(Reuters) – Quantitative easing may well be pushing investors to hold more cash rather than risk assets, blunting its impact as monetary policy.

Known as the portfolio rebalancing channel, the thinking behind QE rests partly on the assumption that buying up government bonds will drive interest rates down and entice investors to tilt their holdings towards riskier investments like stocks. That in turn is supposed to goose investment and consumption.

Unfortunately, that assumption may be running afoul of, or fouling up, the way in which most investors construct their portfolios, according to Toby Nangle, head of multi-asset investments at London-based Threadneedle Investments.

He argues, convincingly, that by driving rates to rock-bottom levels, government debt can no longer properly play its role as ballast in an overall portfolio, steadying the ship and allowing investors to take on more risk than they otherwise would dare.

“Despite working in asset management for sixteen years, I have never met a major, sophisticated, institutional end-investor who did not believe (with a good degree of confidence) that on a five-year horizon stocks outperform bonds,” Nangle writes in a note to clients. (here)

“This begs the questions of why give out bond mandates at all when clients could go all out on their favorite asset? The answer, of course, is that they care about the volatility of their overall portfolio returns.”

In a normal market, government bonds and stocks are complementary assets; owning the former allows you to hold more of the latter for a given level of risk tolerance. That’s because although both assets are quite volatile, when held together in a portfolio they actually produce less volatility.

Investors care about volatility – deeply. Suffering swings in value isn’t just stomach-sickening, it can be ruinous, both for the careers of the asset managers involved and for the real needs of the owners of the capital.

And indeed, the data shows – and this is elementary portfolio construction – that mixing longer-dated government bonds with equities leads to less volatility than would be suffered if you held either asset in isolation.

Government bonds, therefore, are not just a hedge, but a hedge with a positive yield. That, in fact, is a principal reason for their popularity.

THE QE EFFECT

Now consider what happens when government bond-buying lowers the yields on those bonds to essentially nothing, or to a negative yield in inflation-adjusted terms. And also consider that under QE you as an investor are participating in a market dominated by one buyer – one whose motivation isn’t profit but jobs and inflation and who might if it served its purposes at some point in the future become a massive seller.

“Most developed government bond markets now achieve little for my portfolio and I have sold them down to zero. I prize those markets that do offer the promise of offsetting equity volatility with a positive yield and use them to maintain chunky exposures to the most attractive equity markets,” says Nangle.

So, what then to hold?

The problem is that most of the available assets other than government bonds which have a positive yield, such as corporate bonds, are much more highly correlated with equities. That means that they add risk and volatility to a portfolio.

That leaves cash, which has zero return but which doesn’t have the capital loss downside of a bond. Sadly, if you hold more cash you need to cut your exposure to equities or again take on more risk. Either way, QE may be having the unintended effect of driving some to hold more cash.

So what are investors really doing?

A look at markets would seem to indicate that most are stepping up their risk, but the evidence isn’t all one way. While money market holdings, in the U.S. at least, are down substantially from credit crisis peaks, they are still at historically high levels. And cash assets at commercial banks have skyrocketed, undoubtedly for complex reasons, but something which can be clearly read as showing household and corporate caution about the future.

As for QE, this all adds to the impression that its success as monetary policy is unproven.

For investors the bottom line is that the world has become a riskier place, and central bankers are forcing you to share the burden.

(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on)

Known as the portfolio rebalancing channel, the thinking
behind QE rests partly on the assumption that buying up
government bonds will drive interest rates down and entice
investors to tilt their holdings towards riskier investments
like stocks. That in turn is supposed to goose investment and
consumption.

Unfortunately, that assumption may be running afoul of, or
fouling up, the way in which most investors construct their
portfolios, according to Toby Nangle, head of multi-asset
investments at London-based Threadneedle Investments.

He argues, convincingly, that by driving rates to
rock-bottom levels, government debt can no longer properly play
its role as ballast in an overall portfolio, steadying the ship
and allowing investors to take on more risk than they otherwise
would dare.

“Despite working in asset management for sixteen years, I
have never met a major, sophisticated, institutional
end-investor who did not believe (with a good degree of
confidence) that on a five-year horizon stocks outperform
bonds,” Nangle writes in a note to clients. (here)

“This begs the questions of why give out bond mandates at
all when clients could go all out on their favorite asset? The
answer, of course, is that they care about the volatility
of their overall portfolio returns.”

In a normal market, government bonds and stocks are
complementary assets; owning the former allows you to hold more
of the latter for a given level of risk tolerance. That’s
because although both assets are quite volatile, when held
together in a portfolio they actually produce less volatility.

Investors care about volatility – deeply. Suffering swings
in value isn’t just stomach-sickening, it can be ruinous, both
for the careers of the asset managers involved and for the real
needs of the owners of the capital.

And indeed, the data shows – and this is elementary
portfolio construction – that mixing longer-dated government
bonds with equities leads to less volatility than would be
suffered if you held either asset in isolation.

Government bonds, therefore, are not just a hedge, but a
hedge with a positive yield. That, in fact, is a principal
reason for their popularity.

THE QE EFFECT

Now consider what happens when government bond-buying lowers
the yields on those bonds to essentially nothing, or to a
negative yield in inflation-adjusted terms. And also consider
that under QE you as an investor are participating in a market
dominated by one buyer – one whose motivation isn’t profit but
jobs and inflation and who might if it served its purposes at
some point in the future become a massive seller.

“Most developed government bond markets now achieve little
for my portfolio and I have sold them down to zero. I prize
those markets that do offer the promise of offsetting equity
volatility with a positive yield and use them to maintain chunky
exposures to the most attractive equity markets,” says Nangle.

So, what then to hold?

The problem is that most of the available assets other than
government bonds which have a positive yield, such as corporate
bonds, are much more highly correlated with equities. That means
that they add risk and volatility to a portfolio.

That leaves cash, which has zero return but which doesn’t
have the capital loss downside of a bond. Sadly, if you hold
more cash you need to cut your exposure to equities or again
take on more risk. Either way, QE may be having the unintended
effect of driving some to hold more cash.

So what are investors really doing?

A look at markets would seem to indicate that most are
stepping up their risk, but the evidence isn’t all one way.
While money market holdings, in the U.S. at least, are down
substantially from credit crisis peaks, they are still at
historically high levels. And cash assets at commercial banks
have skyrocketed, undoubtedly for complex reasons, but something
which can be clearly read as showing household and corporate
caution about the future.

As for QE, this all adds to the impression that its success
as monetary policy is unproven.

For investors the bottom line is that the world has become a
riskier place, and central bankers are forcing you to share the
burden.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

The U.S.’s share of global manufacturing output fell by 23
percent in the 40 years to 2010, as China rose, outsourcing
boomed and a new highly integrated global supply chain was born.
This has utterly remade the U.S. and global economies, affecting
everything from how much and how U.S. workers make money to how
most companies are organized and compete.

Now a combination of factors – from cheap U.S. energy to new
technology to a falling wage gap – may partly reverse some of
those changes, bringing some manufacturing back on-shore.

If, and to the extent, this happens, literally every
investment in your portfolio will be affected.

RENAISSANCE OR CYCLICAL UPTURN?

First off there is a host of solid reasons to think U.S.
manufacturing may finally be catching a break. The
low-hanging fruit of globalization has mostly been gathered, and
while we can’t expect a return to the U.S. dominance following
World War II, many of the advantages enjoyed by U.S. competitors
have been eroded.

Energy is a great example. The discovery and exploitation of
shale gas and other new energy sources in the U.S. will likely
give manufacturers close to the source a real and ongoing cost
advantage. Consultants PWC have estimated that an additional one
million manufacturing jobs may be created by 2025 solely due to
the advantages of cheap shale and demand for the products used
to extract it. That alone is 1/6th of all the manufacturing jobs
in the U.S. which disappeared between 1998-2010.

At the same time, the wage gap between China and the U.S.,
once vast, has been narrowing sharply. While Chinese factory
workers cost just 3 percent of their U.S. counterparts in 2000,
by 2015, according to Boston Consulting, they may cost 17
percent as much. And while productivity per worker hour is
growing in China, it is not keeping up with wage growth. Taking
all costs into account, Boston Consulting says that South
Carolina, Alabama and Tennessee are among the least expensive
manufacturing locations in the industrialized world.

Technological change may also benefit the U.S., notably the
rise of 3-D printing, a form of manufacturing where products and
parts are literally sprayed into existence by laser and other
printers, rather than being hewn from solid metal. It makes the
most economic sense to site 3-D plants close to markets and in
places where intellectual property rights will be best
protected, two arguments in favor of the U.S.

To be clear, this is a speculative play. New energy sources
may well be found elsewhere, wage growth might accelerate in the
U.S. and any number of other roadblocks can and probably will
arise. What now looks like a secular shift may turn out to be
just a cyclical recovery in manufacturing, and possibly a
short-lived one.

HOW TO PLAY IT

One huge beneficiary of all of this will be the U.S.
Treasury and its securities. Higher tax revenues and growing
employment will make deficit issues easier to handle, while an
improving trade balance should benefit the dollar.

While energy production and related companies will be an
obvious beneficiary, expect better growth in manufacturing to
also help chemicals and capital goods firms.

But, just as the hollowing out of manufacturing hit
everything from house prices to banks in the mid-West, so will
the benefits of a reversal be widespread.

“Due to the strong multiplier effect of manufacturing jobs,
the beneficiaries of a U.S. manufacturing renaissance will be
found in small and midsize U.S.-focused industrial suppliers and
in other sectors of the economy,” Shirley Mills, of fund manager
The Boston Company, argued in a recent paper.

That means everything from component suppliers to retailers
to banks.

Catching the flip side of this trade, lightening up on those
who will be hurt, is just as important. The obvious losers are
emerging market countries and companies, which will be at a
relative disadvantage and which, if manufacturers, may have to
cope with rising wages and falling profit margins.

You might also want to look skeptically at some of the
classic U.S.-listed, globally diversified companies which have
done so well in the past decade or two. If re-shoring – the
bringing back to the U.S. of manufacturing – becomes
economically compelling, the global supply and production chain
many of these companies have built will be an expensive and
counterproductive sunk cost.

Your best bets therefore may be the smaller and midsize
publicly traded companies which have never been able to
diversify production internationally.

Like offshoring, this is likely to be a big and slow-moving
trend, so making slow but significant changes to portfolio
holdings over time is probably the strategy which offers the
best risk/reward combination.

(Reuters) – Buy Japanese stocks if you must but don’t expect Abenomics and the fall of the yen to revitalize Japan’s economy.

The yen has fallen by more than 20 percent since Prime Minister Shinzo Abe, who advocates aggressive monetary and fiscal policy, was elected in December, busting through the 100 yen to the dollar level last week.

In part the theory behind Abenomics is that a weaker yen will revitalize industry, which will export more and plow the proceeds into hiring and capital investment.

The stock market certainly believes: benchmark shares in Tokyo are up 36 percent this year and more than 68 percent over six months.

But a look at the actual data shows Japanese companies, like British ones during a similar bout of currency weakness in 2008, appear to be more eager to use a newly competitive currency to pad profits through higher margins rather than higher export volumes.

Thus far, Japanese exporters appear to be doing just that. Despite yen falls the price of Japanese exports in local currency has barely budged.

“Japanese companies have not actually cut the foreign currency prices of their exports. Just as with the UK exporters, the Japanese have chosen to hold foreign prices constant, maintain market share, and increase the yen value and thus the yen profit associated with yen depreciation,” UBS economist Paul Donovan writes in a note to clients.

This idea, called a “pricing to market” strategy, refers to the strong tendency of exporters of finished products like cars and technology to respond to price pressures from their competitors but not themselves to use a cheaper home currency to cut prices and boost sales.

This was certainly the case in Britain, whose exporters of goods and services used a 24 percent fall in the value of the pound in 2008 and 2009 to boost profits but to hold their export prices essentially unchanged.

Even worse, from the point of view of the Bank of England, which must have hoped cheap sterling would lead to economic recovery, British companies showed a strong tendency to do very little with the extra cash, piling up an additional $40 billion in bank deposits between 2008 and 2012.

GLOBAL STIMULUS

If Japan follows that model, Abenomics may in the end succeed in enriching investors but have a disappointing impact on Japanese growth and inflation.

Of course, many of those investors will be Japanese savers, and some, feeling flush with newly valuable portfolios of stocks, may spend more than otherwise they would, helping Japan’s economy in much the way the Federal Reserve hopes quantitative easing will help the U.S.

Still, the Japanese experience with equity booms, and with the bust of the past two decades, is such that it is hard to see many of the country’s aging population going on a buying spree because the Nikkei index has had a few good months.

Still, the extra profits made by Japanese exporters are real, and will have to go somewhere. Donovan of UBS lays out four options.

The first is to stockpile cash, as British companies appear to have done. This is possible, but Japanese companies are already cash-rich in aggregate.

The second is to pay the money out, either as dividends to investors or as higher wages to employees. This would be positive for Japan’s economy, but there is little evidence thus far it is happening.

The third, and this one is the devout hope of the Bank of Japan and the Abe administration, is that some of the money gets plowed into increasing production at home. Why domestic investment would increase in the absence of a pick-up in demand is unclear. Foreign demand for products which aren’t cheaper will depend on foreign economic conditions, while domestic demand will be tempered by an aging population.

That leaves foreign investment as the final, and perhaps likeliest beneficiary of the Abenomics-driven revival in corporate profitability. While there may be some temptation to invest in more capacity at home, especially if corporate executives believe the weaker yen is here to stay, this would be a big reversal of the trend Japanese corporations have followed in recent years. Foreign direct investment out of Japan has doubled in size compared to domestic fixed investment since 2004, and is now actually larger.

Given that there is good demand growth globally for Japanese products, but little of that demand growth can be expected to come from the aging island itself, this makes sense.

Abenomics contains an irony: the effect of its stimulus will be enjoyed in substantial part by hedge fund managers and clients in New York and London and by workers in Japanese factories as yet unbuilt in places like Kentucky.

(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on)

(James Saft is a Reuters columnist. The opinions expressed are his own)

In fact, your dad and mom very may well have abandoned the market entirely. That could be the single best indicator that stocks have room to run.

The Dow Jones industrial average closed above 15,000 for the first time on Tuesday, the same day the S&P 500 made its all-time high for the fourth consecutive trading session.

You can argue all you like about how corporate profits are vulnerable and the market is hung from the clouds on slender threads spun by Ben Bernanke, but what you can’t say is that we are in classic broad-based stock market mania.

Two facts:

1 – Only 52 percent of Americans own stocks, according to polling from Gallup published on Wednesday. That’s the lowest since they started asking the question in 1998.

2 – Only 31 percent of small investors describe themselves as bullish, well below historical norms, and nearly 36 percent are bears, well above historic averages, according to an American Association of Individual Investors survey released on May 2.

The demographics underpinning these facts may argue for caution, but they do not suggest that we are poised for a correction (absent, of course, some external shock). Instead, these studies suggest there are still some people out there who might, if things stay calm and stocks keep going up, have the money to give the market more gas.

Yes, the stock market rally is in large part the creation of extraordinary central bank policy, and yes, that is a narrow ledge upon which to build a solid foundation.

And indeed, mom and dad may well not own stocks because they are a good bit less well off than they were five or 10 years ago, which in itself does not argue for a sustainably vibrant economy.

Still, if you subscribe to the “manias and crashes” school of financial markets, the single best indicator of an end-stage bubble is that everyone is doing it and, even worse, won’t shut up about it.

We are not there. You probably don’t have a shoe-shine boy, but if you do he definitely isn’t trying to talk you into shale oil plays. Neither is your dentist, though he might well be clubbing together with friends to buy rental properties. And if you tell your cab driver you do something having to do with finance, he is more likely to complain about the iniquities of the investment system than crow about how it is making him rich.

All of this should give those of us with bearish, or as I prefer, skeptical, tendencies, some comfort.

STOCKS, JOBS AND HISTORY

The AAII survey of small investors has been running since 1987, taking in several of the booms and busts of modern Greenspan-style central banking. The survey is simple and asks investors to describe themselves as bullish, neutral or bearish. One of the most striking things about the data is how often extremes line up with market tops and bottoms.

The highest-ever bullish figure was 75 percent, near the peak of the dot com bubble, while the lowest-ever such figure was 6 percent in 1990, when Iraq controlled Kuwait and the first Gulf War was in preparation. Similarly, bearish sentiment hit its all time low at 6 percent in the summer before the crash of 1987.

In the same vein, the Gallup poll showed an all-time high of stock market participation at 65 percent in 2007, and it has been falling ever since, even as the unemployment rate partly recovered.

Now, it may be that small investors have learned the lessons of the bubblicious last three decades and have simply decided to sit this one out, but that is an argument that rests on the hope that human nature has changed. My guess would be that as people get their 401(k), brokerage and mutual fund reports in coming months, they will like what they see and it will fill many with a painful mix of greed and regret. That kind of thing is the true building block of a mania, and that we have yet to see.

So whose money has been driving the rally? Partly it is professional money managers, whose performance is benchmarked against the market and who will thus have been conditioned by the strong recovery in stocks since the crash to be in the market or to look bad. It also has partly been driven by institutions like pension funds and endowments taking on risks, reinvesting the money handed to them by central bank bond buying in something with more yield and upside.

The one common denominator is that all of these professionals know that authorities have effectively underwritten the market.

So yes, you can say this is a cynical rally. Cynical yes, but not crazy, at least not yet. That stage may well come, but it could be when stocks are quite a bit higher than now.

(James Saft is a Reuters columnist. The opinions expressed are his own.)

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by Chelsea Emery and Dan Grebler)

In fact, your dad and mom very may well have abandoned the
market entirely. That could be the single best indicator that
stocks have room to run.

The Dow Jones industrial average closed above 15,000 for the
first time on Tuesday, the same day the S&P 500 made its
all-time high for the fourth consecutive trading
session.

You can argue all you like about how corporate profits are
vulnerable and the market is hung from the clouds on slender
threads spun by Ben Bernanke, but what you can’t say is that we
are in classic broad-based stock market mania.

Two facts:

1 – Only 52 percent of Americans own stocks, according to
polling from Gallup published on Wednesday. That’s the lowest
since they started asking the question in 1998.

2 – Only 31 percent of small investors describe themselves
as bullish, well below historical norms, and nearly 36 percent
are bears, well above historic averages, according to an
American Association of Individual Investors survey released on
May 2.

The demographics underpinning these facts may argue for
caution, but they do not suggest that we are poised for a
correction (absent, of course, some external shock). Instead,
these studies suggest there are still some people out there who
might, if things stay calm and stocks keep going up, have the
money to give the market more gas.

Yes, the stock market rally is in large part the creation of
extraordinary central bank policy, and yes, that is a narrow
ledge upon which to build a solid foundation.

And indeed, mom and dad may well not own stocks because they
are a good bit less well off than they were five or 10 years
ago, which in itself does not argue for a sustainably vibrant
economy.

Still, if you subscribe to the “manias and crashes” school
of financial markets, the single best indicator of an end-stage
bubble is that everyone is doing it and, even worse, won’t shut
up about it.

We are not there. You probably don’t have a shoe-shine boy,
but if you do he definitely isn’t trying to talk you into shale
oil plays. Neither is your dentist, though he might well be
clubbing together with friends to buy rental properties. And if
you tell your cab driver you do something having to do with
finance, he is more likely to complain about the iniquities of
the investment system than crow about how it is making him rich.

All of this should give those of us with bearish, or as I
prefer, skeptical, tendencies, some comfort.

STOCKS, JOBS AND HISTORY

The AAII survey of small investors has been running since
1987, taking in several of the booms and busts of modern
Greenspan-style central banking. The survey is simple and asks
investors to describe themselves as bullish, neutral or bearish.
One of the most striking things about the data is how often
extremes line up with market tops and bottoms.

The highest-ever bullish figure was 75 percent, near the
peak of the dot com bubble, while the lowest-ever such figure
was 6 percent in 1990, when Iraq controlled Kuwait and the first
Gulf War was in preparation. Similarly, bearish sentiment hit
its all time low at 6 percent in the summer before the crash of
1987.

In the same vein, the Gallup poll showed an all-time high of
stock market participation at 65 percent in 2007, and it has
been falling ever since, even as the unemployment rate partly
recovered.

Now, it may be that small investors have learned the lessons
of the bubblicious last three decades and have simply decided to
sit this one out, but that is an argument that rests on the hope
that human nature has changed. My guess would be that as people
get their 401(k), brokerage and mutual fund reports in coming
months, they will like what they see and it will fill many with
a painful mix of greed and regret. That kind of thing is the
true building block of a mania, and that we have yet to see.

So whose money has been driving the rally? Partly it is
professional money managers, whose performance is benchmarked
against the market and who will thus have been conditioned by
the strong recovery in stocks since the crash to be in the
market or to look bad. It also has partly been driven by
institutions like pension funds and endowments taking on risks,
reinvesting the money handed to them by central bank bond buying
in something with more yield and upside.

The one common denominator is that all of these
professionals know that authorities have effectively
underwritten the market.

So yes, you can say this is a cynical rally. Cynical yes,
but not crazy, at least not yet. That stage may well come, but
it could be when stocks are quite a bit higher than now.

Widely seen as a central banking superstar (a role not
without its dangers), Carney is credited with helping to steer
Canada’s economy through the financial crisis and its aftermath
with its banking system and reputation intact.

But one cost of bagging Carney as the successor to Mervyn
King was a very long run-in of more than seven months, during
which Britain has lurched towards and away from recession all
the while giving the impression of an economy more punch drunk
than strengthening.

The rate-setting Monetary Policy Committee of the BOE is
widely expected to do very little when it votes this Thursday,
missing an opportunity to cut rates from the record low 0.50
percent where they have sat for four years. It is also very
unlikely the BOE will increase its quantitative easing
bond-buying plans or further follow up or expand on its efforts
to channel credit to households and businesses.

Looked at narrowly, another month or two of inaction, while
a contrast to the comparative activism of the Bank of Japan and
even the European Central Bank, is not that bad. The very recent
run of economic data in Britain has been mildly encouraging,
dampening fears that the country was listing towards its third
recession since 2008. Surveys of businesses showed some strength
in the dominant services sector and very slight contraction in
manufacturing and construction. As well, GDP expanded in the
first quarter, confounding minority expectations of a new slide
into recession.

Take two steps back and the somewhat quiet period before
Carney’s ascendancy, if that is what his era turns out to be, is
slightly more troubling. The background for the British economy
is well known: this is a slump worse than the Great Depression,
both deeper and without the same vibrancy of the 1930s recovery.
And with years of falling living standards, many households are
squeezed. A survey by a consumer advocacy group found that 20
percent of participants borrowed money or used savings to meet
the cost of food in April.

Britain’s coalition-leading Conservative party remains
committed to a program of deficit reduction, despite criticism
from the International Monetary Fund, placing more pressure on
monetary policy.

“Our hopes now rest on either a significant and speedy
recovery of our biggest trading partner, the euro zone economy
(and that looks to be going in the wrong direction), or monetary
policy,” UK-based fund manager Jim Leaviss wrote in a note to
clients.

“In other words do the government’s hopes all rest on Carney
doing something new and different, or massively increasing the
scale of what the Bank of England has done before? If so we
might all be disappointed.”

LITTLE STEERAGE ROOM

To be sure, the BOE has taken steps to goose growth, notably
making changes in April to a program designed to lend money to
banks for lending on to households and businesses.

Not only has inflation been above the BOE’s 2 percent target
for more than three years – it now stands at 2.8 percent -
prices in the inflation-protected bond market imply investors
are demanding 3.1 percent over 10 years to compensate them for
anticipated inflation.

That may give Carney little room to implement so-called
forward guidance, a policy he has been associated with in Canada
which involves trying to move market prices by telling investors
how long low interest rates will be kept in place. The risks are
that forward guidance either finds little traction or,
conversely, erodes faith in the BOE’s commitment to fighting
inflation.

Opening up a hot front in the currency wars is also not an
attractive option, for Britain or for the BOE. There is
considerable firepower on the other side, as shown by the
willingness of the other major central banks to pursue easy
money policies. As well, Britain, with its consumer-oriented
economy, would suffer more from the high import prices brought
on by a weak pound than it would benefit as an exporter.

Carney, therefore, is going to have a hard row to hoe.
Expectations are high, morale is low and global conditions, with
weakness in Europe and China, are not necessarily developing to
Britain’s advantage.

When the new central banker does land, pressure will be high
to “do something,” especially by subscribers to the Great Man
theory of central banking.

Carney may end up looking back fondly on his pre-BOE days.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

(Reuters) – Britain may well come to regret the exceptionally long gap between Governor of the Bank of England-to-be Mark Carney’s appointment in November and his first day on the job in July.

Widely seen as a central banking superstar (a role not without its dangers), Carney is credited with helping to steer Canada’s economy through the financial crisis and its aftermath with its banking system and reputation intact.

But one cost of bagging Carney as the successor to Mervyn King was a very long run-in of more than seven months, during which Britain has lurched towards and away from recession all the while giving the impression of an economy more punch drunk than strengthening.

The rate-setting Monetary Policy Committee of the BOE is widely expected to do very little when it votes this Thursday, missing an opportunity to cut rates from the record low 0.50 percent where they have sat for four years. It is also very unlikely the BOE will increase its quantitative easing bond-buying plans or further follow up or expand on its efforts to channel credit to households and businesses.

Looked at narrowly, another month or two of inaction, while a contrast to the comparative activism of the Bank of Japan and even the European Central Bank, is not that bad. The very recent run of economic data in Britain has been mildly encouraging, dampening fears that the country was listing towards its third recession since 2008. Surveys of businesses showed some strength in the dominant services sector and very slight contraction in manufacturing and construction. As well, GDP expanded in the first quarter, confounding minority expectations of a new slide into recession.

Take two steps back and the somewhat quiet period before Carney’s ascendancy, if that is what his era turns out to be, is slightly more troubling. The background for the British economy is well known: this is a slump worse than the Great Depression, both deeper and without the same vibrancy of the 1930s recovery. And with years of falling living standards, many households are squeezed. A survey by a consumer advocacy group found that 20 percent of participants borrowed money or used savings to meet the cost of food in April.

Britain’s coalition-leading Conservative party remains committed to a program of deficit reduction, despite criticism from the International Monetary Fund, placing more pressure on monetary policy.

“Our hopes now rest on either a significant and speedy recovery of our biggest trading partner, the euro zone economy (and that looks to be going in the wrong direction), or monetary policy,” UK-based fund manager Jim Leaviss wrote in a note to clients.

“In other words do the government’s hopes all rest on Carney doing something new and different, or massively increasing the scale of what the Bank of England has done before? If so we might all be disappointed.”

LITTLE STEERAGE ROOM

To be sure, the BOE has taken steps to goose growth, notably making changes in April to a program designed to lend money to banks for lending on to households and businesses.

Not only has inflation been above the BOE’s 2 percent target for more than three years – it now stands at 2.8 percent – prices in the inflation-protected bond market imply investors are demanding 3.1 percent over 10 years to compensate them for anticipated inflation.

That may give Carney little room to implement so-called forward guidance, a policy he has been associated with in Canada which involves trying to move market prices by telling investors how long low interest rates will be kept in place. The risks are that forward guidance either finds little traction or, conversely, erodes faith in the BOE’s commitment to fighting inflation.

Opening up a hot front in the currency wars is also not an attractive option, for Britain or for the BOE. There is considerable firepower on the other side, as shown by the willingness of the other major central banks to pursue easy money policies. As well, Britain, with its consumer-oriented economy, would suffer more from the high import prices brought on by a weak pound than it would benefit as an exporter.

Carney, therefore, is going to have a hard row to hoe. Expectations are high, morale is low and global conditions, with weakness in Europe and China, are not necessarily developing to Britain’s advantage.

When the new central banker does land, pressure will be high to “do something,” especially by subscribers to the Great Man theory of central banking.

Carney may end up looking back fondly on his pre-BOE days.

(James Saft is a Reuters columnist. The opinions expressed are his own)

(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

(Reuters) – Put away the sunblock and beach towels, for central bankers this is going to be yet another summer of extraordinary measures.

Major central banks around the world, struggling with low growth and sagging inflation, seem to be moving towards joining their peers at the Bank of Japan in considering even more radical measures to stimulate growth.

The European Central Bank on Thursday cut interest rates and threw out broad hints about a range of unconventional measures it may pursue, without committing to anything specific. Europe’s central bank also cut its main interest rate by 25 basis points to 0.50 percent and lopped a half a percentage point off of its marginal lending facility, taking it to 1 percent.

On Wednesday the Federal Reserve kept rates on hold but inserted a key phrase into its statement which opened the door to increased or decreased bond buying if needed. While the Fed, which is divided on the need for and wisdom of more quantitative easing, or QE, was careful to keep its options open, the significant change was that it was for the first time in recent months discussing the possibility of doing more.

Despite buoyant stock markets and giddy debt markets, the global economy is in a clearly weakened state and getting worse.

It is not unfair to use the word depression to describe what is happening in the euro zone, with mass unemployment showing little sign of improving. Euro zone inflation slumped to just 1.2 percent in April, and is in outright deflation in the hardest hit areas.

The JP Morgan Global purchasing manager survey showed that manufacturing world-wide is teetering just above the line that separates expansion from contraction, with weakening conditions in all the major economies.

EURO FIX

So what can the ECB do?

Its major problem is that too little of its easy monetary policy actually benefits businesses. That’s because Europe, an economy which is highly dependent on bank financing, is in the midst of a banking crisis and recapitalization, especially in its periphery. Even though banks can now fund their day-to-day liquidity needs cheaply, few are willing to make aggressive loans, preferring to hold government bonds.

In an economy which gets 80 percent of its corporate funding via banks, as opposed to the 80 percent via capital markets in the U.S., that is a crippling problem.

ECB chief Mario Draghi said the bank would consult with other euro zone institutions about efforts to channel credit to the real economy, particularly smaller enterprises, perhaps by jump-starting the securitization market. He also discussed the possibility of policy which would mean negative interest rates, where depositors would actually pay for the privilege of warehousing money.

None of this will be easy for the ECB to agree. While some of its members are prepared to do more, and may have argued for more this time, the Bundesbank wing of the central bank is consistently opposed.

FED DIVIDE

The Federal Reserve is in similarly sticky territory. Employment remains soggy and the Fed’s favorite measure of inflation rose just 1.1 percent last month, implying both economic weakness and room to maneuver.

Interestingly, the term premium, essentially the extra interest investors usually demand for holding longer-term debt, has shrunk to zero. That may imply a bond bubble but it may also show a lack of faith in future growth, and by extension future interest rates.

On the face of it, this would seem to argue for the Fed to increase its bond buying, or perhaps to begin to purchase a broader range of assets so as to better get the stimulus to companies and households.

But while there is clearly room for the Fed to do more to hit its twin inflation and employment goals, actually doing more is going to be controversial within the Fed, implies risks to financial stability and, perhaps worst of all, is liable to be more of what already isn’t working.

The overall likelihood is that the economy continues to show weakness and by summer we are discussing yet another global slump, though perhaps a mild one. Chinese data is weak and for all the talk of the death of austerity, government spending in Europe, the UK and the U.S. will remain under pressure.

Like a going-out-of-business sale that lasts all year, at some point we may need to drop the word “extraordinary” from extraordinary monetary policy.

(James Saft is a Reuters columnist. The opinions expressed are his own)

(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on)

(Reuters) – In the past week we’ve had two object lessons in the madness of the bond market: Rwanda and Apple.

Apple Inc, maker of the ubiquitous iPhone and iPad, on Tuesday sold $17 billion of bonds, the largest-ever corporate issue, at rates of interest barely discernible with the naked eye.

Also recently, Rwanda issued a debut $400 million Eurobond in a sale that was heavily oversubscribed. As the market has taken to calling Apple’s issue iBonds, you could easily call Rwanda’s 10-year offering aidBonds, as foreign aid is one of the largest sources of government revenue for the tiny African country.

While Apple and Rwanda are at different ends of the risk spectrum, both deals neatly illustrate the headlong rush for anything investable and carrying something vaguely resembling an interest rate.

FRUIT OF THE TECHNOLOGY TREE

Apple’s historic deal, its first since 1994, was priced closer to what a AAA borrower would pay, rather than a AA+ company with a dominant position in the turbulent tech sector. A $5.5 billion 10-year piece yields 2.45 percent, while three years gets you 0.511 percent, five years 1.076 percent and 30-years just 3.883 percent. Demand was stratospheric, with offers to subscribe totaling more than $50 billion.

For purposes of comparison, a 30-year U.S. Treasury bond yields 2.83 percent. The U.S. Treasury, while not possessed of the design savvy or cache of Apple, has access to something a lot more useful – a theoretically endless and costless supply of dollars the government can create to meet its obligations.

Apple, with more than $140 billion in cash on its balance sheet, was motivated to do the deal by tax concerns. Borrowing will allow Apple to buy back shares and pay dividends while limiting the tax hit it would take on repatriating cash held outside the United States.

The question with Apple, surely, isn’t “Will you get your money back?” but instead, “Could you be paid better for the quite small risk that you won’t get paid back?”

This is where that 30-year bond looks especially foolish for investors.

Remember BlackBerry? The communication device’s fall from grace after Apple and other competitors entered the market is an object lesson in exactly how quickly the fortunes of tech companies can change.

Or look back 30 years ago to the Apple of that day. You could make a case that the Apple of 1983 was International Business Machines Corp, then a pillar of the stock market which had carried a AAA ratings since its first public debt issue in 1979. IBM is still a strong and vibrant company, but bond investors might remember that it was stripped of its AAA rating in 1992 and has been buffeted by competition and the ever-changing tech landscape.

Yes, there are major difference between the companies and no, Apple is not likely to go the way of BlackBerry. But if Apple suffers only a modest setback in one of its markets, its bonds might easily look woefully underpriced in a couple of years.

RWANDAN YIELD

Rwanda’s deal, which was also heavily over-subscribed, runs for 10 years and carries a 6.875 percent yield, as well as a junk-level debt rating of single B.

While Rwanda has been growing impressively in recent years – at about an 8 percent clip – this is a small, agrarian country with a history of civil strife and a massive dependence on external aid.

Not only does aid make up 38 percent of government spending, it accounts for 10 percent of GDP. Remember, this is a dollar bond and Rwanda cannot print dollars, but only earn, borrow or solicit them.

In fact, of the foreign currency flowing into Rwanda last year, 49 percent fell under the category of “current transfers,” meaning it was mostly aid and remittances of Rwandans working abroad.

While one can only hope for success and prosperity for Rwanda, it seems to me that this is a very long and low-yielding deal with multiple potential points of failure.

So why are we here? Why are investors willing to bet that history won’t repeat itself for Rwanda but will for Apple? In short, because central banks are creating conditions in which investors stretch for yield but cannot create the growth that will allow them to make decent long-term returns overall.

The main determinant of Apple’s yield is Treasury yields, and those have been driven lower by central bank buying, which has also freed up private money that needs a home and still wants to hit its return benchmarks.

Likewise, Rwanda, which competes in a global marketplace without many high-yielding instruments and thus can lock up 10- year money at a very attractive price.

While risk management means that investors probably cannot abandon the bond market, even in its moment of madness, they should remember that 10 years is a long time in emerging markets, and 30 years an eternity in technology.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(James Saft is a Reuters columnist. The opinions expressed are his own.)

(Editing by Chelsea Emery; Editing by Dan Grebler)