financial markets’ love affair with emerging market assets, which peaked in 2010, has plumbed new depths during August. Emerging market equities (in $ terms) are now down by 12.2 per cent so far this year, while developed market equities have risen by 11.2 per cent.
Emerging currencies have been in free fall. As a result, interest rates have been tightening as GDP growth expectations have been persistently marked downwards, which is usually a toxic combination for risk assets. Read more
The appointment of Raghuram Rajan, a Chicago economics professor, to the helm of the Reserve Bank of India is certainly an intriguing one. His arrival comes at a time when the Indian economy stands at the threshold of an outright foreign exchange crisis, more serious than anything seen since Manmohan Singh’s economic reforms of the early 1990s. Mr Singh is now Prime Minister, and seems to have lost his magic touch.
As Rajan himself has commented, central bankers can move from hero to zero in very short order, and so too can entire economies. India’s economy was generally deemed to be a startling success as little as two years ago. Now it is seen more like an old-fashioned emerging market, with severe supply side failures combined with unsustainable fiscal and balance of payments deficits. Read more
Last week, the Chinese authorities created a stir when they announced that they are initiating an urgent review of outstanding debt for all of the various levels of the public sector in China, right down to individual villages. This raised market concerns, because one interpretation of this action is that the authorities may not have a handle on the amount of publicly-guaranteed debt in the economy, particularly in the local government sector, where the growth of debt has recently been extraordinarily rapid.
The authorities do not appear to have decided when (or whether) the results of this survey will be announced and of course there will be the usual suspicions that the eventual numbers will be massaged for public view. Until recently, it had generally been assumed by China watchers that, while the growth in private and corporate credit was running dangerously ahead of GDP growth, there was a major silver lining in the healthy financial condition of the government sector. Read more
The US official statisticians have today issued revised statistics for GDP dating all the way back to 1929. It may be alarming for investors and policy makers to hear that our understanding of economic “truth” needs to be amended for the last 84 years, but the changes have not in fact made much fundamental difference to the debates which matter for the economy today.
In particular, there has been very little change in the Fed’s likely view of the amount of slack which remains in the economy, though the latest version of growth in the last few quarters, including the publication of data for 2013 Q2 for the first time, may persuade them that economic momentum is a little firmer than previously believed.
The most dramatic-sounding news in today’s release is that the level of nominal GDP has been revised up by 3.4 per cent in 2013 Q4. This follows a number of methodological changes, the most important of which is to treat R&D spending as a positive contributor to investment and GDP, rather than as an input to the production process. But since this change impacts GDP levels for decades in the past, it does not make much difference to our understanding of the economy’s capacity to grow in the immediate future. It simply involves viewing the same objective truth through a different coloured lens. For most practical purposes, this change can be ignored.
There are, however, three areas where the revisions could be significant: Read more
As the financial markets begin to wind down for their summer lull, activity surrounding the Federal Reserve is hotting up. Next week, the FOMC will decide whether to give a clear signal that it will begin to taper its asset purchases at its subsequent meeting in September. Furthermore, President Obama has said that the appointment of a new Chairman (yes, he said “Chairman”, though he might have meant “Chair”) will come in the autumn, and controversially dropped broad hints that Lawrence Summers is being seriously considered for the job. Previously, it has been assumed that Janet Yellen was a shoo-in. Not any more.
What are the markets to make of this? Let us start with the easier one, which is the likely action of the FOMC on Wednesday. There is no compelling reason for a major change of language in this week’s statement. The economy has slowed in the second quarter, with many economists now predicting growth in real GDP of only around 0.5 per cent, but there have been signs of firmer activity in July, and the employment numbers due on Friday are expected to be firm. Read more
Macro investors remain very intrigued by Mark Carney‘s arrival at the Bank of England, which could have major implications for sterling and UK equities. The minutes of the new governor’s first MPC meeting showed that the committee voted 9-0 against any immediate easing in monetary policy, but the crunch will come with the publication of the Inflation Report on 7 August. Only then will we discover whether the incomer has persuaded his colleagues to try to shock UK economic expectations towards a new equilibrium.
There was little sign of this in the minutes, which hinted that the longstanding two thirds majority against further QE has remained intact. Whether that will remain the case once the new mandate has been agreed with the Treasury is the great unknown. Read more
In the past decade, the world’s central banks – first in the emerging and then in the developed world – have embarked on a Great Expansion in their balance sheets which is unprecedented in modern times. This blog sketches the anatomy of the Great Expansion and attempts to project what will happen as the US Federal Reserve tapers its asset purchases in the next 18 months.
The latest episode in the saga has, of course, involved the Fed’s attempt to distinguish between “tapering” and “tightening”, a distinction which the markets have been reluctant to recognise . The US forward interest rate curve shows the first rate increase occurring very close to the time when the Fed is planning to stop buying assets in mid-2014. Whether it intended to do so or not, the Fed has de facto tightened US monetary policy conditions and will have to work hard to reverse this. Read more