Archive for June, 2013
The market’s focus of late has been on the Fed, US growth and China. There has been news out on all three in recent days – but there has also been some news out on Europe.
This week saw further agreement on an EU-wide framework for banks (specifically as regards the topical subject of bailouts). It accompanies ongoing work on arrangements for federal – sorry, supranational – oversight of national budgets.
News on European affairs passes with little comment these days. This would have been unthinkable a short time ago. When budgetary oversight was agreed about 18 months ago it was headline news across the world. And the catalyst for the whole sequence of emergency summits, the insolvency and bailout of Greece just over three years ago, was of course seismic: during the week after the bailout announcement itself, the Euro Stoxx 50 index fell by over 11%. Then, after the attention-grabbing trillion dollar support package for the whole eurozone was announced the following Sunday, it rallied by over 10% in a day.
Now there is no such excitement. Like the banking system and budgetary oversight measures, the emergency EFSF and ESM programmes have come along quietly – from zero to just shy of €200bn in funds raised in three years. Once upon a time – when eurozone bond markets went haywire in 2011 – the then ten-year EFSF bond, backed by guarantees from all eurozone sovereign states, traded briefly at 2% over the yield on its German government benchmark. Now that spread stands at 0.6%, and despite all the volatility has dribbled along in a range of 0.4% – 0.7% all year.
This is quite a turnaround. From star of the show (albeit as anti-hero), Europe hardly seems to appear on stage any more. Which begs the question: are we being complacent? Do arguments over 0.5% vs 0.3% on US incomes and 7.0% vs 7.5% growth in China miss the bigger point? Has the European crisis become the elephant in the room?
As a bear case it is a tempting proposition. Just when we have all started ignoring Europe, a new bailout or political upset will come along and upset the apple cart again. If only those headstrong Eurozoneans would adopt an expansive approach to fiscal policy and improve their competitiveness via currency devaluation, etc., they might enjoy the kind of economic success which characterised Britain in the 1970s (this blog has never fully understood the logic of this confidently-touted advice).
There is an alternative, of course. A slew of indicators in recent weeks, from activity gauges to measures of confidence, have shown that the beaten-up Continental economy might at last be turning the corner and emerging from its painful though shallow slump into the anguished and shallow upturn its central bank expects.
Still, the pace of recovery in Europe doesn’t matter so long as it finally occurs. No one thinks of Europe as the engine of world growth. But it is obvious that the benefits of entrenchment in activity there would extend to those countries who are seen that way (China, for instance).
Without wishing to extend the list of animals too far: if Europe turns out to be the elephant in the room the bears will undoubtedly have their day. Otherwise – at some point – it will be the turn of the bulls again.
On Wednesday, Fed Chairman Bernanke held a press conference. Making it clear that (in his phrase) the Fed would be “letting up a bit on the gas pedal” rather than hitting the brake, he announced that asset purchases conducted under the quantitative easing programme would likely start tapering off this year if the US economic recovery continued to show strength.
So far, so reasonable. QE is an emergency monetary measure designed to stimulate growth in desperate times. If the times no longer look desperate emergency measures are no longer required. Mr Bernanke’s announcement was a signal that the Fed’s view on the recovery has grown more positive. Some might describe that as good news.
Markets, however, did not see things that way. For them the story was the oncoming shrinkage of central bank stimulus. Since QE involves bond buying, bond markets sold off with the 10 year US treasury yield up about 30bp since the end of last week. Since some participants in the rather confused rush into owning gold had bought the metal out of fear that the QE programme would usher in hyperinflation and dollar collapse, gold continued its fall, closing below $1,300 an ounce for the first time in almost three years. And equity spiked lower again: the S&P 500 dropped by 2.5%, its biggest one-day fall in percentage terms since November 2011 (when Italy was thought to be on the edge of default), and losses in Europe were even worse.
Much of this behaviour is defensible in logic. But the reaction is also interesting for what it tells us about sentiment.
Back in the panic of H2 2011 the Fed got a similar bashing from markets when it announced a change to its QE programme. It wouldn’t be buying a greater quantity of bonds outright; it would simply be lengthening the maturity of the programme to move longer as well as shorter term interest rates lower. Dubbed “Operation Twist”, readers may remember that the market lurched lower – not because it didn’t like the idea but because the economic view put forward by the Fed as justification for the move was surprisingly negative.
In other words, just the opposite happened in 2011 as happened this week. Then, the market ignored the Fed’s intention to increase monetary stimulus and focused on its gloomy assessment of the economy. Now, the market is ignoring the more constructive economic view and focusing on the intention to reduce monetary stimulus.
This week’s stock market reaction has been bearish. Not as bearish as it was in September 2011: then, the fall after the Operation Twist announcement was 6%, not 2.5%. But it is bearish nonetheless. An American stock market which rallied on the back of the most consistently positive economic data period for some years has now fallen as the chairman of the central bank expressed a cautious view that this period would continue.
It is foolish to be dismissive of sentiment. Operation Twist succeeded in driving US mortgage rates to new lows, and housing market activity has picked up ever since. If bond market fears deepen and long term rates continue to go higher, some of that shine could be taken off over the next few months. But it is undeniable that fear is more rational at some times than at others.
During 2011 the US labour market was stalling, the Greek crisis brought fears of catastrophe in Europe and China was tightening monetary policy to contain an inflation problem. Today the US economic picture is so much more obviously confident as to be almost unrecognisable, the “European crisis” has not been remotely as bad as feared and the Chinese are keener to promote growth than stifle it.
Markets are equally in a much happier condition than they were two years ago. As a result, the opportunities are not quite so obvious as they were back then. But episodes like the current period of bearishness can still create them – with or without the help of press conferences from central banks.
On the 23rd of May the Nikkei 225 Stock Average in Tokyo closed 7.3% lower, the biggest daily fall since the Great East Japan Earthquake of 2011. By yesterday the index was down almost 20% from its peak just over a fortnight previously.
At the beginning of this episode there was a lot of speculative attribution of cause. Was weak manufacturing data from China responsible? Or perhaps the Federal Reserve would end its stimulus programme as the US recovery strengthened? Whatever the reason, it was not clear whether the fall would represent a correction for a market which had enjoyed a dizzying bull run, or a kamikaze attack on equity pricing globally.
A couple of weeks later it is tentatively possible to point to the former. The Euro Stoxx 50 and the FTSE 100 are down about 4% and 6% since the 22nd. The S&P 500 has drifted all of 1% lower. And rather closer to Tokyo, the Shanghai Composite has fallen by less than 4%.
Furthermore, if the sharp downward pressure on the Nikkei lately does turn out to be specific to Japan it will reflect market pressures, not fundamental changes to the behaviour of or outlook for the economy. Much the same could be said of the way up of course and the index remains 24% higher for the year to date. But on the very day the tumble began, the Bank of Japan published its Monthly Report for May saying that growth was generally picking up. Since then, there have been positive surprises from a range of indicators including retail sales, industrial production and housing activity.
Moving back west the data has also been surprising. There was a nasty shock from the US on Monday when the ISM index of manufacturing activity indicated a mild contraction, falling to its lowest level since mid-2009. But in Europe the news has been good. In the UK we have seen stronger-than-expected activity levels across the economy – in manufacturing, services and construction – together with a continued gentle increase in house prices and firming of confidence (a connection which will be familiar to readers). In the benighted old eurozone itself PMI data has begun to recover a little more quickly than anticipated as well, and confidence indicators have also been strengthening. Only yesterday, ECB President Draghi told a press conference that the zone would return to growth this year (though the bank is keeping further emergency measures up its sleeve in case the crisis should deepen again).
It is interesting that European stock markets fell in response to Draghi’s remarks. The logic of course was that more emergency stimulus would have been better – though another perspective would be relief at the assessed absence of the requisite emergency. (Markets often respond in disobliging ways to central bank activity.)
It is still too early to write off the risk of contagion from Japan, especially if the correction becomes a full-on collapse. It would be hugely premature to write off the possibility of another emergency for the ECB to contend with. But it is worth observing that we are almost half way through 2013 and about a year from the point at which market confidence really began to recover from the 2011 crash. Japan’s rally has been an impressive spectacle. The avoidance of catastrophe and an end to the recession in Europe could be a major game changer.