Archive for February, 2016

Great Expectations

A speech to the G20 summit in Shanghai from the Governor of the Bank of England has drawn some media interest today. Mark Carney’s words of caution to his fellow central bankers on the subject of negative interest rates centred on the “zero sum game” of seeking export-led recovery. He noted, quite rightly, that “beggar-thy-neighbour” policies at the country level would do nothing to address the sluggishness of global demand. And only on Tuesday he told the Treasury Select Committee that Britain’s policy rate would not go negative.

He did, however, say that it might be cut.

Sterling hit a new trade-weighted low on Wednesday and has now fallen by more than 10% from its August peak to a level last seen two years ago. Now the downward trend started back in November and has also received a helping hand from David Cameron’s successful reform of the European Union last Friday. But Governor Carney’s words, and those of his colleagues on the MPC this week, do undermine the credibility of his Chinese lecture at least a little.

This is especially the case since the pound’s impact on inflation has long been singled out in the Bank’s quarterly reports on the subject. A bout of moderate currency weakness could give a nice boost to CPI, if only on a forecast basis, bringing it closer to the target rate of 2% per annum without the MPC having to resort to any further loosening of policy over the coming months. And the side effect of a positive impact on British exports is just something the Bank would, regrettably of course, have to live with.

Look at the last Inflation Report and the underlying data, however, and even sterling is a side-show. As so often over the past 18 months the big news is oil.

This blog wrote about the impact of energy prices on the Bank’s assumptions for inflation back in November. Since then the effect has grown. Oil price assumptions for this year and next are down by 34% and 29% respectively; forecasts for gas prices down by 24% and 21%. On the MPC’s arithmetic this is in the process of translating into added deflationary pressure in 2016 of 0.4% p.a. by way of petrol prices and gas bills alone, with additional effects via the pass through of lower production costs (this being more difficult to time as well as to quantify).

It is, then, unsurprising that it has been oil, not sterling, which has exerted the more powerful pressure on interest rate expectations. These were already very benign, with UK rates only expected to rise late this year or some time into next. Look at futures markets today, however, and they are not pricing in any chance of policy tightening until the second half of 2018, with the base rate remaining under 1% until at least the end of the following year. As with the pound this change has been quite rapid. The 3-month LIBOR future for December 2019, which now prices at 1.02%, was priced at 2% on New Year’s Eve.

While the press looks to the pound, therefore, the rates market has been looking at the oil price.

And yet even the February Inflation Report is rightly cautious on this subject. It notes that the drag from lower energy prices will unwind over time, and that its CPI forecast on a three year view is broadly unchanged. Elsewhere it further notes that the labour market has strengthened more rapidly than expected back in the autumn: in fact it now forecasts UK unemployment of 4.8% both this year and next, revised down from 5.2% and 5.0% respectively. This is nothing less than a prediction of full employment, if the history of the last forty years is any guide. And at the same time the ratio of vacancies to the total labour force has risen again. This measure averaged 1.5x over the period 2010-12, when the UK labour market stagnated around an 8% level. Then it rose to 1.7x in 2013 and 2.0x in 2014, a time of rapid jobs growth which saw unemployment reduce to 5.7%. For 2015 the ratio hit 2.3x and unemployment already stood as low as 5.1% come December.

Under normal circumstances this would ignite at least an amber warning of cost pressures by way of wage increases. At present, however, this pressure is contained by the current low level of headline CPI, as the Bank also notes. (What the Bank doesn’t note but is nonetheless equally material is that low inflation has a direct impact on wage settlements in the public sector – about one in every six jobs in Britain – together with pensions and other welfare payments.)

The UK is close to full employment, the deflationary impact of a strong pound has fallen away in short order and price pressures are being contained only by the continued weakness of a commodity whose average annual price change in either direction over the last ten calendar years has been 30%. Interest rate markets are expecting this happy circumstance to persist for at least the next two to three years. From some perspectives – that of the property market, for instance – it would be lovely if they were right. But the more prudent thing to do, surely, is to think about what might happen if they are not.

Let us leave the last word to the Bank of England:

“At its meeting ending on 3 February, the MPC judged it appropriate to leave the stance of monetary policy unchanged . . . All members agree that, given the likely persistence of the headwinds weighing on the economy, when Bank Rate does begin to rise, it is expected to do so more gradually and to a lower level than in recent cycles.

This guidance is an expectation, not a promise. The actual path Bank Rate will follow over the next few years will depend on the economic circumstances.

26/02/2016 at 4:04 pm

Subsidence Damage

Stock markets are enjoying a bit of a bounce today, and oil futures are up. Risk assets are showing weak signs of an effort to get back up onto their knees. Of course the Chinese stock market opens now after the New Year holiday and may fall 7% in twenty minutes again on Sunday night. And at the end of the week David Cameron will emerge from a European summit, proudly clutching some kind of permission slip and ushering in the Brexit referendum. But today we can enjoy some relief from the carnage. However . . .

Worries have surfaced over the London property market this week. Only this morning, Bloomberg reported that central London has “fallen into the grip of the bears”. One can quibble with some of the detail: falls in REIT shares are not the same as falls in the price of property, for instance (which is why the sector is currently on a price / book ratio of 0.85x). Still, their data shows a fall in buying interest from sovereign wealth funds of £2bn in the six months to November. As one analyst put it: “London is becoming a victim of its own success as the petro-dollar trade unwinds, with SWFs selling assets.” Falling stock prices may not have much of an impact, then, but the falling oil price may be something else.

On the other hand, one headline out a week earlier stated that the prime central London residential market will benefit from cheap oil, the reason being that anxious sheikhs will see it as a safe haven. Or if you don’t buy that argument, what about demand from China, with investors and business people from the Far East just as keen on London as the Americans, Arabs and Russians before them? Admittedly both of these lines come from estate agents – but then again, who would know more about the market?

Of course London is only part of the UK market as a whole, residential is not the same as commercial – and even there the Bloomberg point about a £2bn reduction still apparently left incremental SWF demand of £16bn to play with. So even if those making a bull case for property are talking their own books up, we are perhaps some distance from the end of the world.

This will come as a relief to all those in Britain (almost everyone) who sees their own home as an inviolably valuable asset. For homeowners it is not a question of markets: there is a Property Ladder. And it will continue climbing up to Heaven long, long after we have got there ourselves.

Not as many people who live here do own homes as they used to, of course. Rather than being carried up the Property Ladder, they are pouring their money down what is seen as the Rental Drain. According to survey data from National Statistics the proportion of UK residents who own their homes has fallen to its lowest level for at least a quarter of a century. The proportion of those in social housing has dropped over a much longer period, standing at about the same level it was in the 1950s. Private rentals make up the difference. For obvious reasons this change has a demographic distribution, with just under half of those aged between 25 and 34 now renting (without counting those still living in the family home).

There are all sorts of reasons for these changes but one of them is indisputable: affordability. Again, there are various underlying factors at work here, but using a model of the strain put on average earnings by a hypothetical average vanilla mortgage arrangement, affordability fell below its 40-year average last year at a time when interest rates have remained near zero. In the immediate aftermath of the Great Recession, UK housing looked cheap on this measure. Since then, rates have not moved, and average earnings have only increased by about 1.6% per year. The movement from cheap to just shy of fair has come about almost entirely as a result of the appreciation in prices.

Worries about the oil price aside, then, we might raise a bit of an eyebrow about the vulnerability of UK homeowners – or at least, UK mortgagors – to any increase in interest rates as and when it comes. In many cases such an increase will be affordable: measures like these speak only of the affordability to those maxing out the credit card today. On the other hand, mortgage approvals are running at the rate of over 70,000 per month at the moment – low by historic standards (affordability again) but still high enough to cause problems for large numbers of those caught out when the music stops.

This blog has argued lately that the current market pessimism is overdone. Many fears seem groundless, and too many people appear to be looking for lightning to strike in the same place twice.

But there are reasons to be fearful where the conditions exist for painful disruption to markets which have become complacent about risk. Whatever the timing, and whatever the scale of the eventual damage, there are cracks showing which suggest that the UK property market might be in just such a situation.

12/02/2016 at 4:31 pm

Concerning Growth

The bells of doom continue to toll, with headlines appearing in recent days about the forthcoming global recession (e.g. yesterday’s news wires, business TV channels, the financial press, etc.) Now it is true that the MSCI World Index of developed-market stocks has just suffered its biggest monthly fall since all the way back in the distant past of August 2015. But does this really augur a global recession, similar to the Great Recession of 2008-9?

In times of crisis this blog believes that it behoves us to seek refuge in facts.

Let’s start with Europe. Yesterday’s EU Commission forecast carried a lower estimate of economic growth for the eurozone this year than it did at the time of the autumn forecast last November, it’s true, and this has been taken in some quarters as support for the bear case. But the revision is negligible: down from +1.8% to +1.7%. It still represents an increase on 2015, not a diminution. And in absolute terms these kinds of numbers are breakneck for the poor old euro area, where growth has averaged a meagre +1.3% real over the whole period of the single currency’s existence and a paltry +0.7% over the last ten years, marred as they were by the double dip recession. Logic, too, is not on the side of the bears here: Europe as a whole is the single biggest importer of crude oil by some distance. So while Norway and Scotland are not enjoying crude prices of $30 per barrel, last year’s figures for the eurozone economy bear out the massive positive effect they have had on the continent more broadly. The forecast numbers for this year do the same.

Crossing the Atlantic, the picture in the US and Canada is more mixed. With its oil economy hit hard Canada’s GDP growth has fallen away to zero in recent months, and is predicted to come in at 1.2% for 2015 overall – less than half the growth rate of the previous year. Last week’s US print for Q4, up only 0.7% on an annualized basis, was weak but roughly as expected: markets had been bracing themselves for the effects of the strong dollar on growth. Though even then it is worth noting that the greenback has plunged somewhat over recent days amid all the disappointment. And for the current calendar year the consensus is for growth of 2.4% – a little below trend, perhaps, but not, in any way, shape, or form, a recession.

Another ocean away, Japan only just emerged from a real life recession back in 2014. The consensus GDP forecast for 2016 is +1.0%, and with consumer and business confidence strengthening into the end of last year there is no sign that this represents unreasonable optimism. With the long run in mind one might observe that growth of 1% per year is not desperately exciting, that this is connected to the country’s demography and that there are lessons for many other economies on this front soon similarly to be learned – but that is another, much larger, story.

Hopping across the seas around China and her neighbours – minding our step over those disputed archipelagoes on the way – emerging Asia is not very convincing as a recessionary prospect either. Only this week the Chinese government published a revised growth target of 6.5-7%: this is below the double-digit rates of expansion to which we became accustomed prior to the Great Recession but not exactly sluggish, and quite some distance from an economic contraction. South Korean growth is forecast to tail off a bit this year, true – all the way down to +2.9% from +3.0% last year. Growth in Malaysia too is expected to come off the boil, reaching a mere +4.5% this year. Still it is not all bad news for the Asian economies: growth rates are actually expected to increase this year in India, Indonesia, the Philippines, Thailand and Taiwan.

Lest we allow ourselves to be lulled into a false sense of security, there are countries where growth prospects remain quite bleak. Mineral economies for instance, such as those of Brazil, Russia and Venezuela, are forecast to contract again this year, albeit at less alarming rates than in 2015. These are the areas where cheap oil tends to be a net economic negative. Elsewhere, however – for most of the world – it is a net positive. (The figures on this subject are readily available if any “oilmageddon” bears reading this piece care to look at them.)

Finally, the idea that we are going to be driven into a recession by the stock market’s late gurgitations is the height of self-regarding ludicrousness. Just think: back in the 1990s, NASDAQ were putting adverts on in the middle of News At Ten, Cisco Systems was worth about as much as Belgium and day trading was the easy route to fulfilling the American dream. Then everything collapsed in 2000. And the effect on the US economy? Real GDP growth in the fourth quarter of 2001 fell to +0.2% on the year. That is as bad as things got. There was never any recession.

Equally it is almost impossible to make a reasoned, cold case for a global recession this year. Predictions to the contrary are not without their use though. They tell us something about sentiment, and suggest – perhaps quite strongly so – that the current dislocation might present the more level-headed investor with a buying opportunity or two.

05/02/2016 at 4:42 pm


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