At sixes and sevens
- Monetary policy overstreched, growth elusive
- G7 meeting likely to prove cautious, muted
- Market has not fully returned to policy normalisation theme
By Neil Staines
To be "at sixes and sevens" is to be in a state of confusion and disorder, or of disagreement between parties. Derived from the game of dice in the 14th century, the idiom's contemporary meaning was to "carelessly risk one’s entire fortune".
After more than six years of extreme accommodation and monetary activism, a material recovery in global growth remains elusive. Against both this backdrop and a rising tide of criticism against the efficacy of central bank actions, the G7's leaders meet in Ise-Shima, Japan.
Central bankers and markets have broadly reached the conclusion that monetary activism has reached its lower bound in most cases (or at least has reached the point of significantly diminished returns), aptly summed up by Angela Merkel’s remarks in Japan today that there is “hardly any leeway left for monetary policy”.
Indeed, the market reaction to the initiation of negative rates in Japan, and the resultant higher JPY and lower equities, seems to endorse this sentiment.
On the fiscal front, host nation Japan – with its government debt-to-GDP ratio of more than 230% – is (perhaps ironically) the most likely of the G7 members to add stimulus. At the other end of the scale, the UK and Germany are perhaps the most able (yet also the most unwilling) protagonists of further fiscal expansion.
In the US, "lame duck" president Barack Obama is unlikely to pass any meaningful fiscal package with elections pending. Italy and France, meanwhile, are bound by commitments to deficit reduction under the Stability and Growth Pact – commitments that already stretch credibility due to their reliance on higher than likely growth forecasts.
“As a writer, you tend to use words to paper over structural cracks” — Stephen Fry
What about structural reform, something that Mario Draghi has been urging until blue in the face for the past several years? It is unlikely that this G7 meeting will see its members agree to anything in this regard either.
Officially, there will be little rhetoric about currency valuation outside of the standard pledges not to manipulate and that currencies should be allowed to float freely. However, with the US recently placing Japan, Germany and China (not present) on its watchlist for currency manipulation, it is likely that even unofficial words may be chosen carefully.
Behind the closed doors of their home nations, however, (silent) currency wars are very much alive.
“Status quo, you know, is latin for the mess we are in” — Ronald Reagan
Currency markets are very much driven by three core issues at the current juncture. The first is the possibility of a Brexit. The recent swing in the polls has been sharply in favour of the "Remain" camp (one whose rationale we have outlined over recent weeks). As sentiment has swung back towards the UK maintaining the status quo, the currency has gained and implied volatilities have fallen back sharply.
While all of this seems fairly sensible, however, it is not likely to be quite so simple. Over the next few weeks, a narrowing of the "Remain" lead is likely at some point and, thus, a lower GBP and higher baseline volatility by implication.
While nerves have calmed on the political front, Brexit still has the capacity to disrupt currency markets, risk assets and even the US rate normalisation process.
The other two drivers, the USD and equity markets, are more closely linked. The macroeconomic backdrop over recent sessions has generated a strong bounce in equities and risk assets, together with rising US yields (at the front end at least). This combination should be very supportive for the USD at current levels, yet its progress has been very disappointing.
One reason is that, while the front end of the US rate curve has risen, increased talk of US rate rises has had a far more muted impact at the long end. This lack of conviction has worked against the USD but in favour of equities.
As long as the US data remain in the "Goldilocks" zone (too hot for fear, too cold for rapid rate hikes), this muted activity in FX and overvaluation in equities can be extended
It’s not over til the Fed lady sings?
UK GDP data this morning came in as expected on the headline (weaker net trade, stronger private consumption), maintaining the uncertainty over the current UK economic slowdown.
Transient, Brexit-induced activity postponement, or a more sinister weakness? As the week draws to its close (ahead of the long weekend in the UK), US GDP will come into focus tomorrow afternoon before a possible acid test for recent Fed hawkishness when chair Janet Yellen speaks at Harvard at 18:15 BST on Friday.
While neither monetary policy nor the state of the economy are not scheduled topics, clues as to her agreement or disagreement with recent (non-voting) members’ hawkish commentaries will be keenly awaited.
— Edited by Michael McKenna
Neil Staines is head of trading at The ECU Group