Financial markets have got it into their collective head that the UK economy is recovering and that a rate rise is imminent. But is Bank of England governor Mark Carney on the same page? Almost certainly not, according to Ian Campbell, our guest today from Breakingviews, who says the UK may continue to see low rates until 2016, a year later than markets are currently pricing in, after Wednesday’s quarterly inflation report. “I’m not sure he is deliberately trying to confuse the markets,” Ian said of Carney. “His ‘Mansion House’ speech sounded more hawkish—perhaps more hawkish than he intended. One thing he is saying is that markets should look at the data.” Depressed UK wage growth, the prospect of softer inflation as the oil price barely holds above $100 a barrel and the eurozone – the UK’s key export market – struggling to fend off deflation as many of its key economies falter are some of the factors that could well stay the BoE’s hand. Sterling as a result has dropped to its lowest in four months against the dollar, which some of our GMF members believe is something of a welcome development, after cable touched a five-year high above $1.70 just a month ago. “I’m with you on the pound. In the U.S., earnings are rising by close to 2 percent. Labour participation has dropped and the inflation rate is pushing up—though not very different to the UK’s for now,” Ian said. “However, I think the Fed will need to raise rates next year. The U.S. economy has grown by a lot more than the UK since 2008 and has recovered for more. The delay there could be inflationary,” he added.
Can you guess which major asset has gained the most so far in 2014 and looks set to gain further? The S&P 500 is hovering just shy of record highs, while emerging markets have gained some 20 percent since the worst of the market turmoil in February. But it is not a major stock market, not even the mighty German DAX, which gained close to 30 percent in both 2012 and 2013, that tops the league tables. Rather, it is gold and it’s no coincidence given the extent to which investors have been unnerved by the outbreak of the crisis between Russia and the West over Ukraine, as well as by their dubiousness over the resilience of the recoveries in both the United States and China. Granted, U.S. interest rates look more likely to rise than fall over the coming year as the data is coming in stronger, but even the hardiest gold bear would do well to allocate some of their hard-earned cash to bullion, our guest today, Mark O’Byrne, from online bullion dealer Goldcore said. “It is all about diversification and not a question of ‘either or’ regarding major assets,” he said.“ It is not absolutely safe – nothing is, but a significant body of academic research and history shows it acts as hedging instrument and safe-haven asset. At the same time, it should only be an allocation in a portfolio of some 5 to 20 percent.”
The gold price saw an epic 12-year bull run – something not even the mighty S&P 500 has been able to achieve – come to an end in 2013, when investors grew confident enough about the outlook for the global economy to move into more risk-sensitive assets such as equities, thereby boosting the dollar. Since then, the gold price has risen by nearly 8 percent to just above $1,300 an ounce. That said, it is still worth just over half of its inflation-adjusted record high in the 1980s of some $2,400. The grim reality is that sentiment in the gold market is close to its worst in living memory, as miners and refiners deal with a price that has fallen by more than 30 percent from its peak just three years ago and investment banks jettison their precious metals and broader commodities businesses for fear of falling foul of new U.S. trading regulations.
It looks like there will be no avoiding austerity for Ghana, which has just gained the agreement of the International Monetary Fund to help the sub-Saharan nation with its economic challenges, but this might be what the country needs to stabilise its currency and restore its image as rising regional star, our guest today said. Ghana’s growing budget deficit, fuelled by government spending outpacing revenue, and stubbornly high inflation are just two of the factors that have pushed the cedi currency into what can only be described as free-fall, with a 60-percent drop against the dollar in the year to date, its worst yearly fall since its value halved over the course of 2000. The government’s reluctance to seek outside help has cost it precious time, but our guest today says the fact that President John Mahama has engaged with the IMF will serve as reassurance to investors. And with a $1.5 billion Eurobond due to come to market later this month, it’s not a moment too soon.“The immediate reaction has been a near 7 percent appreciation in the cedi last week compared to the week before, so we are beginning to see the benefits come through. In Ghana’s case a dose of austerity will be needed as the flipside of a cut in government spending,” Angus Downie, head of research at pan-African lender Ecobank, said during a visit to GMF. “An IMF loan would help comfort many investors, as it would bolster the policy reforms to be implemented. But the government would probably be keen to take the policy advice only, as a loan might signal weakness or failure of their own efforts,” he added. Indeed, Ghana was the first sub-Saharan African country outside South Africa to tap the Eurobond market in 2007 and as Reuters Breakingviews pointed out last week, the country’s problem isn’t inadequate economic growth. Real GDP rose 7.3 percent in 2013, only modestly below the 8 percent target and one of the highest increases in Africa. Even in the first quarter of 2014 real GDP rose at a 6.7 percent annual rate. But taking the IMF’s advice, which most market-watchers agree will be austerity-shaped, will send a more powerful signal than anything else. “ The technical advice is the key issue for me as FX reserves are not yet at a critical low level,” Angus said.
So you think the summer is a quiet time for the markets? Think again! Using the VIX index, which tracks changes in the implied volatility of options on the S&P 500 index, as a gauge, markets are far more likely to be choppy in the months of July, August and even into September. In the last 20 years, the VIX rises by an average of 10.2 percent in July, making this its most volatile month, followed by an average of 5.8 percent in August and another 8 percent in September, the second-most volatile month of the year.
Implied volatility in the currency market has hit multi-year lows, sparking some concern in GMF about complacency, but even that is picking up as the northern hemisphere summer goes on. Looking at the average change in one-month implied volatility for both the yen and the euro, the month of May sees the largest increase in the two, right in time for the start of the summer.
The euro has taken a lot of flak this week in the GMF. From its billing as most unloved currency in the G10 space for a number of our analysts and traders, to the bane of the big European corporates, many of which this week have complained of a hit to their balance sheets from the currency’s relative outperformance earlier in the year.
Big Paris-listed names such as automaker Renault, construction rivals St Gobain and Lafarge, as well as German luxury carmaker Daimler have all pointed to the headwinds created by the euro’s strength against the dollar, as well as against a lot of key emerging currencies such as the Chinese yuan, the rouble or the Brazilian real.
A sovereign bond market rally that has taken yields to record lows and a central bank ready, willing and able to back up the economy have made the euro one of the most vulnerable currencies in the G10 space, according to our guest today, Morgan Stanley European head of FX strategy Ian Stannard. And this isn’t just from the point of view of monetary policy, with the European Central Bank busy keeping rates low while others such as the Bank of England, are moving into tightening-mode. “There are signs that the large portfolio inflows to Europe, which had been a major driver of the euro over the past year starting to slow down,” Ian told us. “The market appears to have reached a point where lower yields no longer suggest inflows and could now be deterring inflows to Europe, leaving the euro vulnerable – euro/dollar seems to be returning to a more traditional relationship with yields and yield spreads.”
Yields on core German debt, as well as those on so-called peripheral bonds such as Spain and Italy, have fallen to record lows this month, driven by the prospect of the ECB keeping the liquidity taps on, in light of faltering economic growth and stubbornly low inflation. With rates set to rise elsewhere, investors, tired of eeking out returns in a near-zero interest-rate world, will be eager to park their funds in markets that offer better returns, and even if that is just putting cash in the bank, pretty much anywhere else in the G10 would look like a good deal. “In Europe, we would look for yields to remain low, driven by domestically-orientated flows, with liquidity provided by the ECB, which we think will start to crowd out foreign investors, where there more attractive opportunities appearing,” Ian said. “This could especially be the case with signs that U.S. front-end yields are attempting to push higher.”
Nigeria, Africa’s largest economy and star market of the frontier world, is faced with the uncomfortable situation of rising inflation, slowing growth and a desire by both the central bank and the government to cut interest rates to protect the economy. We heard today from the deputy governor of the central bank, Kingsley Moghalu, who joined us in the forum to talk about how he and his boss, Godwin Emefiele, who was sworn in last month, plan to deal with it. “There has been an uptick in the inflation numbers, but inflation is still within the band that the central bank has indicated it can tolerate, and that is in single digits. Does that mean we’re going to do nothing about it? No. We will certainly always continue to monitor inflation and address inflation threats using the various tools at our disposal,” Dr Moghalu said. Consumer inflation rose to a 10-month high of 8.2 percent in June. Interest rates are at 12 percent, where they have held for the last two years.
“Fiscal reforms are very important complementary process to monetary policy because monetary policy does not exist in isolation,” Moghalu said. “The economy is managed through both fiscal and monetary policy. Therefore I think fiscal reforms, several of which are ongoing as I speak, remain necessary for monetary policy to be even more effective. Call it burden sharing!”
Commodities haven’t exactly fallen out of favour with investors since the Federal Reserve began slowing its monthly purchases of U.S. government bonds, but they’ve hardly been flavour of the month either. That honour most likely goes to the U.S. equity market, which, despite some of the softness in the past week from investor nerves over geopolitical tensions in the Middle East or between Russia and Ukraine, is still within sight of record highs.
Gold, the on-off safe-haven, is close to its lowest in around a month, having lost nearly 20 percent in the last two years, and is likely to fall further, particularly as U.S. monetary policy slowly tightens. Silver is closely correlated to gold but highly volatile, sort of a high-beta beast. Then there’s the platinum group metals, ostensibly precious given their scarcity, but far more closely linked to the health of the global economy. Palladium, which has gained 21 percent this year – partly because of the threat of sanctions on top producer Russia – has attracted a lot more attention than its sister metal, platinum.
The shooting down of a Malaysian Airlines passenger aircraft over eastern Ukraine left 298 people dead and the world’s leaders demanding an international investigation into what our reporters in region say could mark a pivotal point in the worst crisis between Russia and the West since the Cold War. This was certainly also the view of our guest this morning, Alisa Lockwood, senior manager and country risk analyst at IHS. “Although we still don’t have any confirmation of who was behind this, the accusations that are being made against the separatists mean that (Russian president Vladimir) Putin will be under pressure to do more to seek a peaceful resolution. If he does, and this is accompanied by a strong push by the Ukrainian armed forces — and potentially the introduction of a multilateral peacekeeping force — then we will see a swift resolution,” Alisa said. “But if Russia blames the Ukrainian side for this incident and continues to be intransigent, this will unite Europe in pursuing stricter measures that it has thus far held back from.” The United States earlier this week imposed its toughest sanctions yet on Russia, hitting a number of the country’s largest companies such as Rosneft and Gazprombank, although Gazprom itself was spared.
Kiev and Moscow for now have blamed one another for the disaster, which, if it is confirmed that the Boeing 777 was shot down deliberately, will be the worst attack on a commercial airline since the late 1960s. Russian stocks have borne the brunt of investor unease over the broader economic impact of further sanctions. The rouble-traded MICEX index has fallen by nearly 5.7 percent this week, marking its biggest weekly decline since mid-March when Moscow annexed Crimea. World stocks are set for their largest week of declines since then as well. Volatility had declined to near record levels across most asset classes as few expect any surprises from the major central banks in the coming months, which has left geopolitics as one of the key potential catalysts. Indeed, investor nervousness, as gauged by the VIX index – which reflects the volatility of options on the underlying S&P 500 – is at its highest in three months. The VIX itself jumped by more than 32 percent on Thursday in the wake of the crash – the largest one-day rise in percentage terms since April 2013. “On the markets, it’s been an incredibly violent year — Ukraine, Syria, Iraq, Libya, now Gaza — and it’s really caused only very minor ripples,” Reuters EMEA economics and politics editor Mike Peacock told the forum. “But there was a kneejerk (reaction) down last night and if this escalates into a more dramatic Russia versus West standoff, it could have an impact.” Mike pointed out that while there was no real question of western military action, trade sanctions must be on the agenda now even though these would hurt the European Union as well as Russia. “If imposed, Moscow could start trying to interfere with gas supplies to western Europe. Given a mild winter and warm summer, the EU has plenty of stockpiles for now, but it would bite hard in the winter. Anyway, we’re not there yet, and the hope is that Putin takes a sizeable step back,” Mike said.
Sterling has vaulted higher today against the dollar and the euro, after a surprisingly sharp rise in UK consumer prices in June prompted some in the market to reassess their expectations for the timing of the first rate hike from the Bank of England. Consumer inflation rose 1.9 percent on the year in June, according to the Office for National Statistics, trumping expectations among economists polled by Reuters, who had expected inflation to accelerate to 1.6 percent from 1.5 percent in May. And let’s not forget the 10.5 percent rise in house prices in May that the ONS reported alongside that. But scratching at the surface of the inflation numbers shows a sharp rise in the price of clothing and footwear – which is unusual in June when the summer sales take place, which is totally at odds with other gauges of consumer inflation such as the British Retail Consortium’s report last week that showed retail prices staged their biggest annual drop since at least December 2006 in June. Furthermore, a separate measure of wholesale prices today showed a decline in inflation at the farm and factory gate, all of which would suggest the BoE is unlikely to feel the pressure to act sooner, rather than later, to raise interest rates. “It would definitely be worth waiting for more confirmation. it was curious that factory gate prices were lower than expected, so little sign of pipeline price pressures from there,” our guest Swaha Pattanaik, from Breakingviews,told us earlier. “And it would be interesting to know why the sales that usually lead to clothing and footwear price markdowns in June seemed to kick in later. I’m not sure if there were then bigger markdowns or that there is just less stock to markdown,” she said, adding that the level of uncertainty about what is going on is quite high.
BoE governor Mark Carney said today inflation expectations remain well anchored and while he was aware of the CPI report, he would draw attention to the central banks’ forecast in May that inflation was only expected to return to the target of 2 percent in three years. In other words, “we’re on it”. There’s just one snag, at least according to some of the Twitterati that we here at GMF follow. And that is tomorrow’s unemployment data. Were that to show enough improvement to pull the jobless rate below its current 6.6 percent level, it might be harder for Carney to stick to the argument that the state of the economy doesn’t warrant a swifter tightening in policy.