Archive for November, 2014

It’s Not Dead, It’s Resting

Today has been dominated by news from the world’s central banks. First, Mario Draghi gave markets a boost by announcing that the ECB would take action to increase inflation and inflation expectations, which he described as “excessively low.” Then, with the eurozone Stoxx 50 index already up by more than 1%, the People’s Bank of China said later in the morning that it was cutting interest rates with effect from tomorrow. At the time of writing, the Stoxx 50 is up by almost 3%, with markets around the world also enjoying a boost, from equities to oil to industrial metals. Bond markets are up too; after all, all this has to do with lacklustre demand and low inflation – all good, bond-positive stuff.

Now growth of 0.8%, which is what is forecast for the eurozone this year, is sub-trend even for the sclerotic economies of the Continent, so low inflation is not really a surprise. Elsewhere, however, there has been quite a lot of other news on prices out this week with a different tone.

This Tuesday we had the October CPI and RPI data out here in the UK. Headline numbers were a little firmer than expected, with CPI up 1.3% on the year as against expectations of a 1.2% rise. RPI ex mortgage interest payments – the old monetary target measure – also surprised somewhat, up to an annual 2.4% from 2.3% in September. Part of this was to do with transport costs, but another reason was also due to rising prices for toys and computer games in the run up to Christmas.

This might seem rather dry and the numbers immaterial. But it is the last point which ought to raise an eyebrow. There is clearly sufficient consumer buoyancy in the UK market just now to allow retailers to increase some prices – good, old-fashioned supply and demand at work. This might well be connected to the fact that the economy has been growing, house prices rising and the unemployment rate falling. Indeed, at 6%, unemployment has already dropped by more than 1% this year alone and is 2.5% below its 2011 peak.

Then on Thursday we had CPI numbers out from the US. The headline rate, which had been expected to fall, remained constant at 1.7%, while the core rate (which excludes food and energy prices) ticked up a little to 1.8%, all of which surprised markets. Interestingly, the “recreation” component of the index – which includes video and audio products – was again one of the reasons. And again, we know that the US lies at the more robust end of the growth scale across developed economies, and that unemployment has fallen to 5.8%, with 2014 already showing the fastest drop for any year since the rate peaked at 10% in 2009.

Rounding the theme off, this afternoon it was Canada’s turn. The headline CPI change on the month, which had been expected to fall with weaker energy prices, actually rose, bringing the annual rate for October up from 2% to 2.4%. The core rate – which in Canada’s case excludes eight “volatile” items, plus indirect taxes – also increased from 2.1% to 2.3%. Price inflation has been gathering steam in Canada significantly this year, up from only 1.3% on the core measure at the end of 2013, and here the sectors responsible ranged from shelter to transportation to food and clothing.

One might go so far as to say that there are two conflicting themes visible in this area at present. On the one hand there is Europe and Japan, each with their own problems, each battling low growth and each trying to ramp up inflation. On the other hand there is the UK, the US and the rest of the dollar zone, where activity has been stronger for some time, labour market slack has reduced and inflation, while not yet problematic, is certainly not problematically low.

With the Brent crude future down by almost 30% since the middle of the year it is difficult to get worried about inflation just now. But there are signs in some major economies that the massive disinflationary impact of the Great Recession is now over. Some people still worry about the next banking or property market crash just like the one they witnessed a few years ago – who knows, in China, perhaps? – and perhaps they are right to do so. Those who worry about prices today generally seem to worry about them falling, focused as they are on the euro-Japanese side of things.

Still, it is the shocks from left field that cause the most excitement, and uncomfortable levels of inflation on the UK-US-dollar zone side of things would fit that bill. (Markets are not expecting policy to be tightened in Britain, the US or Canada until next September at the earliest.) As John Cleese pronounced in Michael Palin’s shop during the famous sketch, inflation might well be definitely deceased and bereft of life. But just imagine what a surprise it would be for an audience if the dead parrot prop suddenly squawked to life and flew out the shop window.

21/11/2014 at 4:32 pm

Ursa Major

As we know, the taper tantrum last year had a baleful effect on emerging market assets and currencies. 2014 has turned out rather better for them – with one notable exception: Russia.

It feels like rather a long time since the annexation / independence of the Crimea back in March, and the illegal deposition / welcome overthrow of President Viktor Yanukovych beforehand feels much longer ago still. Yet with the EU menacing further sanctions later this month, economic stagnation in Russia could become recession. The low oil price is not helping; the rouble hit new lows again this week. And so: will Russia be plunged into crisis, as in 1998? Or is this a buying opportunity?

There is no denying the seriousness of Russia’s predicament. Currency weakness of 39% against the dollar since the middle of the year will entail higher inflation, also pushed up by sanctions, and interest rates have had to go up as a result with the Bank of Russia Key Rate up from 5.5% at the start of the year to 9.5% today. Last month alone, the country’s foreign exchange and gold reserves fell by over $28bn as the central bank intervened in the currency market, to little avail. Bond markets have weakened, with the cost of borrowing more than 2% higher in longer maturities than it was at the end of 2013. There is indeed a convincing bear case to be made for the Russian bear.

On the other hand, Russian fundamentals are hardly what they were in ’98. In those days the country’s reserves were below $10bn and its debt to GDP ballooned to just shy of 100% over the course of the crisis. Today Russia has reserve assets of over $428bn and gross debt to GDP on IMF numbers of 14%. In addition, under 30% of its bond liabilities are denominated in foreign currency.

The oil price is of course a concern. But the price of gas has risen, and with winter almost upon us in Europe Russia will be profiting in coming months from increased demand. Crucially, both commodities price in dollars, so the country’s gigantic trade surplus – averaging $19.3bn per month for the six months to August – represents a reliable inflow of hard currency.

We also have the Great Recession as a recent comparator. Brent crude dipped below $40 a few times in 2008-9, the rouble had depreciated against the dollar by over 55% at one point, those reserve assets plummeted from $593bn to $381bn, real GDP fell by 11.2% on the year to Q2 2009, and yet there was no default. GDP was back to its pre-recession peak by the end of 2011. By 2010 the currency had already re-stabilised and during that year reserves increased again by $41.7bn, all while the Brent crude future averaged just over $80, below where it stands today.

Is there, then, a bull case? It seems likely that Russia will weather the current crisis, but betting on this is a different matter. For one thing, much of the asset weakness is down to the currency. Russian equities have actually been rallying, and rose by almost 8% in local terms last week. For the year to date the MICEX price index is only 0.5% down. In dollar terms, however, the market has fallen more than 30%. On a p/e basis it looks cheap relative to other bourses but then it always does because of the country’s governance problems. This year its valuation has held at a higher level than at any other time since the flash crash of 2011.

Taking a punt on the rouble would be a brave endeavour to say the least. And there are as always other financial fish to fry. Russia’s underlying balance sheet and export strength should reassure those concerned about a re-run of the Yeltsin era. But even with the bear in such difficulties it is hard to work up any enthusiasm about taking hold of its paw.


07/11/2014 at 4:47 pm

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