Global economic / liquidity backdrop benign, supporting equities

Posted on Friday, July 10, 2015 at 04:33PM by Registered CommenterSimon Ward | CommentsPost a Comment

The MSCI All-Country World Index in US dollars was down by 6.5% from its 21 May all-time peak as of Wednesday, the recent low. The modest response to “Grexit” risk and Chinese stock market chaos is consistent with the assessment here of a supportive global economic / liquidity backdrop.

A post in February suggested that global economic growth would pull back into mid-2015 before strengthening in the second half of the year. The pull-back has been sharper than expected: six-month growth of industrial output in the G7 developed economies and seven large emerging economies (the “E7”) fell to zero in May – see chart.

The real or inflation-adjusted money stock leads the economy, typically by about nine months. The recent economic slowdown was signalled by a decline in six-month growth of G7 plus E7 real narrow money in the third quarter of 2014. Real money growth, however, rebounded in late 2014 / early 2015, suggesting stronger economic performance during the second half.

Other leading indicators have improved: a composite G7 plus E7 measure derived from the OECD’s country leading indicator indices recovered significantly in May (new OECD data were released this week). The lower oil price, meanwhile, may start to have a positive economic impact during the second half. An earlier post examined changes in global economic growth after five previous large oil price falls: there was no clear pattern after six months but growth was consistently higher a year later.

An important gauge of liquidity availability for markets is the gap between the growth rates of real money and industrial output. An investment strategy of buying world equities after this gap turns positive but moving to cash when it falls sharply or becomes negative would have outperformed buy and hold by 2.7% per annum over the last 45 years. Real money growth has moderated since February but a simultaneous economic slowdown has maintained a substantial “excess liquidity” cushion.

UK Budget: big changes, few winners

Posted on Wednesday, July 8, 2015 at 05:08PM by Registered CommenterSimon Ward | CommentsPost a Comment

The big story of the Budget is a dramatic reduction in the squeeze on departmental spending. The Chancellor made room for less spending restraint by cutting deep into the welfare budget and raising taxes significantly. He also allowed his borrowing targets to slip again.

The fiscal stance over the next two years is less restrictive than projected in March. Cyclically-adjusted net borrowing falls by 2.1 percentage points (pp) of GDP between 2015-16 and 2017-18, down from 3.1 pp in March.

The Chancellor attempted to soften the welfare cuts by raising the personal allowance and introducing a compulsory “national living wage” for over 25s, targeted to reach £9.00 per hour by 2020 versus the current minimum wage of £6.50. The OBR expects little inflationary impact from this measure but admits to significant uncertainty.

The living wage announcement represents an attempt to shift some of the burden of welfare cuts onto the corporate sector. The OBR estimates a direct impact on corporate profits of almost £4 billion by 2020, which would outweigh the benefit of a lower corporation tax rate and other business “giveaways”. Firms also suffer a big hit over 2017-19 from an accelerated payment schedule.

Households are significant net losers too, with higher taxes on dividends, buy-to-let investors, pension contributions, insurance premiums and cars swamping the cost of increases in personal / inheritance tax allowances and a raised higher rate threshold.

Higher borrowing and the living wage may incline the MPC towards an earlier rate hike. With the burden on business rising, neither equities nor gilts have much to cheer.

Greece: latest thoughts

Posted on Monday, July 6, 2015 at 12:00PM by Registered CommenterSimon Ward | CommentsPost a Comment
  • The comfortable “no” majority – the opposite result to that predicted by betting markets – will, at least, serve to accelerate the conclusion of the crisis.

  • The priority of the Eurozone authorities will shift from securing a deal with Greece to protecting other EMU members from financial contagion. This could involve an expansion of QE, a political commitment by leaders to implement the recommendations of the recent “five presidents’” report on strengthening monetary union, and financial guarantees against any ECB losses on its Greek exposure. Such measures would support markets.

  • The Eurozone authorities are very unlikely to agree a softer bail-out deal with up-front debt relief, as promised by PM Tsipras to his electorate. Without a deal, the ECB will be unable to maintain its current level of liquidity support to Greece without Eurozone guarantees against losses, let alone increase it. Banks will run out of cash in days, further increasing economic hardship. The government’s popularity may unravel swiftly, leading to new elections, perhaps triggered by the resignation of the president.

  • The liquidity crunch is likely to force the government to pay bills with scrip / IOUs, possibly as early as 12 July when public sector wages are due. These would trade at a large discount and their introduction could further undermine government popularity by raising fears of Grexit. Despite the “no” majority, polls indicate that support for the euro is at a record high.

  • The choice facing Mr Tsipras, therefore, is to accept a deal similar to the one he rejected 10 days ago or risk his popularity imploding along with the economy. Events are moving fast and a prolonged “Grimbo” – Greece remaining in the euro but with the banking system and economy in lockdown – is unlikely.

  • The suggestion here remains that wider market implications of the Greek crisis will be limited by a supportive global economic / liquidity backdrop and the determination of the Eurozone authorities to prevent contagion.

Eurozone money trends: no additional boost from QE

Posted on Monday, June 29, 2015 at 12:11PM by Registered CommenterSimon Ward | CommentsPost a Comment

Previous posts argued that QE programmes in the US, UK and Japan gave little boost to broad money growth, helping to explain their disappointing economic impact. Early indications are that the current Eurozone programme is proving similarly ineffectual.

Monthly growth of broad money M3 averaged 0.4% over March-May, unchanged from the previous six months (QE started in early March).

The earlier posts argued that the QE impact on broad money was small for two main reasons. First, central bank bond purchases were partly offset by sales, or reduced buying, by banks. This demand reduction was a direct result of QE – banks had less need to hold liquid securities because QE was boosting their reserves. Secondly, QE encouraged capital outflows – some of the money created, in other words, flowed abroad.

These effects are evident in the latest Eurozone data. Banks sold €25 billion of government securities over March-May versus ECB purchases of €147 billion. By contrast, banks bought €40 billion in the six months before QE started.

The first chart shows six-month M3 growth and the contributions of the various credit counterparts. The “government contribution” shows the net effect of ECB and bank transactions in government securities (as well as changes in direct lending and government deposits). This is positive but lower than in December / January. Banks’ net external assets, meanwhile, are now acting as a drag on broad money growth, having been strongly expansionary in 2013-14. This implies that the (non-bank) capital account of the balance of payments has moved into substantial deficit, offsetting the large current account surplus.

The biggest contributor to M3 growth recently has been a reduction in bank’s longer-term funding. Holders of maturing bank bonds have been reluctant to reinvest because of the paltry yields on offer. The fall in yields probably reflects the ECB’s interest rate cuts last year and global trends, rather than QE.

While QE has failed to provide an additional boost, monetary trends continue to suggest respectable economic prospects. Six-month growth of real M3 and M1, however, has fallen back as inflation has recovered – second chart.

The country breakdown shows a further rise in growth of real M1 deposits in core countries but a decline in the periphery – third chart. There was a notable slowdown in Italy, while growth rose in Germany and remains strong in Spain and France, though lower than last month – fourth chart.


Greece: brief thoughts

Posted on Monday, June 29, 2015 at 11:55AM by Registered CommenterSimon Ward | CommentsPost a Comment
  • Financial crises in peripheral / emerging economies are often symptomatic of tightening global liquidity conditions.

  • However, Greece has lacked market access for many months and its crisis reflects the government’s voluntary decision to reject an EU / IMF support programme.

  • The global real narrow money growth measure tracked here has slowed recently but remains solid and well ahead of industrial output expansion, implying “excess” liquidity.

  • The US and Chinese economies appear to be regaining momentum after weakness in early 2015. The Eurozone is growing moderately while Japan has slowed after a strong first quarter.

  • Greece’s recession will now deepen significantly and capital controls may remain in place for months.

  • The direct economic and financial implications for the rest of Europe are negligible, reflecting the small size of the Greek economy and the shift of financial exposures to official creditors.

  • The main risk is political contagion, i.e. that a perceived unjust outcome for Greece increases support for anti-EU parties in other countries. Spain and Portugal hold important elections later this year. However, Greek economic hardship may cause other electorates to become more risk averse. The euro remains popular across EMU countries, even where the EU is not.

  • The Greek government has called a referendum for 5 July on EU / IMF proposals that have now been withdrawn. The government will campaign for “no” but nevertheless expected the EU / IMF to provide additional financial support this week. This was refused and the ECB has frozen emergency liquidity assistance (ELA) to Greek banks, resulting in their closure until the election.

  • “Grexit” is still not the most likely scenario. Greeks will probably vote “yes” to signal their desire to retain the euro. The current government would probably then fall, resulting in a temporary “national emergency” coalition or new elections. Negotiations on a new deal would be difficult because the current Greek government has squandered any remaining goodwill and a magnified recession will inflict further damage on public finances and the banks. The ECB would keep ELA frozen until a deal was concluded, requiring capital controls to be maintained. The government would probably be unable to meet some spending commitments, issuing IOUs instead. An eventual deal would keep Greece in the euro and allow a slow lifting of capital controls, as occurred in Cyprus after its 2013 crisis.

  • The initial reaction of bond markets to the Greek news has been smaller than feared, with 10-year Italian and Spanish spreads over Germany widening by about 30 bp. This partly reflects confidence that the ECB will modify and / or expand its QE programme to provide additional support for peripheral markets if necessary.

  • The suggested scenario here, therefore, is that Greece will remain a source of negative news for the foreseeable future but the wider market implications will be limited because of a benign global liquidity / economic backdrop.