Following are notes from our weekly editorial planning meeting:
Not unlike this year’s British “summer”, the gloom is now all pervasive. Not panicky mind, just gloomy. And there is a significant difference where markets are concerned at least. The former involves surprise and being wrongfooted — but latter has been slow realisation that what were once extreme views on the depth of the credit swamp are fast becoming consensus thinking. The conclusion for many now is that we’re probably stuck in this mire for several more years – anywhere between 5 and 20 years, depending on your favoured doom-monger. Yet, the other thing is that markets also probably positioned in large part for that perma-funk — be it negative yields on core government debt or euro zone equities now with half the p/e ratios of US counterparts. In short, the herd has already hunkered down and finds it hard to see any horizon. Those who can will resort to short-term tactical plays based on second-guessing government and central bank policy responses (there will likely be more QE or related actions stateside eventually despite hesitancy in the FOMC minutes and Fed chief Bernanke will likely give a glimpse of that thinking in his congressional testimony next week); or hoping to surf mini econ cycles aided by things like cheaper energy; or hoping to spot one off corporate success stories like a new Apple or somesuch.
So has all hope been snuffed out? The reason for the relapse mid-year depression is only partly related to the political minefield frustrating a resolution of the euro crisis – in some ways, things there look more encouraging policywise than they did two months ago. It stems as much from a realization of just how broken the banks credit creation system remains – a system that had hinged heavily on extensive collateral chains that have now largely been broken or shortened and starved of acceptable high-quality collateral. Curiously, QE – by removing even more of the top quality collateral – may even be exaggerating the problem. Some even say the extreme shortage of this quality “collateral” may require more, not less, government debt in the US and UK and would also benefit from a pooling of euro debt – but everyone knows how easy all that’s going to be politically.
Despite all this, global markets have remained fairly stable over the past week – in part due to policy hopes underpinning risk markets and in part because there’s not many places left to hide without losing money in “safe-haven” bunkers. World equities are down about 2 percent over the past week, but still up more than 6 percent from early June. Risk measured by volatility indicesis a smidgen higher too. Oil has firmed back toward $100pb, disappointing everyone apart from oil exporters. Spanish and Italian 10-yr yields are a touch higher. And at least part of the caution everywhere is ae vigil ahead of Chinese Q2 GDP data on Friday – numbers that now almost rival the U.S. monthly payrolls in global market impact.
Next week finds us in the thick of the Q2 earnings season, but Bernanke’s testimony may well end up stealing the show as QE3 speculation boils again, the IMF prepares to cut world growth forecasts on Monday and a stream of inflation reports from US/UK/euro zone reveal the leeway major central banks now have to ease credit yet again. Spain borroww again Thursday and the July US Philly Fed index, a major mood setter for the rest of month, will be important. Canadian, Turkish and SAfrican rate decisions will be watched closely. EU/IMF officials hit Budapest to discuss a lending programme for Hungary.
But perhaps the most important metric of the coming week may well be how euro banks react to the disappearance Wednesday of the interest rate on more $800bln of cash they are hoarding at the ECB. Already we have seen nearly 500 bln shift to similarly 0% current accounts from overnight deposits, but whether some of that will now find its way out the yield curve of euro government bond markets or — shock, horror — into direct business lending will be hugely important in the days and weeks ahead. The passing of the EBA bank capital deadline on June 30 and the ESM-bank deal may encourage some attempt to put this money back to work.