Race to the bottom
- Only response to fragile global economy seems to be ever looser policy
- Loose monetary and fiscal policy has resulted in higher equity prices
- Whatever the shock, expectations of c.bank liquidity and easing drive up equities
- Turkey is a case in point, but implications of Turkish uncertainty remain significant
- We urge caution and prudence towards equities and risk assets
- Australia and New Zealand take centre stage in race to the monetary bottom
- Expect ECB's Draghi to play up the economic risks of Brexit and urge reforms
- Weekend G-20 meeting in Chengdu, China will focus on Brexit-related issues
“Can’t tell the bottom from the top” — The Hollies
Global financial markets are stuck in a dichotomy in many ways. The global macroeconomy remains “fragile and uneven” (to quote Mario Draghi and Christine Lagarde among others), and geopolitical frailties are increasing apparent and increasingly concerning.
On the flip side, the response to these seemingly endless global concerns has been ever looser monetary policy, and, where possible (Japan being the extreme case), ever looser fiscal policy in the quest for higher demand, firmer growth and brisker inflation. The result, however, has been higher equity prices (new record levels in many instances) as ever flatter (or even negative) yield curves distort forward valuation metrics and foster a culture of corporate buybacks.
Indeed it seems that irrespective of the size or severity of the shock or event, the ultimate response is higher equity valuations fuelled by central bank liquidity and (implied) further monetary easing.
The failed coup attempt in Turkey at the end of last week is a case in point. However, unlike the Turkish economy minister who this morning said the economy would be back to normal within a week, we are more inclined to heed Moody’s, which issued a ratings review on Turkey yesterday citing medium-term implications for credit and growth against the backdrop of an already fragile current account deficit.
The implications of heightened political uncertainty in Turkey for the rest of the world are, from our perspective, far greater than markets' "knee-jerk" reaction to buy stocks on expectations of monetary easing. We would urge caution and prudence towards equities and risk assets.
Overnight headlines also highlighted the race to the monetary bottom as Australia and New Zealand took centre stage. A Reserve Bank of New Zealand consultation paper proposing an increase in loan-to-value (LTV) ratios, including limits for investors, effectively provides greater scope for further monetary easing. The New Zealand dollar remains vulnerable as August now looks increasingly likely to yield a new low in NZ interest rates.
The Reserve Bank of Australia published the minutes of its July monetary policy meeting on Tuesday, maintaining that inflation is expected to “stay quite low for some time” and that “new data will allow the Board to adjust policy if appropriate”. The RBA also reiterated that the “higher AUD could complicate [economic] adjustments”.
“Success is how high you bounce when you hit bottom” — George S. Patton
This weekend’s G-20 meeting in Chengdu, China will focus on issues related to Brexit and its implications for the European Union and global trade relations. Although Chengdu is the home of the panda, global problems at this stage of the economic cycle are far from black and white. As if this were not enough to keep the UK and GBP firmly in the spotlight, the data calendar for the UK is also action-packed this week.
UK data blast
This morning UK inflation came in slightly on the hawkish side of expectations, but the data probably do not contain any impact from the post-Brexit period of July (the last week). If we include the core data, it does, however, add further credence to the theory that the UK data seemed to be stabilising before the June 23 referendum.
Tomorrow’s UK employment report may be more significant to gauge any evidence of the impact of Brexit uncertainty on employment (focus on the claims change for June). We have noted previously that the record-high levels of employment and low interest rates are likely to support household consumption through the uncertainty period.
Next up for the UK is retail sales data for the month of June (Thursday) followed by manufacturing and service sector PMI data (Friday). We retain our "active watch" strategy in relation to GBP as the height of uncertainty plays out. At the same time, however, we do not subscribe to the many prophecies of doom towards the UK economy, housing market or massive corporate exodus that many commentators have launched.
Indeed, with M&A activity likely to remain firm as the fog of uncertainty lifts, there are a number of areas where we feel we are likely to see GBP strength over the second half of 2016. We will elaborate further over coming weeks.
“A small leak will sink a great ship” — Benjamin Franklin
Last but not least it's worth noting the European Central Bank's governing council meets on Thursday. Despite his recent "kitchen sink" approach to monetary accommodation, ECB president Mario Draghi will not want to be left behind in the global race to the (monetary) bottom. While further measures may be unlikely this Thursday, we would expect Draghi to play up the economic risks to the EU and the Eurozone from Brexit and — as has been the case for a number of years now — we would expect him to reiterate the importance of structural reform from Eurozone (and other EU) nations. Maybe one day they will listen.
— Edited by John Acher
Neil Staines is head of trading at The ECU Group