Archive for July, 2013
It has been a quiet few days for the markets. Following the volatility of the last couple of months the summer lull seems to have arrived at last, dovetailing nicely with the heatwave and the sporting calendar. We may be lucky enough to experience the second summer in a row with no fear of looming disaster and subsequent crisis of confidence.
Recent releases of price data from the US came accordingly as salutary reminders that there is always something to go wrong. On Tuesday we saw CPI inflation for June post its biggest monthly gain since February, bringing the annual rate up from 1.4% to 1.8%, and last Friday, PPI data saw the biggest monthly rise since October and the annual rate – up to 2.5% – reached its highest level for a year.
We should not be unduly – or at least immediately – concerned. Many other price indicators, from the Fed’s favoured GDP-based yardstick to import prices to purchasing manager surveys, suggest there is nothing serious to worry about. Consumer expectations and market views (as reflected by the “breakeven” CPI level between conventional and index-linked US government bonds) are anchored close to long term trends. And of course despite the recent strengthening of the US labour market, unemployment remains above target, consumer confidence still sits below its pre-Great Recession levels, industrial capacity utilisation has only just about caught up to average rates for the last 10-20 years and as today’s news about the default of Detroit reminds us, not everything in the American garden is rosy. There is, in short, nothing to suggest an inflationary spike.
On the other hand, what happened to the shale revolution? The price of natural gas in the US bottomed last year at under $2 / million BTU but has doubled since. Crude oil (using the West Texas Intermediate price) is about 20% above its level 12 months ago. Combined with other supposedly one-off effects this pushed PPI at the raw materials level all the way to 11% on the year to June.
Looking further ahead, what happens when and if the labour market starts to tighten? US GDP growth remains sub-trend – as does inflation. It would be natural to expect both to rise together.
It is interesting to note the lack of attention paid to pricing data currently. Detroit is making the most read headlines across the Atlantic today, but markets will take the news in their stride. It is not a surprise. A resurgence of price pressure over the next few quarters, however, would come as a surprise to many. In the meantime, it is not a situation for which it does much harm to be prepared.
“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.”
So this blog speculated all of seven days ago. Since when, two shock ministerial resignations in Portugal threatened to bear the point out directly.
Markets appear to be considerably less fragile than they were a couple of years ago, but this is still the kind of surprise they can do without. On Wednesday the Portuguese stock index fell by more than 5% and the country’s ten year bond yield rose from 6.5% to an intraday high of almost 8%. It looked as though the European drama was about to begin yet another deadly act.
Perhaps it was fortunate that attention was distracted by revolution in Egypt that very day. This was received more favourably by local markets, with the Egyptian Exchange index 7% higher on yesterday’s close. And as of this afternoon, negotiations in Portugal seem to have headed the crisis there off: bond yields have settled below 7% again and the equity market has recovered about half its lost ground so far. (German finance minister Wolfgang Schäuble did make one ominous comment though: “I think the euro is now viewed on the world’s financial markets as so stable that domestic political situations in individual countries … don’t mean a crisis for the stability of the euro as a whole.” So we can’t be out of those woods yet.)
If nothing else, the relatively sanguine response to these events tells us something about market confidence. The absorption of Portugal’s left-field political turmoil in particular is worthy of note. Above all, however, they remind us that we cannot plan for tail risk, and we certainly cannot be sure exactly what the view round the next corner is going to look like once we get there.
Lacking omniscience, we have a clear choice. We can allow ourselves to be spun into a dizzy panic by day-to-day news flow and volatility. Or we can follow the fundamentals, watch what happens to pricing – and try not to get so thunderstruck we lose the conviction to exercise our judgement accordingly.