January in the rearview mirror
As January 2012 drifts into the rearview mirror as a bumper month for world markets, one way to capture the year so far is in pictures – thanks to Scott Barber and our graphics team.
The driving force behind the market surge was clearly the latest liquidity/monetary stimuli from the world’s central banks.
The ECB’s near half trillion euros of 3-year loans has stabilised Europe’s ailing banks by flooding them with cheap cash for much lower quality collateral. In the process, it’s also opened up critical funding windows for the banks and allowed some reinvestment of the ECB loans into cash-strapped euro zone goverments. That in turn has seen most euro government borrowing rates fall. It’s also allowed other corporates to come to the capital markets and JP Morgan estimates that euro zone corporate bond sales in January totalled 46 billion euros, the same last year and split equally between financials and non-financials..
But to the extent that the ECB move was aimed primarily at preventing a seizure of the banks, then one measure of success can be seen in the degree to which it steepened government yield curves in Spain and Italy. A positive yield curve, which measures the gap between short-term and long-term interest rates, is effectively commercial banks’ ATM — they make money by simply borrowing short-term and lending long. This chart then shows some normality returning to the benchmark interest structure.
The problem, as highlighted by bond investor Pimco and others, is twofold. One, how does all this extra liquidity find its way to the real economy if fearful households and companies don’t or can’t borrow more or are still assiduously paying down debts — the suffocating ‘deleveraging’ process scaring investors and policymakers alike? It’s one thing lending back to governments, and that may be a necessary move to prevent economic meltdown, but that’s not going to generate renewed economic activity or job growth on its own. And then, two, what if banks — under regulatory and market pressure to rebuild shot balance sheets — simply refuse to expand “risky” lending again and hoard these cheap borrowings as cash that gets put back on deposit at the central bank?
On the former, there has been some positive news recently from the United States on consumer credit growth late last year and the ECB’s liquidity injection will help in Europe. But the latest ECB loans survey shows that a quarter of euro zone banks polled late last year expected to make it harder for firms to get loans in future.
Significantly, the ECB continues to report its banks depositing almost half a trillion euros with the central bank in overnight facilities. As the graphic shows, clearly not all is well.
Markets then seem justified in their relief at renewed central bank activism — correcting at least some of the more extreme positioning and pricing of the fourth quarter of last year. But there is a long road ahead and coasts are far from clear.
Thankfully, the aggregate corporate earnings picture — though slowing — continues to show some impressive resilience in the face of the public sector squeeze in the developed economies and earnings punch well above trend averages as this graphic shows. But this too will likely slow further as underlying global growth eases through the year both the emerging and developed world.
As with so many global economic stories, the answer may lie in China and the degree to which the emerging giant can sustain its slowing but still impressive growth rates while the western world repairs its shattered finances.