Tag Archives: Olivier Desbarres

Hawkish pendulum may have swung too far

I have long argued that the risk of a collapse in global economic growth and inflation was over-stated and more recently that major central banks had likely reached an important inflexion point.

A global recession and global deflation have seemingly been averted and central bank policy rate cuts and extensions of quantitative easing programs have become rarer occurrences.

Donald Trump’s election has turbo-charged expectations that reflationary US-centric policies will drive global, and in particular US growth and inflation in 2017, that the Fed’s hiking cycle will step up a gear and that US yields and equities and the dollar will climb further, heaping pressure on emerging economies and asset prices.

But analysts and markets may now be getting ahead of themselves.

My core reasoning is that US inflation may not rise as fast expected, due to lags in the implementation of Trump’s planned fiscal policy loosening and immigration curbs, residual slack in the US labour market and disinflationary impact of higher US yields and a stronger dollar.

As a result, the FOMC, which will see important personnel changes in early 2017, may argue that the market has already done some its work and not be as hawkish as expected.

In this scenario, US short-end rates could lose ground while long-end rates continue to push higher, resulting in a steepening of a still not very steep US rates curve.

One corollary is that factors which have wakened the euro may lose traction as 2017 progresses.

 

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The A-Team had a plan, the British government has a nebulous goal

The UK has its own eclectic A-Team led by Prime Minister May, tasked with getting the UK out of the EU and securing a more beneficial relationship with trading partners.

Theresa May, David Davis, Liam Fox and Boris Johnson have been dealt a tough hand and unsurprisingly have so far refused to reveal the intricate details of their daring plan.

But voters, businesses, parliament, EU leaders and foreign trading partners are pressing the government to elaborate on its tactics and strategies for Brexit.

There was break-through of sorts on 7th December, with the 650 members of the House of Commons (MPs) voting overwhelmingly to allow the government to trigger Article 50 by end-March in exchange for publishing the details of its Brexit plan.

But the devil is in the detail – or lack thereof. This parliamentary vote is not binding and the government has only agreed in the vaguest of terms to publish its plan for Brexit.

If MPs receive the plan late in the game and/or it is insufficiently detailed and assuming the Supreme Court rules that government has no prerogative to trigger Article 50, parliament may decide to delay or even scupper the process by which Article 50 is triggered.

Moreover, this likely vote in the House of Commons and House of Lords may well be only one of multiple votes which parliament has to hold between now and the approval of a final treaty between the UK and the EU.

In addition to these possible parliamentary hurdles, the government may also have to navigate a number of pending legal cases.

Some of these parliamentary votes may not take place and these legal actions may fail. There is certainly scope for further compromise between Theresa May’s government and parliament.

But the risk is that this reputation-sapping cat-and-mouse game extends beyond March, in turn making it far more difficult to predict the end-outcome – which ranges from the UK reverting to WTO rules (the “hardest” form of Brexit) to the UK staying in the EU.

Given the uncertain path which British executive and legislative bodies will take to reach a difficult-to-predict outcome at an unidentifiable point in the future, forecasting Sterling remains fraught with difficulty.

In this context I would expect Sterling to continue lacking direction near-term, particularly as the FX market has, it would seem, already priced out the more negative scenarios for the UK economy. Mixed UK data may not provide Sterling with much direction either way.

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Black swans and white doves

In the past week European and global politics, strong US growth data, mixed global macro numbers and eurozone, Chinese and Indian central bank policy have eclipsed Trump-mania.

What is perhaps more remarkable is markets’ reasonably benign, “risk-on” reaction, bar the euro’s sell-off in the wake of today’s ECB policy meeting.

One interpretation is that markets have become complacent to the risks presented by President Trump’s constellation of pseudo-policies, surging nationalism in Europe, the UK’s uncertain economic future and continued capital outflows from China.

I have a somewhat different take, namely that markets are rightly discounting some of the more extreme and perverse scenarios, including:

  1. Protectionist US policies coupled with higher US yields and a strong dollar collapsing tepid emerging market, and eventually global, economic growth;
  1. The “no” vote in the Italian referendum leading to the economic collapse of the European Union’s third largest economy;
  1. Surging European nationalism culminating in the collapse of the eurozone and/or European Union;
  1. The British government opting to sacrifice growth in exchange for a hard version of Brexit and;
  1. Capital outflows from China ultimately forcing policy-makers into accepting a Renminbi collapse and shocking a corporate sector with significant dollar-debt.

 

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Renzi Referendum Frenzy – Storm in a brittle tea cup

All eyes are riveted to the Italian referendum on constitutional reform due on Sunday 4th December.

The “no” vote is still ahead in the polls, even if the past 18 months should have taught us to be weary of polls’ predictive powers.

The worst-case-scenario advanced centres on reformist Prime Minister Renzi’s resignation, the rise to power of the euro-sceptic Five Star Movement (M5S), a jump in Italian bond yields, the fragile banking sector and economy’s collapse and Italy’s eventual exit from the eurozone and EU.

The more likely political, financial and economic outcome from a “no” vote is perhaps less dramatic, in my view, and financial markets, including the euro, have been reasonably well behaved in the run-up to the referendum.

A “no” vote may well usher in a less reform-minded technocratic government and fuel support for the populist M5S and its leader Beppe Grillo but their path to the top will not be straightforward.

The banking sector, riddled with bad-loans and planning a recapitalisation of its balance-sheet, can ill afford the negative press a “no” vote may bring. But both Italian and eurozone policy-makers have a strong incentive to shore up Italian banks and the economy, even if posturing may precede an eventual solution.

The ECB may well extend its QE program at its policy meeting on 8th December in order to help alleviate any stress in eurozone markets but I don’t expect other major central banks to follow suit with monetary policy loosening of their own near-term.

Finally, while the future of the eurozone and EU has been written off many times, I don’t envisage Italy being the trigger for a break-up of either. Read more

EM currencies, Fed, French elections and UK reflation “lite”

Rising US yields, stronger dollar, FX outflows from emerging markets into US equities, President Trump’s still uncertain policies regarding global trade and country-specific concerns continue to weigh on EM currencies.

But the pace of depreciation in EM currencies has abated, with a number of central banks hiking their policy rate and likely intervening in the FX market. China is manipulating its currency but perhaps not the way that US President Trump thinks.

With the market having almost fully priced in a December Fed hike, it will focus on FOMC members’ likely further downward revision to their forecasts for the appropriate policy rate.

Commentators are making a number of assumptions about next year’s French presidential elections and the potential impact on the euro. Some seem reasonable, others less so.

The first assumption is that Fillon will beat Juppé in the second round run-off of the Republican primaries on 27th November. This is indeed the most likely outcome.

The second assumption, which I agree with, is that no presidential candidate will clear the 50% threshold required in the first round of the elections on 23 April to become President.

The third assumption, now seemingly hard-baked, is that no Socialist candidate stands even a remote chance of making it to the second round of the presidential elections on 7th May 2017. I would argue that it is too early to write off that possibility.

The fourth assumption, which I believe is still far-fetched, is that Front National leader Marine Le Pen could win the second round to become President, which in turn would precipitate France’s exit from the EU and pressure the euro.

UK markets’ mixed reaction to Wednesday’s Autumn budget was in line with my expectations of higher yields and stronger Sterling.

Chancellor Hammond’s modestly stimulative package reflects the realities and uncertainties which the UK economy has faced since the June referendum. This is still the over-riding theme markets will have to deal with in the near and potentially long-term.

Hammond had one hand behind his back and a moving target to hit. He has backloaded spending to 2018-19 and beyond with a focus on infrastructural projects to boost languishing UK productivity. Read more

Nationalism, French presidential elections and the euro

The shock results of US presidential elections and UK referendum are shining the spotlight on the rise of nationalist and populist policies.
 
The rejection of the political, economic and social status-quo has lead to increasingly vocal predictions that populist and/or nationalist parties will cause major upsets at forthcoming elections in EU member states, including Italy and Austria.
But forecasts that a broad-sweep of nationalist parties will rise to the highest political echelons in EU countries may still be far-fetched.
 
In most cases these parties still command only modest popular support which can be overstated in polls and difficult to translate into actual political power.
 
France is such an example. Support for Marine Le Pen, leader and presidential candidate of the far-right Front National (FN) party, has risen in recent years and she will likely make it to the second round of presidential elections in April-May 2017.
But she is unlikely to become President, with opinion polls showing she would lose the head-to-head vote, almost irrespective of the candidate she faces.
 
Moreover, the FN is likely to remain a minority party following next June’s elections for the French Assembly.
 
France’s presidential and parliamentary elections will in any case have far more modest repercussions for the global economy and asset markets than the election of Donald Trump in the US.
 
Even in the very unlikely event of Marine Le Pen becoming president, the impact on the euro could be modest and short-lived as France’s economy accounts for only 21% of the eurozone’s economy.
 
ECB policy and German elections due in September 2017 are likely to exert greater influence on the euro’s path.
 
It is also noteworthy that the euro has been one of the most stable major currencies in the past six-and-a-half years, despite the Greek crisis and the shock UK referendum result.
 
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What will Asian central banks do?

Global risk appetite nudges higher as “West Wing” versus “Yes Minister” plays out

Cinemagoers have in recent years been treated to the daft yet watchable Alien vs Predator and Superman vs Batman movie franchises but nothing compares to the Frankenstein-esque beasts of US and UK politics which have been thrust on voters both sides of the pond – a tragi-comic blend of “the West Wing” versus “Yes Minister” with more twists and sub-plots than a John le Carré novel. Read more

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

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