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.
Being able to choose whether or not to put additional insulation in your home or switch to a utility supplier that uses a mix of conventional and renewable energy sources seems like a good thing, particularly to the more environmentally-aware consumer. While every little surely helps, this “opt-in” voluntary approach isn’t enough to significantly cut a nation’s carbon footprint, or the burden that power prices place on households, according to our guest this morning, John Webster from energy efficiency consultancy OPower. Opower advises governments and utilities on “behavioural energy efficiency programmes (BEE)” – built on the idea that by providing consumers with better information about their energy consumption will make them more likely to cut their use. “Our belief is that BEE offers the chance for European member states to achieve significant energy-efficiency savings for close to ALL their households,” John told us. As the battle to stem climate change hots up, Europe, home to some of the world’s tightest environmental legislation, is at risk of being overtaken by the United States, generally more resistant to tackling climate issues, in the push to cut greenhouse gases. The U.S. recently proposed rules to cut emissions from the country’s power plants that the government believes will cut household energy bills after 2030 by forcing these facilities to be more efficient.
Governments focus their efforts on the so-called energy “tri-lemma” – security of supply, affordability and reduction of carbon. Consumers are routinely advised to take simple measures to cut their energy consumption by improving the insulation in their home, or installing so-called “smart meters”, which can give a real-time digital read out of a household’s power use. Yet placing most of the onus on the consumer isn’t the answer either. “The consumer should not (and does not) bear the responsibility for meeting the challenges of the tri-lemma, but the engagement and empowerment of consumers DOES have a role (along with many other supply-side actions already underway) in addressing them,” John said. The European Union has set itself the target of improving energy savings by a fifth by 2020, but its progress towards that goal, now a mere 5-1/2 years away has been very mixed. A study released in April showed only three out of 28 EU member countries have drawn up adequate plans to show how they will curb future energy use to help meet that target. “There have been many good programs defined, but with limited adoption … a reliance on installed measures (cavity wall filling etc.) can only go so far …” John said. “But by rolling out ‘opt out’ programs such as providing BEE style insight. This is exactly how utilities in the US in a regulated market have delivered 2-3% savings each and every year,” he said. Doesn’t sound a lot? Well it does when this is across the ENTIRE population, John added.
The Global Markets Forum team held its third quarterly social gathering in London on Monday. A handful of plucky forum members, as well as some of our regular guests, gathered for an evening of drinks and bowling in London’s well-heeled Bloomsbury district. Economists, analysts and asset managers, several of whom had only met virtually in GMF, donned those much-mocked blue and red leather bowling shoes and took to the lanes, along with the Forum moderators. The flow of conversation was punctuated regularly by the satisfying smash of the pins or the disheartening clunk of a gutter-ball and cheers of either elation or groans of defeat. Our bowlers also had the chance to catch up with some of our regular GMF guests such as G+Economics chief economist Lena Komileva, who tried her hand for the first time, or Sean Maloney, of Finconomics, who turned out to be a bowling black-belt, even with an injured hand, or Oxford Economics head of global macro Gabriel Stern, who barely left a spare pin standing. With so much communication taking place virtually today, GMF believes in helping members make connections by putting some “social” into “social media.”
We’ve had an action-packed couple of days down at London’s landmark Hilton Hotel, where we’ve attended the Euromoney Global Borrowers & Investors conference. Europe’s major debt managers are optimistic on the environment for funding themselves, as well they might be now that yields are, almost half what they were at last year’s conference. The European Central Bank has popped the lid on its toolbox and the storm that swept emerging markets at the start of this year has settled into sporadic cloudbursts. Spain (unemployment 25.9 percent, gross government debt-GDP 111 percent) can fund itself as cheaply as Britain (unemployment 6.6 percent, debt-GDP 103 percent) and Portuguese 10-year bonds yield under a point less than the mighty 10-year Treasury note. Things are so good in fact, that the terms “core” and “periphery” might well now be passé, especially now that the reach for yield has taken off in earnest and every basis point matters. “Investors obviously had demand for higher yielding assets,” Tammo Diemer, managing director of the German Finance Agency said during a panel discussion. “The weaker euro zone countries have regained competitiveness … so we have seen (these) spreads tightening.”
The likes of Italy and France may have had their knuckles rapped by the European Commission for not adhering religiously to their budget deficit targets, but investors have rewarded any sign of reform or fiscal restraint handsomely. Add to that the backstop in the form of beefed-up European institutions such as the proposed banking union and there is every reason to continue investing, Maria Cannata, the head of the Italian debt agency said. Pablo de Ramon-Laca, the head of funding at Spain’s treasury arm, said there is no such thing as a peripheral country any more, although “countries all face their own challenges.” Pablo sounded a more cautious note when he spoke to us on the sidelines of the conference on the fall in Spanish borrowing costs. “A basis point in USD is not the same as a basis point in EUR. If Spanish rates were indeed lower than those of the U.S., there would be a very good opportunity for Spanish investors to buy USTs. As a matter of fact, currencies count, since they encompass expectations of inflation, future monetary policy etc.,” he said. “Check our outstanding March 2018 USD bond and compare with a UST of equivalent maturity, and you’ll see that lower rates in Spain are an optical illusion. Spain’s rates are right for its own circumstances, growth prospects, challenges.”
It might be summer in the City of London and most tourists would be forgiven for putting off a trip to Britain, in light of the pound’s ascent to five-year highs against the dollar and 2-1/2 year highs against the euro. And while the long cable trade might look overdone to Reuters FX analyst Neal Kimberley, he says there’s certainly a case to be made for further strength in the pound, thanks in part, to the Middle East. The pound is up by 2.7 percent against the dollar so far this year and 3.6 percent against the euro. Britain is planning a five-year 200-million pound sukuk, or Islamic compliant bond, that it hopes will strengthen London’s position as a sukuk hub and protect it against competition from other key sukuk trading centres such as Luxembourg, Dublin or Dubai.”UK Plc is open for Islamic business,” Neal told the forum this morning. “One of reasons why the pound is so well bid is because Middle East investors like it … the size (of the sukuk) is irrelevant. It is the willingness of the British government to issue a sukuk that has engaged Middle East investors,” Neal said.
Adding to that are the scores of Middle East families that travel to London to escape the heat and hit the shops, which gives the pound an additional lift. And indeed, a look at the charts shows that the second quarter of the year tends to be the pound’s strongest against the dollar. Over the last 15 years, cable has risen by an average 1.32 percent in the period between March and June, compared with an average decline of 1.1 percent in the first quarter, its weakest against the greenback. “… I admit it is a crowded trade,” Neal said. “So I prefer to be short EURGBP to long cable. So knowing in my own mind that the market thinks it knows the European Central Bank wants a lower euro, I can’t be long (the euro) and I’d like to be short versus the pound.” With the Bank of England looking increasingly likely to raise rates this year, there seems to be only one way for the pound to travel – north towards London and the City.
The England squad are relying on probability and mathematics to cling on to their World Cup bid, the bets on Brazil to clinch this year’s title are waning as the likes of Argentina and Germany storm through the group stages in Rio and there are the shock-exits from the likes of current champions Spain, who will leave without a point to their name. Volatility, something that is noticeable by its absence in the markets right now, has the habit of cropping up when and where you least expect it. Today, we took a look at volatility in sports and our guest, Jason Trost, co-founder of betting exchange Smarkets, said he wants to bring financial technology to betting and turn sports into an asset class in its own right. This World Cup, which has seen some of the biggest names drop out of the running, is turning into the highest-scoring, least predictable tournament in living memory – good, old-fashioned volatility, in other words. Fund managers and traders might bemoan the lack of vol in the markets right now, but the modellers that create the technology that make peer-to-peer betting possible – such as that offered by Smarkets – is something of a headache. “A lot of the syndicates are having a tough time with the World Cup this year,” Jason said, adding that sports markets are a lot more sophisticated now than they were at the time of the last World Cup in 2010, simply because of the greater number of platforms available to bet. The online market in Britain alone is estimated to be worth some $3 billion.
Football stirs passions, but there is little room for emotion when trading the financial markets, as should be the case in sports trading, Jason said. The England squad’s 2-0 defeat against Uruguay on Thursday would have cost any patriotic punters pretty dearly, for example.” It was … interesting to see England get totally overbought in the last two games. Both times, the price drifted very strongly shorter on no real news. The market ran out of sellers. It was the sports-better equivalent of a short squeeze,” he said. England’s World Cup bid is looking increasingly tenuous and that might mean anyone looking to place a bet, might let their heads guide their wallets, more than their hearts. “There’s a common misconception that betting for a particular outcome is a good/bad idea. It never matters what you bet on, it matters what price you get. Even if you want to bet emotionally, you can still get good value. For example if England were 10:1 yesterday, that would be good value. But if England were 1:10, bad value,” Jason said. “With betting, it’s important to remember that it’s a zero-sum exercise. For every winner, there is a loser of an equal amount. By definition, if more people bet for outcome x, more people have to bet against outcome x. It wasn’t just a case of emotions, it was more supply and demand of global risk.” With volatility, value and supply and demand all playing such vital roles in gambling, it’s possible that Jason’s concept of sports as an asset class might become reality sooner than we realise.