GFC Economics

The UK Coalition's Big Squeeze

2012-01-25T12:23:00.001Z

The combination of negative GDP data, rising unemployment, falling inflation and a declining PSNB-ex all suggest that the BoE will be redoubling its efforts to pin and hold gilt yields at ultra low levels in the coming months. As noted last week, the gilt market has entered a new paradigm. The trading range for yields has shunted downwards, possibly to 1.25% - 2.25% for the ten year yield. The global backdrop may improve this year but, it is unlikely to be strong enough to prevent the MPC from extending QE. The PSNB-ex data show that the government has entered into a ferocious squeeze on public spending, which in the short run, will only add to the risks of a recession. And in the case of the UK, the money multiplier benefit of lower yields, will as Mervyn King acknowledged last night, remain impaired by the absence of a competitive banking system.

Political And Asian Risks For 2012

2012-01-05T12:10:00.000Z

Understandably, most market participants remain exercised by the threat posed to the global
economy by fiscal deflation in Euroland and the potential fallout from bank runs across weaker
members of the single currency. But at the start of the New Year, it pays to take a broad
perspective and consider whether the euro will indeed prove to be the biggest danger facing the
world economy. Already, markets have been given a foretaste of one alternative risk. The current stand-off between the US and Iran has been a long time coming: a serious conflict between the two would seriously dent the current recovery in the US economy - and aggravate
Euroland’s debt crisis. Given that President Obama is presumably keen to do what it takes to
secure re-election in November this year, one has to assume that the US would be inclined to
kick this particular can down the road. Electorally, early 2013 might be a better moment for the US to confront Iran over its nuclear ambitions.

A Brighter 2012 For The US

2012-01-03T12:06:00.000Z

The US housing data offered two contrasting stories as 2011 drew to a close. The price data on confirmed that a huge backlog of foreclosed properties is weighing on valuations. And yet, last week’s pending home sales report was unequivocally strong. The dichotomy may be an encouraging sign: lenders are taking more aggressive steps to clear their inventory of repossessed homes. It is only natural to expect prices will sag. The sales data point to a market that may start to clear in 2012. And there are signs that construction is turning higher in response to strong rental demand. The improvement in the Conference Board’s consumer confidence index - particularly for the present situation - suggests that the economic recovery has genuine momentum. Friday will be an important test, with claims data pointing to a rise in payrolls above 200k. It may take two revisions for such a positive number to be realised. Either way, investors will face a dilemma vis a vis Treasuries. The FOMC is not going to rush into further stimulus so long as the economic data surpasses expectations. But Treasury yields did not stop falling during the early years of the 1990s’ recovery: indeed, the jobless rate fell to 5.2% before the bond market finally turned. There will be corrections in the Treasury market in response to the improving economy during 2012. But the backlog of foreclosures implies yields could ultimately fall to new lows this year. However, in response, the S&P 500 could revisit the highs of October 2007 (1565.1).

Germany Still In The Driving Seat

2011-12-13T12:04:00.000Z

BTPs (and Spanish bonds) are back under the cosh and it is tempting to conclude that the summit in Brussels failed. With the ECB taking a hard line on bond purchases, investors feel misled: the ECB president talked of a “fiscal compact” and yet even before the summit failed to secure full support for a Treaty change, Mr Draghi had warned that government debt purchases are “neither infinite nor eternal”. In truth, we should not have been that surprised. When Mr Drahgi talked of “sequencing” on December 1st, there was a clear inference that governments had to deliver on fiscal policy. Announcing accelerated bond purchases at the latest ECB monthly meeting would have fallen foul of this important tenet. Indeed, it seems that the markets are misjudging the significance of this new policy order. The ECB is going to be watching the actions of Euroland governments far more closely than any supposed progress towards a fiscal union. The euro will only survive if the budget deficits are brought down quickly enough to reassure bond investors. QE cannot in its own right solve the sovereign debt crisis. Indeed, premature QE can, through moral hazard, make it worse. Hence, Mr Draghi talks of abiding by the “spirit” of the ECB’s founding charter. QE can only reinforce a drop in bond yields which governments have to initiate through individual actions, not words or any change in treaty. And Chancellor Merkel still holds the upper hand: Mr Draghi is sounding more and more like a German central banker. The option NOT to buy bonds remains the biggest policy weapon, far more powerful than any new proposed inter-government accord. Expect higher peripheral yields heading into the New Year.

IMF Warning On Japan Understates Risks

2011-12-01T12:27:00.000Z

Stock markets are getting a lift from coordinated central bank action and more positive data out of the US. Calls from ECB governor Mario Draghi for a “fiscal compact” between Euroland governments and the possibility that this will pave the way for an emphatic response from the ECB also underline the potential for a short term rally in equities. But today’s commentary focuses on the longer term risks facing Japan. In a recent report, the IMF drew a parallel between the Euroland debt crisis and the incessant rise in Japan’s public sector debt burden. The IMF can hardly be reassured by this week’s announcement of yet another supplementary budget for Y2tr or more – the fourth this fiscal year – to “protect the nation’s post-quake economic recovery”. It will not be impressed either by the ruling DPJ’s proposal to offer tax credits to offset the adverse impact of the planned consumption tax hike. The repeated deployment of supplementary budgets when the economy is hit by ‘exogenous’ shocks also undermines the government’s pledge that “it will make an all-out effort” to avoid new issuances “exceeding Y44tr” in FY2012. The IMF warning on Japan was timely, and the risks remain acute, particularly vis a vis the yen, which could be forced up sharply in response to capital repatriation.