Markets like it when the powers that be give them what they want, that is what we have seen this week. US markets reached fresh all-time highs in the aftermath of Fed chairman Ben Bernanke’s testimony to Congress earlier this week, while US futures point to a recovery in sentiment today after China’s central bank announced that it would remove the PBOC’s floor in lending rates.
Markets call the shots
So either the markets’ are in cheerful mood as the summer grips the West or they are getting used to being able to call the shots regarding stimulus measures taken by government and other public officials. China’s steps to liberalise lending rates means that banks can now offer lower interest on all lending based on “commercial principles”. Housing credit policies are slightly different, the PBOC has opted to “temporarily” adjust the floating rate for individual mortgages; however the PBOC stressed the importance of the “healthy development of the real estate market” and hopefully avoid sub-prime catastrophes down the line. Ostensibly these changes are designed to improve service levels, promote independent pricing and also reduce financing costs; however, the timing could be designed to boost growth in the second half of this year and thwart a slowdown that threatens to shrink GDP to the 7% range, below Beijing’s 7.5% target for 2013.
The usual suspects had a field day with this news: the Aussie and Kiwi were higher, while European stocks sucked up the good news and safe havens like the yen and the Swiss franc retreated. Only yesterday the IMF said that China needed to reform and support the economy, Ms Lagarde could not ask for a quicker reaction than this. But after the announcement, now the hard work begins. Growth in credit will need to be carefully monitored so it is directed towards the consumer sector rather than the saturated export/ manufacturing and real estate sector.
Sep-taper: is it happening or not?
Bernanke, on the other hand, was trying to be the everyman who pleases everybody. With only a few months left until (most likely) his term expires at the start of 2014, it would have been more fun if he really spoke his mind, but alas, the Fed’s highly paid PR and media trainers have been hard at work with Ben over the years and he did not stray from the party line. So this is what we know so far:
• Sep-taper is not set in stone, but most likely will happen as long as we don’t get disastrous payrolls between now and then and as long as inflation doesn’t fall off a cliff.
• The Fed is still very accommodative – just because its saves a few billion each month by scaling back asset purchases does not mean that monetary policy will be tighter come the end of the year.
• Instead, the Fed may stop buying assets altogether in the middle of next year, but don’t worry, rate hikes are unlikely for the next 2-3 years.
Are you listening Mr Carney?
Economic thresholds and forward guidance are extremely complicated: Bernanke spent a long time explaining to Congress that just because the unemployment rate fell to 6.5% (Fed’s target) it would not mean it would hike rates or stop making asset purchases. This begs the question, why have thresholds in the first place? The Bank of England has promised to give us its verdict on FG next month, but don’t expect them to have made a final decision. FG is complicated and not clear cut, we doubt that all members of the Monetary Policy Committee will be able to agree on forward guidance and the finer details of thresholds by the next meeting. This will probably leave GBPUSD range bound between 1.5000- 1.5300 in the coming weeks. Although the pound has staged an impressive rally this week, a wave of selling interest is hitting the markets around 1.5270-85 – a cluster of daily moving averages. Will next Thursday’s Q2 GDP release be enough to get us above this significant hurdle?
Detroit, Greece and other stories of financial woe
The city of Detroit has succumbed to the inevitable and applied for bankruptcy. Everyone thought it would be a European member state that would go the financial wall this year; instead it happened across the water. Detroit highlights the ugly reality of running out of money, only 30% of ambulances run at any one time, police cars have on average 300k miles on the clock and it takes a patrol car 5 times as long to reach a crime scene in Detroit than it does in the rest of the US; I dread to think what the life expectancy is compared to the average. The American Dream is well and truly dead for Detroit; it’s hard to see a new industry moving in when the infrastructure is so bad. But the difference between the US and the Eurozone is that the US can have its equivalent “Greece” moment with Detroit without it causing shock waves in the financial or sovereign bond market. The United States may have many failings, but it works, the Eurozone would be wise to remember that as rumours surface that Greece (otherwise known as the giant money pit) may need another EUR 10 billion as soon as September…
Europe’s political deficit is its biggest problem
Interestingly, Portugal is desperately trying not to go the same way as Greece. Its fragile coalition has met at an emergency meeting today to try and reach a “national salvation pact”. The US is a good reminder that political stability and unity can make a problem like Detroit seem manageable, and markets won’t bat an eyelid. The political deficit in the Eurozone is now its most pressing problem.
So what does this all mean for the markets? Detroit can go under yet the US stock market can traverse back to record highs; it looks less and less likely there will be a political crisis in Portugal and Spain any time soon, which could support EUR assets in the coming weeks. Greece’s problems are far from over but Germany is likely to engineer the crisis brewing in Athens so that it won’t explode until later this year after German Federal elections. This brings us back to central banks; the end of extraordinary monetary policy remains the biggest risk out there.