Losing focus in a fragile world
- World Bank highlights global corporate fragility
- ECB extends its QE lending into corporate arena
- Soros gloomy on world prospects, especially EU
The World Bank published its latest economic updates earlier this week, the main message being that the global economy is struggling to regain momentum with growth faltering in many major economies. The balance of risks is tilted to the downside.
The World Bank also highlights a growing fragility in the global economy, in the form of private sector credit, especially in the corporate sector, since 2010. Corporate earnings are fragile (EPS fell by around 8% in the US and ~20% in Europe and Japan in Q1) and it is possible that declining profit margins are one source of weakness in hiring (as highlighted in yesterday’s JOLTS employment data).
ECB starts corporate purchases
It is very interesting, therefore, that the European Central Bank expanded its extraordinary monetary accommodation stance directly into the corporate arena yesterday. Its purchases included multinational powerhouses such as Siemens, Renault and RWE, but also sub investment grade rated Telecom Italia (Moody’s Ba1 since 2013).
It could be argued that as a very liquid peripheral company, it is exactly the kind of borrower the ECB should be targeting. At the same time, while the ECB reiterated last week that it would not "dump" its holdings if ratings fell below the initial purchase criteria, with the impact of global central bank easing significantly diminished, it could be argued that the ECB is increasing its downside (balance sheet) risks disproportionately to boosting the upside (economic) risks.
Kiwi takes flight
The Reserve Bank of New Zealand kept rates unchanged last night, disappointing expectations of a rate cut and a reinforced dovish bias. Instead, governor Wheeler expressed “financial stability concerns” over accelerating house price growth and a faster than expected rebound in headline consumer prices. Despite (admittedly watered down) protestations about the strength of the currency, NZD rallied sharply in the face of the hawkish (or at least less dovish) surprise. Interest rate differentials, however, continue to suggest a significantly lower NZD over time, as does the global economic risk backdrop.
The problems facing the world’s central bankers were further emphasised in South Korea overnight as its central bank surprised markets by cutting rates, highlighting the difficulties of reviving an economy with excess savings.
Global monetary policy is at (or very close to) the point of diminished marginal utility, and the balance of risks is tilted to the downside. In this regard, it is interesting to note our recent sentiment being mirrored by George Soros who, it has been suggested, “has returned to trading, lured by opportunities to profit from what he sees as coming economic troubles” [WSJ]. Soros emphasises the troubles of the Eurozone (and EU) in particular, where he suggests that there is “a good chance that the European Union will collapse under the weight of the migration crisis, continuing challenges in Greece and a potential exit by the UK.”
We have recently stressed the point that the risks to the EUR are underpriced (at the very minimal relative to GBP and the UK). Soros added that “If Britain leaves, it could unleash a general exodus, and the disintegration of the European Union will become practically unavoidable”. It is hardly surprising that bureaucrats across Europe (elected or not) have thrown their weight behind the Remain campaign.
In the markets, with the ‘Fed on Hold’ theme back in favour, bond yields are tumbling everywhere (10-year Germany now within touching distance of 0.00%!). In the US, real yields are at their lowest levels in over a year, weighing on the USD on a trade weighted basis, and liquidity across the currency space is increasingly diminished.
The Brexit debate will likely intensify its dominance on financial markets over the coming two weeks. However, for now we will put our direct thoughts on the UK and Brexit to one side. Instead we would emphasise that from our perspective, the downside for equities and risk assets are increasing. Equally, in FX the markets focus of attention has been elsewhere, leading to what we would consider an over-flattering valuation of the EUR.
– Edited by Clare MacCarthy
Neil Staines is head of trading at The ECU Group