Category Archives: Big Picture

So much change – so little difference

Events, data and price action in recent days have provided much debate and if anything reinforce my view that volatility in asset prices is unlikely to be tamed any time soon (see Be careful what you wish for, 1 November 2016). The odds of Donald Trump winning next week’s US presidential elections have gone up, the probability of the UK opting for hard Brexit has come down, US data have been mixed and global yields and equities have come off. But ultimately I do not think the underlying picture has changed as much. Read more

Be careful what you wish for

The rise in bond yields in developed economies in the past 6 weeks remains one of the over-riding themes as we head into the last seven days of the US presidential campaigns.

Markets are now fretting about the implications for global growth and asset valuations and ultimately whether elevated global risk appetite will correct more forcefully.

Higher international commodity prices, a pick-up in global GDP growth in Q3 and early Q4 and easing deflation fears suggest that interest rate policies in developed economies may have reached an important inflexion point – in line with the view I expressed six weeks ago.

Developed central banks may refrain from loosening monetary policy further near-term, with the exception of the RBNZ and possibly ECB. At the very least, policy-makers will tweak a discourse which has largely focused on doing “whatever it takes”.

Recent US data have paved the paved the way for a 14th December Fed hike, conditional on Democrat candidate Hilary Clinton wining the 8th November US presidential elections.

But with the exception of the Fed and possibly a handful of EM central banks, rate hikes are a story for the latter part of 2017 (perhaps) while further rate cuts remain on the cards in Brazil, Russia, Indonesia and India.

Higher global yields and still uncertain US election outcome are taming global equities and volatility has spiked but EM currencies have still managed to eek out modest gains.

Assuming Hilary Clinton wins next week, I would expect the initial reaction to be a rally in global equities, EM currencies and Dollar and an underperformance of safe-haven assets.

But I would also expect market pricing for a December Fed hike to rise a little further, which could in turn eventually curtail any rally in global equities and EM currencies.

In this scenario, the Dollar would likely end the year stronger, as per my January forecast of a third consecutive year of albeit more modest Dollar gains.

Whether global risk appetite avoids its early 2016 fate will depend on the interconnected factors of underlying macro data and the Fed’s credibility. In any case, market volatility could spike in the run-up to March 2017.

The self-reinforcing sell-off in Sterling and UK bonds has only very recently abated, with markets seemingly taken some comfort from a number of factors including the only modest slowdown in UK GDP growth to 0.5% qoq in Q3.

But optimism over UK GDP data is not warranted as growth has become more unbalanced and slowed in August-September despite a significant easing in UK monetary policy. Read more

Global Central Bank Easing Nearing Important Inflexion Point

Recent comments from the Fed, ECB and BoJ have rattled financial markets after a summer of relatively low volatility.

The correction in financial markets has so far been relatively modest, particularly for equities and the dollar. But the questions remain where global monetary policy goes from here, the implications for asset valuations and ultimately whether elevated global risk appetite will correct more forcefully.

My core view is that eight years of ultra-low (and in some cases negative) central bank policy rates and expansive bond-buying programs have helped stabilise global growth and inflation, albeit at low levels.

At the same time, the costs of ultra-loose monetary policy, including asset price bubbles, distortions in bond markets, pressure on the banking sector and even rising inequality, may be starting to outweigh the benefits.

Therefore, major central banks, with the exception of the BoJ, may refrain from loosening monetary policy further near-term.

I would certainly expect central bank policy rate cuts to become increasingly less frequent than in the past and the ECB and BoE to keep the modalities of their current QE programs broadly unchanged for now.

At the very least, the world’s most influential central bankers may going forward tweak a discourse which has in recent years largely focused on doing “whatever it takes”.

To be clear, the risk near-term remains biased towards more central bank monetary policy easing. Bar the Fed and possibly a handful of EM central banks still fighting weak currencies and high inflation, no major central bank is likely to hike policy rates or tighten monetary policy this year, in my view. That’s a story for 2017, at the earliest.

But if we have indeed reached an inflection point in global central bank monetary policy, if anything financial markets will become more sensitive to any downturns in still tepid global growth and inflation and to the negative side-effects of loose monetary policy.

In this context higher volatility is likely to prevail and global risk appetite may struggle to forcefully regain traction for now. Read more

Right or wrong, further central bank rate cuts still on the cards

Just over a year ago the Chinese central bank’s seemingly innocuous 2% devaluation of the renminbi versus the dollar sent global equity markets and emerging market currencies into a tailspin, with the threat of a rarely-defined “hard landing” in Chinese economic growth grabbing the headlines. Global risk appetite once again fell off a cliff four months later as markets fretted over the possible end of ultra-loose US monetary policy after the Federal Reserve had the audacity of suggesting that more hikes could follow its first-hike-in-a-decade.

It is somewhat pointless to debate whether markets were “right” or “wrong” to react to these events as prices are simply the by-product of supply and demand and can remain “right” or “wrong” for long periods of time (put differently markets are neither right or wrong, they just are). But it is fair to say that between August 2015 and March 2016 markets were particularly sensitive to any “negative” news from the US and China, be it weaker than expected data points or a suspect policy announcement.

Fast forward twelve months and markets have swung to the other extreme, desensitized to “bad” news and happy to amplify any “good” news. Global equities are up, volatility has collapsed, bond prices have surged and EM currency rallies have extended. The lack of volatility in currency, equity and bond markets, which I highlighted in It’s oh so quiet…for now (14 June 2016), was only briefly interrupted by the Brexit vote, terrorist attacks in mainland Europe and an attempted coup in Turkey. There are some tangible explanations for this. Read more

Emerging markets – What will sour sweet spot?

Emerging market (EM) asset prices have performed well since the UK referendum on 23rd June. The overall driver is the perceived view that the risk-reward of investing in EM has improved, both due to better relative returns and more limited risks.

Major developed central banks’ willingness to keep monetary policy loose to put a floor under economic growth is central to this improved risk-reward trade-off for EM assets.

Near-zero rates in most developed markets have put in high-relief high-carry currencies such as the BRL and ZAR which are also benefiting from high global metals prices.

On the risk side of the equation, slowing rather than collapsing global growth and higher commodity prices have attenuated concerns about EM economies’ ability to prosper.

Moreover, stable and still significant EM central bank FX reserves have dulled fears about their ability to defend their currencies in the event of an endogenous or external shock.

At the same time, acute economic, political and geo-political risks in developed economies has led markets to revisit the perceived notion that emerging countries’ economies and political set-ups are inherently less stable and more risky.

Put differently, developed market economies remain just about strong enough to drive EM growth but are sufficiently weak and susceptible to endogenous shocks to highlight the attractiveness of EM assets. The question is what, if anything, is likely to destabilise this fine balance.

The two events which have seriously rattled EM assets, including currencies, in the past year had their epicentres in the world’s two largest economies: the PBoC’s renminbi “devaluation” in August and subsequent government tinkering with Chinese equity markets and the US Fed’s first hike in a decade on 16th December.

An EM crisis is still more likely to have its birthplace in the US or China than Europe for example, in my view, with EM asset prices in the past 18 months relatively resilient to made-in-Europe stresses.

US GDP growth remains unspectacular, with the manufacturing sector weighed down by a strong dollar, while China’s economy is still dependent on loose credit policy and vulnerable because of banks’ growing non-performing loans.

While both the Fed and Chinese policy-makers have seemingly learnt lessons from prior misjudgements, in both countries the risk of policy mistakes remains very much alive. Moreover, the US presidential elections scheduled for 8th November present a significant event-risk to emerging markets and their currencies.
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Post Referendum Circular Reference

It has been a fortnight since the UK electorate voted to leave the EU and the British political and financial landscape has already changed dramatically. But what we don’t know or can only tentatively forecast still dwarfs what we know.

The referendum result simply reflected a popular preference for the UK to leave an international organisation, nothing less, nothing more. There is no precedent for UK and EU leaders to rely on and Article 50 is at best only a very skinny rule book.

For all intents and purposes UK and EU leaders are flying blind. It’s not even obvious who is at the controls, let alone who will lead negotiations on behalf of the EU and in particular the UK following seismic changes in political personnel.

The next steps are thus anything but straightforward and the UK government and EU are currently caught in a prisoner’s dilemma, with none of the key players seemingly willing to make the first move.

The referendum result is not legally-binding, only advisory, and therefore the Lower House of Parliament will likely have to vote on whether to trigger Article 50. But the British government has so far provided only a vague wishlist and simply doesn’t know what the EU may or may not agree to.

Parliament will not want to kick start an almost irreversible process whereby the UK has announced a divorce but doesn’t know the terms and conditions of this divorce, let alone what its new relationship will look like. Unsurprisingly, the British government is playing for time.

But EU leaders have suggested that discussions about the UK’s exit from the EU and future trade agreements were conditional on the UK government first triggering Article 50. And that takes us back to square one.

When this deadlock is broken will depend on many variables, including the length of the stalemate itself, who is in charge at the point of making a decision and the ability and willingness of negotiating parties with different vested interests to compromise.

I would argue that the longer this stalemate lasts, the greater the likely damage to the UK and EU economies and the greater the odds that Article 50 is not triggered in the first place or that a mutually satisfactory deal is eventually reached. Early British general elections cannot be discounted, nor can a second referendum in a more extreme scenario.

Assuming that the current circular reference paralysing EU and UK leaders is unbroken near-term, the associated uncertainty will likely continue to weigh on the UK economy, sterling and global risk appetite. Whether this morphs into a deeper and more widespread crisis may boil down to how patient global financial markets are willing to be. Read more

Brexit: More questions than answers

The UK, the world and financial markets have now had five days to digest the British electorate’s vote to leave the EU and its impact on UK and global asset prices.

So far Sterling and Japanese and European equity markets have borne the brunt of the initial shock, while the FTSE is down only 3.3% since Thursday and most major and emerging market currencies have been reasonably well behaved (see Figure 1).

But there are still far many more questions than answers and the situation remains extremely fluid.

For starters there is no precedent for a country leaving the EU and thus no clear-cut rulebook to rely on. The government has limited institutional capacity to start negotiations with the UK’s 27 EU partners until Article 50 of the Lisbon Treaty is triggered and no timeline has been provided for when this will happen (assuming it is triggered at all).

Perhaps unsurprisingly given the mammoth task ahead, the Leave campaign leaders have been very short on specifics regarding the mechanics and timing of the UK’s exit from the EU, the likely shape of future trade treaties and national policies such as immigration. Prime Minister Cameron’s de-facto resignation and wholesale changes in personnel in the opposition Labour Party are adding to the head-scratching.

Moreover, it is not one country seeking to leave the EU, but a union of four countries – England, Wales, Scotland and Northern Ireland – which further complicates matters as both Scotland and Northern Ireland seem intent on remaining part of the EU and potentially breaking free from the UK.

At this point in time, all we can do is take stock of what we know (or at least we think we know) and what we don’t know (but can tentatively try to forecast).

I would conclude, as I did in Europe – the Final Countdown (21 June 2016), that the many layers of political, legal, economic and financial uncertainty are likely to keep UK investment, consumption and employment, as well as Sterling on the back-foot for months to come. Financial market volatility is also likely to remain elevated in coming weeks.

In this context the US Federal Reserve is likely to keep rates on hold in coming months and the European Central Bank can probably afford to do little for the time being. The Bank of England is likely to seriously contemplate cutting its policy rate while the Bank of Japan will be under renewed pressure to curb soaring Yen strength.

Of course, British policy-makers and business associations have come out and said the right things in order to limit the carnage and contagion. But they have far more limited room to reflate the economy and fade gyrations in financial markets than they did during the 2008-2009 great financial crisis. They are not in control at this juncture and it is not obvious who is.


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UK referendum: Blame the weather, not Brussels

The outcome of today’s crucial UK referendum on EU membership will partly depend on how many of the 46.5 million registered voters cast their postal votes and turn up today at voting booths which opened at 07.00 (UK time) and will close at 22:00.

Opinions polls have concluded that a lower voter turnout today would favour the Leave vote while a higher turnout would favour the Remain vote. 

But intentions to vote are not the same as actually ticking the ballot box. Bad weather is more likely to keep people at home and turnout low, favouring the Leave vote while dry weather would in theory encourage people to vote, in turn favouring the Remain camp.

There have so far today been scattered showers across the UK and the Met Office has issued an amber weather warning for the East of England, London and South-East England, with predictions of thundery showers throughout the day.

However, the Financial Times is reporting that in many parts of London there are long queues at several polling stations and the Met Office is forecasting largely dry and cloudy weather elsewhere in the UK.

It is somewhat ironic that the unpredictable British weather, a favourite topic of conversation, could potentially change the British economic landscape for years to come.

The consensus expectation is that if the UK votes to remain in the EU, sterling, UK equities and to an extent the euro and global equities will rally sharply. But this rally could start to fade after a few days, as markets refocus on global data and events and the British turn their attention to the all-important matter of the Euro 2016 championships and perennial question of whether Andy Murray can win a second Wimbledon title.  

But acute uncertainty and market volatility would likely persist for weeks and potentially months should the leave camp win today’s referendum, particularly if it wins by only a very narrow margin and/or turnout is low. Read more

Europe: The Final Countdown

On Thursday 23rd June, the British electorate will hold arguably the most important vote in a generation, with the result of the UK referendum on EU membership due to be announced on Friday.

The latest opinion polls have the remain camp slightly ahead and bookmakers attribute a 75% probability of the UK voting to stay in the EU. But caution is warranted as opinion polls have swung back and forth in recent weeks. Turnout, and therefore the weather, may be a critical factor with a high turnout likely to favour the leave vote.

I am nevertheless sticking to my long-held view that the British electorate will vote for continuity and for the UK remain in the EU.

The popular assumption is that after the referendum UK markets and global risk appetite will move in clear directions. This belief is likely to be tested, particularly if the British electorate votes in favour of brexit as the government is not legally bound to the referendum result.

Specifically, the consensus expectation – which I share to a degree – is that if the UK votes to remain in the EU, sterling, UK equities and to an extent the euro and global equities will rally sharply. But this rally could start to fade after a few days, with “business-as-usual” resuming.

Conversely, the over-riding view is that sterling and global risk appetite will weaken, potentially very sharply, in the days following a vote for the UK to leave the EU.

Importantly I see six potential sources of uncertainty and a number of possible scenarios (see Figure 6), particularly if the leave camp wins by only a very narrow margin and/or turnout is low.  Market volatility could thus persist for weeks and potentially months, keeping sterling and UK equities on the back foot:

  1. Prime Minister Cameron’s future;
  2. The risk of the British government ignoring the referendum result;
  3. The risk of the British parliament ignoring the referendum vote, the government re-negotiating a deal on the UK’s membership to the EU and holding another referendum;
  4. The risk of a second Scottish independence referendum;
  5. The risk of a protracted UK exit from the EU leaving the door open to a decision reversal; and
  6. The re-negotiation of new trade treaties.

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