Archive for December, 2013
With 25 December only days away now we might have expected a calm period for markets. The Chinese sometimes enjoy doing things like taking monetary policy decisions on Christmas Day, but whether they are celebrating Christmas, Yuletide or the Holiday Season, western markets and policymakers generally prefer to make a quieter time of it. So it was interesting to see the Fed choose this Wednesday to vote to start tapering off its most recent asset purchase programme.
Fears over tapering reinforced several major market behaviour patterns in 2013, making it one of the year’s key investment themes. Readers may remember the panic which ensued when it was first floated, despite the fact that the Fed’s own research (and calm, thoughtful analysis) suggested that the actual effects of QE3 on the US economy have been negligible. Now tapering is actually to begin, however – from January – market reaction has been quite controlled: the ten year Treasury yield is higher, but only by about 7bp; the trade weighted dollar was stronger by Thursday evening, but by less than 1%; gold fell, but to a price only a little over $10 under its previous low for the year; and the S&P 500 rallied all of 29.65 points on Wednesday before closing yesterday flat.
Speculation, however idle, as to the globally deleterious impact of tapering will certainly continue into the New Year. Perhaps it will continue to have some power as a market theme in 2014. But we have surely reached the point where we can say it is old news. So what other themes may emerge next year?
Growth will be one. This blog has highlighted the importance of a return to growth in Europe, including the UK, in particular. 2013 has already seen the first consecutive quarters of growth across all the major developed economies since 2010. Within the eurozone especially it remains patchy and sclerotic – but better than the alternative, nonetheless. A gathering of momentum in 2014 should see gloom continue to recede from markets which have had to trudge through a bruising and tedious few years. As one rightly respected fund manager put it in his most recent report, when it comes to the rally in developed-world markets, returns “have come from a rerating … But to prosper from here we need growth.”
One other theme which we have followed has been inflation. This has gone right out of fashion as prices have generally been behaving themselves lately. There is nothing to suggest an immediate change here. But a year is plenty of time for labour markets to pick up slack, the more so if the recovery gets a little more earnest – and that alone should begin to see expectations for monetary policy change, whatever happens to other moving parts such as commodity prices. This is a wild card, and like tapering a potentially hazardous one.
A couple of weeks ago we had a look at the impact of higher growth on the UK’s sovereign debt position. There are still countries with serious problems in this area (we might think of Greece in particular), and as a result we cannot discount the possibility of further shocks. But with a more deeply entrenched recovery underway, Britain’s happy story will find other tellers. More and more governments should find themselves closer to balancing, if not actually balancing their books in 2014.
In some cases this will come in the nick of time. Even if inflation expectations do not develop as one of next year’s themes, the burden of debt at the shorter (and cheaper) end of yield curves make higher rates here a potential worry for many borrowers into 2015 and beyond. On the other hand, it is possible that other more problematic sovereigns will join Ireland in revisiting bond markets, putting another stake through the heart of the debt crisis.
Turning to the negative: there were no black swans in 2013. Compared to preceding years this was highly unusual. In 2010 we had the eurozone / sovereign debt crisis, in 2011 the Japanese earthquake and US GDP shock and then in 2012 the Greek elections. These are not things we can plan for. However, with events in the Middle East having moved in favour of Iran this year, and an escalation in tension between China and Japan, it is not obvious that the world has become a materially safer place. In the event that major government bond yields continue to rise a prudent investor (who has been well positioned to date) might look for opportunities to begin diversifying back into these and related assets over the course of next year.
As crystal balls go this one has been kept deliberately opaque. Depending how they play out, these themes could each have very different consequences for market behaviour and the pricing of risk. As a closing observation: even though it has been relatively benign compared to its immediate predecessors, 2013 has still been a nervous year. It still feels as if a large number of market participants and observers are more at home with setbacks than advances.
Should this change convincingly next year it would be something of a theme in itself. In any event, based on vigilant analysis of the fundamentals and a reasoned understanding of price, it should still be possible to make investment sense of 2014, as it has been for the past few years, in spite of everything.
There are a number of notable points which could be made about the Chancellor’s Autumn Statement yesterday. The political as well as the economic mood has clearly moved in his favour. Some of the measures announced, like the establishment of a moving target for the state pension age, were substantial. And of course the Office for Budget Responsibility has revised its economic forecasts up, meaning that the forecast level of government indebtedness has come down.
It is not the first time that this has happened. At the time of the Autumn Statement in 2010 and of the 2012 Budget, OBR debt to GDP projections drifted ever-so-slightly lower, with the peak level of indebtedness on a Treaty basis coming down by 0.8% and 1.2% respectively – before shooting up again in subsequent reports. But the difference this time is much more material: back in March, debt to GDP was forecast to peak at 100.8% in fiscal 2015-16; now the peak is to reach “only” 94.7% in the same year.
The full text of the OBR’s Economic and fiscal outlook attributes the difference to higher nominal GDP and lower borrowing about equally over the two years 2014/15 – 2015/16. It is worth quoting the following directly from the text:
While most public discussion of economic forecasts focuses on real GDP, the key driver of our fiscal forecast is nominal GDP – the cash value of economic activity – and its composition. The level of nominal GDP is higher across the forecast period than in March. … Whole economy inflation – as measured by the GDP deflator – is little changed from March.
In recent years there has been some debate about the possibility that governments would try to inflate their way out of debt (e.g.). Some economists even advocated this as policy. Regular readers will know that the idea isn’t a serious one – and the UK’s new numbers give some proof of this. In debt terms, the tide might just have turned, and higher inflation has played no part in this projection.
What we can say is that a little growth goes a long way. While the forecast for peak debt to GDP has fallen by over 6%, the cumulative change in real GDP to 2015 since the OBR’s March forecast is only +1.3%. As well as growing the denominator of the debt / GDP calculation, higher growth also reduces planned expenditure and increases projected tax receipts, thereby causing the cash amount of borrowing to fall. For economies with uncomfortably high debt, a growth spurt is the best possible cure.
This week’s data from across the Atlantic is warmly encouraging in this regard. US GDP for the third quarter was revised up in the second estimate to 3.6%, right at the top of the forecast range and the highest rate for one and a half years; confidence has rebounded from the blip of the shutdown; and unemployment fell unexpectedly to 7%, its lowest level in five years. (It is interesting to observe that this is the level which, arriving in 2014, was supposed to see the end of the Fed’s QE3. The press conference at which this was announced panicked the markets. So far this afternoon, by contrast, the S&P 500 is up by almost 1%.) If this is all beginning to add up to a proper global recovery it will be the best possible news for indebted developed-world economies.
As always we need to be careful. Reducing borrowing over the medium term will require continued fiscal discipline, and to borrow one of the Chancellor’s phrases, it can be human nature to focus on “fixing the roof” only when we are being rained on from a great height. And we should not give him too much credit either: he boasted proudly that the budget deficit as a share of GDP is expected to have fallen by 11.1% over the nine years following 2009-10. Another way of putting it is that it will have taken nearly a decade of continued borrowing for the UK to have not quite balanced its books again. Back in 1993 on the other hand, when the deficit peaked at 7.9% of GDP, it took only seven years to bring it up to a surplus of 3.5%: a larger improvement of 11.4% in total.
Still, falling government indebtedness is good news, and long may it continue. With a strengthening and prolonged global recovery there is every reason to think that it will.