Global Investing

Oil price slide – easy come, easy go?

One of the very few positives for the world economy over the second quarter — or at least for the majority of the world that imports oil — has been an almost $40 per barrel plunge in the spot price of Brent crude. As the euro zone crisis, yet another soft patch stateside and a worryingly steep slowdown in the BRICs all combined to pull the demand rug from under the energy markets, the traditional stabilising effects of oil returned to the fray. So much so that by the last week in June, the annual drop in oil prices was a whopping 20%. Apart from putting more money in household and business purses by directly lowering fuel bills and eventually the cost of products with high energy inputs, the drop in oil prices should have a significant impact on headline consumer inflation rates that are already falling well below danger rates seen last year. And for central banks around the world desperate to ease monetary policy and print money again to offset the ravages of deleveraging banks, this is a major relief and will amount to a green light for many — not least the European Central Bank which is now widely expected to cut interest rates again this Thursday.

Of course, disinflation and not deflation is what everyone wants. The latter would disastrous for still highly indebted western economies and would further reinforce comparisons with Japan’s 20 year funk. But on the assumption “Helicopter” Ben Bernanke at the U.S. Federal Reserve and his G20 counterparts are still as committed to fighting deflation at all costs, we can assume more easing is the pipeline — certainly if oil prices continue to oblige.  Latest data for May from the OECD give a good aggregate view across major economies. Annual inflation in the OECD area slowed to 2.1% in the year to May 2012, compared with 2.5% in the year to April 2012 – the lowest rate since January 2011. While this was heavily influenced by oil and food price drops, core prices also dipped below 2% to 1.9% in May.

JP Morgan economists Joseph Lupton and David Hensley, meantime, say their measure of global inflation is set to move below their global central bank target of 2.6% (which they aggregate across 26 countries)  for the first time since September 2010.

After peaking at 3.9%oya in September 2011, global inflation is expected to dip to 2.4%oya this month. If our top-down model is correct, global consumer price inflation could slide to just 2.1% by
year-end, 0.5%-pt lower than both our forecast and central bank targets. The risks are most skewed to the downside for the developed markets (DM), where consumer prices are more
sensitive to moves in oil prices.

The JPM economists say this modeled outcome undercuts their own house forecast and if the model is correct, this could accelerate monetary easing by central banks and boost consumer spending.

Next week: Half time…

QE, some version of it or even the thought of it, seems to have raised all boats yet again — for a bit at least. You’d not really guess it from all the brinkmanship, crisis management and apocalyptic debates of the past month, but June has so far turned out to be a fairly upbeat month – weirdly. World equities are up more than 6 percent since June, lead by a 20 percent jump in European bank stocks and even a 20 percent jump in depressed Greek stocks. The Spanish may found themselves at the centre of the euro debt storm now, but even 10-year Spanish debt yields have returned to June 1 levels after briefly toying with record highs above 7%  in and around its own bank bailout and the Greek election. And the likes of Italian and Irish borrowing rates are actually down this month.  Ok, all that’s after a lousy May that blew up most of the LTRO-inspired first-quarter market gains. But, on a broad global level at least, stocks are still in the black for the year so far. It was certainly “sell in May” yet again this year, but it’s open question whether you stay away til St Ledgers day in September, as the hoary old adage would have it.

On the euro story, the Greeks didn’t go for the nuclear option last weekend at least and it looks like there are some serious proposals on the EU summit table for next week – talk of banking union, EFSF/ESM bond buying programmes, euro bills if not bonds, EIB infrastructure/project bonds to try and catalyse some growth,  and reasonable flexibility from Berlin and others on bailout austerity demands. The Fed has announced that it will twist again like it did last summer, by extending the Treasury yield curve programme by more than a quarter of a trillion dollars, and there are still hopes of it at least raising the prospect of more direct QE. The BoE is already chomping at that bit, as well as lending direct to SMEs, and most investors expect some further easing from the ECB in the weeks and months ahead.

Of course all that could disappoint once more and expectations are getting pumped up again as per June market performance numbers. The EU summit won’t deliver on everything, but there is some realization at least that they need to talk turkey on ways to prevent repeated rolling creditor strikes locking out governments out of the most basic of financing — only then have those very same creditors shun countries again when they agree to punishing fiscal adjustments. A credible growth plan helps a little but some pooling of debt looks unavoidable unless they seriously want to remain in perma-crisis for the rest of the year and probably many years to come. It may be a step too far before next year’s German elections, but surely even Berlin can now see that the bill gets ever higher the longer they wait.

Three snapshots for Monday

The yield on 10-year  U.S. Treasuries, fell to their lowest levels since early October today, breaking decisively below 1.80 percent. That compares to the dividend yield on the S&P 500 of 2.28%.

The European Central Bank kept its government bond-buy programme in hibernation for the ninth week in a row last week. The ECB may come under pressure to act as  yields on Spanish 10-year government bonds rose further above 6% today.

Output at factories in the euro zone unexpectedly fell in March, the latest in a series of disappointing numbers signalling that the bloc’s recession may not be as mild as policymakers hope. On an annual basis, factory output dived 2.2 percent in March, the fourth consecutive monthly slide, Eurostat said, and only Germany, Slovenia and Slovakia were able to post growth in the month.

Big Fish, Small Pond?

It’s the scenario that Bank of England economist Andrew Haldane last year termed the Big Fish Small Pond problem — the prospect of rising global investor allocations swamping the relatively small emerging markets asset class.

But as of now, the picture is better described as a Small Fish in a Big Pond, Morgan Stanley says in a recent study, because emerging markets still receive a tiny share of asset allocations from the giant investment funds in the developed world.

These currently stand at under 10% of diversified portfolios from G4 countries even though emerging markets make up almost a fifth of the market capitalisation of world equity and debt capital markets.  In the case of Japan, just 4% of cross-border investments are in emerging markets, MS estimates.

Three snapshots for Thursday

The European Central Bank kept interest rates on hold on Thursday.  President Mario Draghi urged euro zone governments to agree a growth strategy to go hand in hand with fiscal discipline, but as thousands of Spaniards protested in the streets he gave no sign the bank would do more to address people’s fears about the economy

The divergence between Euro zone countries is starting to impact analyst estimates for earnings. As this chart shows earnings forecasts for Spain and Portugal are seeing more downgrades than Germany or France.

The inflation rate in Turkey rose to 11.1% in April, putting pressure on the central bank to raise interest rates:

The “least worst” option?

Western governments saddled with mountainous debts will “repress” creditors and savers via banking regulation, capital controls, central bank bond buying and currency depreciation that effectively puts sovereign borrowers at the top of the credit queue while simultaneously wiping out real returns for their bond holders. So says HSBC chief economist Stephen King in his latest report this week called “From Depression to repression”.

Building on the work of U.S. economist Carmen Reinhardt and others, King’s focus on the history of heavily indebted governments applying “financial repression” to creditors arrives at several interesting conclusions. First, even though western governments appeared successful in using these tactics to reduce massive World War Two debts alongside brisk economic growth during the 1950s and 1960s, King argues that the debt was cut mainly by the impressive economic growth and tax revenues during that “Golden Age” – and this was mostly down to the once-in-a-century period of relative peace that involved unprecedented integration and cooperation among western governments also engaged in a Cold War with the Soviet Union. Compared to this boost, the financial repression was a “sideshow”, he reckons.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           To show that, he applies the interest rate and inflation conditions of the 1950s and 1960s to the current US government debt trajectory and then compares the growth scenario back then with the one faced now. The graphic is revealing. So, for repression to work, it needs to generate higher growth first. And despite lower real rates today than in the days of Mad Men, that seems not to be the case.

Instead, King says governments will adopt this repression tactic anyway just to stave off draconian austerity now and prevent a destabilising surge in economy-wide borrowing rates. This will effectively reduce the amount of credit to the rest of the private sector, or at least elevating its cost, while reducing the pressure on governments to cut the debt levels quickly. The net result, then will likely be “persistently lower growth”, whatever your conclusion about the desirability of  state or the market allocation of resources.

Three snapshots for Monday

Spanish 10-year bond yields hit 6%, around the levels seen in Ireland/Portugal and Italy/Spain at the start and resumption of ECB bond purchases.

U.S. retail sales rose more than expected in March as Americans shrugged off high gasoline prices.

Currency speculators boosted their bets against the euro in the latest week. Figures from the Commodity Futures Trading Commission released on Friday showed a jump in euro net shorts of 101,364 contracts this week from 79,480 previously.

Yuan risks uniting bulls and bears?

Is the outlook for China’s yuan uniting the biggest global markets bulls and bears? Well, kind of.

As China posts its biggest trade deficit (yes, that’s a deficit) of the new millennium and its monetary authorities flag greater “flexibility” of the yuan exchange rate (the PBOC engineered the US$/yuan’s second biggest daily drop on record on Monday), the chances of an internationally-controversial weakening of yuan in a U.S. election year have risen.  A weaker yuan would clearly up the ante in the global currency war, coming as it does amid Japan’s successful weakening of its yen this year and as Brazil on Monday felt emboldened enough in its battle to counter G7 devaluations by extending a tax curbing foreign inflows.  And, arguably, it could bring the whole conflagration around full circle, where currency weakening in the BRICs and other emerging economies blunts one of the desired effects of money-printing and super-lax monetary policy in the G7 — merely encouraging even more printing and so on.

Societe Generale’s long-time global markets bear Albert Edwards argued as much last week:  “We have long stated that if the Chinese economy looks to be hard landing, as we believe it will, the authorities there will actively consider renminbi devaluation, despite the political consequences of such action.”

Fresh skirmishes in global currency war

Amid all the furious G7 money printing of recent years, Brazil was the first to sound the air raid siren in the “international currency war”  back in 2010 and it continues to cry foul over the past week. With its finance ministry issuing fresh warnings last night over hot-money flows being dropped by western economies on its unsuspecting exporters via currency speculation,  Brazil’s central bank then set off its own defensive anti aircraft battery with a surprisingly deep interest rate cut late Wednesday. Having tried everything from taxes on hot foreign inflows to currency market intervention, they are braced for a long war and there’s little sign of the flood of cheap money from the United States, Europe and Japan ending anytime soon. So, if  you can’t beat them, do you simply join them?

The prospect of  a deepening of this currency conflict — essentially beggar-thy-neighbour devaluation policies designed to keep countries’ share of ebbing world growth intact — was a hot topic this week for Societe Generale’s long-standing global markets bear Albert Edwards. Edwards, who represent’s SG’s “Alternative View”, reckons the biggest development in the currency battle this year has been the sharp retreat of Japan’s yen and this could well drag China into the fray if global growth continues to wither later this year. He highlighted the Japan/China standoff with the following graphic of yen and yuan nominal trade-weighted exchange rates.

Edwards goes on to say that this could, in turn, create another explosive FX standoff between China and the United States if Beijing were to consider devaluation — the opposite of what the protectionist U.S. lobby has been screaming for for years.

Central banks and the next bubble (3)

Expectations are running high ahead of next week’s LTRO 2.0 (expected take-up is somewhat smaller than the first time and the previous estimate though, with Reuters poll predicting banks to grab c492 bln euros).

The ECB’s three-year loan operation, along with the BOJ’s unexpected easing, BoE’s QE and commitment from the Fed to keep rates on hold until at least end-2014 may constitute competitive monetary easing, Goldman Sachs argues.

As the moves to ease have been rolled out, we increasingly encounter the argument that such ‘competitive’ (non-coordinated) monetary expansions by developed market central banks are at best ineffective and at worst a zero-sum game at the global level—and perhaps a precursor of something worse, such as a slide towards protectionism.