February 09, 2018
Central Banks Are Telling Markets It’s Time to Grow Up
It’s time for markets to grow up. An important element in the current volatility tantrum is the return of inflation. Last Friday’s U.S. payroll report kicked it off, and the struggle at this week’s 10-year and 30-year U.S. Treasury auctions suggests fixed-income investors don’t spy an end to the rout. This means the next key event for them is U.S. CPI data next Wednesday, which may validate everyone’s fears that the inflation monster is at their door. But what’s more galling to investors than faster price gains is that central banks are actually not running to their rescue at the first sign of trouble. After nearly a decade of being granted a flood of emergency support at the tiniest little scratch, now officials are daring to ask them to stand on their own two feet. New York Fed Governor Bill Dudley called the recent shakeout “small potatoes.” This means one of the most dovish principal Fed voters sees virtually no economic implications from the market’s wails and moans, which is not terribly reassuring for investors expecting any form of official help. Another Fed rate increase at the March 21 meeting looks even more certain. The Bank of England’s hawkish turn on Thursday compounds the felony, as now a second major central bank is on the the rate hike bandwagon. That leaves the Bank of Japan and European Central Bank looking more isolated. The withdrawal of monetary stimulus was never going to be an easy hurdle for markets to jump. But having one of the big four monetary authorities make a significant shift in its rate view for more and earlier rate rises, in the middle of a stock market correction, is unfortunate timing to say the least. In the short term, the bad times look set to continue for fixed income. Fiscal discipline is decidedly not a feature of U.S. tax reforms, and higher Treasury issuance is the necessary end-result — which in turn leads to higher rates. These will feed straight through to raised funding costs for companies, and the more-leveraged will suffer the most. The longer this correction extends then the bigger the hit to confidence and the need for repricing of leveraged risk. Stock markets have seen tailwinds turn into headwinds.
BOE’s U.K. Upgrades All Come Down to a Stronger Global Economy
The U.K. can be thankful that world growth is building up steam. Raising its forecasts for the next three years, the Bank of England’s biggest upward revision was to exports. It sees them increasing 3.25 percent this year, better than the 2 percent predicted just three months ago. That upgrade stands in contrast to the meager 25 basis-point revision to consumer spending and business investment this year, and a cut to the housing-investment prediction. In its discussion of the outlook, the BOE’s Monetary Policy Committee said U.K. net trade is benefiting from “robust global demand” and the past depreciation of the pound. While business investment was being supported by the low cost of capital and global demand, it “remained restrained by Brexit-related uncertainties.” The export growth may indicate the start to a rebalancing long craved by policy makers. Carney’s predecessor Mervyn King was calling for a shift to rely less on consumption more than a decade ago. The National Institute of Economic and Social Research spelled out the U.K.’s position more clearly earlier this week when it raised its outlook. It said a better-than-expected global expansion accounted for about a third of the increase in gross domestic product last year. The resulting boost to trade, at a time when future commerce relationships remain uncertain, was “critical” for the country. On earnings, the BOE sees growth of 3 percent this year and 3.25 percent in 2019, unchanged from its November forecasts. With inflation forecast to slow, that will mean an end to the decline in real incomes that squeezed consumers in 2017, though the prospects for a strong recovery are low. Household consumption is set to grow at about half the average over the past five years, “reflecting weak real income growth,” it said.
China, Hong Kong Are the Biggest Losers as Stock Rout Spreads
As global equity investors reel from the biggest selloff in two years, nowhere has the pain been more acute than in China and Hong Kong. Benchmark indexes in the world’s second- and fourth-largest stock markets have fallen faster than any of their major peers since the rout began late last month, with worries over a Chinese deleveraging campaign adding to global concerns about rising interest rates and stretched valuations. As losses accelerated on Friday, both markets snapped their longest-ever streaks without a 10 percent correction. The sudden tumble, China’s worst since the nation’s 2015 market collapse, has shocked investors who had grown accustomed to the calming effect of state intervention over the past two years. But after guiding the Shanghai Composite Index to its steadiest bull market in history, Chinese authorities are now showing an increased tolerance for losses as they seek to snuff out moral hazard and reduce risk in the nation’s $16 trillion shadow-financing system. The big questions are whether stocks are signalling trouble ahead for the world’s second-largest economy, and whether declines in China will create a negative-feedback loop with international markets. For now at least, analysts aren’t anticipating a 2015-style meltdown. They’re still sanguine about China’s growth outlook, with the consensus estimate for 2018 holding steady at 6.5 percent. Optimists point to calmer price action in the corporate bond market and the yuan, which still trades near its strongest in two years against the dollar.
China’s Inflation Is Easing as Global Markets Fear Price Gains
China’s ability to export inflation to the world appears to be waning, right at a time when investors are worried that global prices are taking off amid faster economic growth. Factory prices, which feed through into the prices export customers pay, are continuing to soften, suggesting the world’s biggest trading nation won’t be passing on much more by way of inflation in the near term. The producer price index rose 4.3 percent in January from a year earlier, its third month of slowing, and consumer prices climbed 1.5 percent. It’s an about turn from a year ago when China was a key source of the reflation that buoyed markets and propelled economic growth. While China’s producer price index remains well into positive territory, its slowing pace means that if global inflation is to take off, price pressures will likely need to be fuelled elsewhere. What Just Happened? Six Views on How the Correction Finally Came “China’s PPI won’t be a drag on global reflation, and it also won’t be the focus,” said Tommy Xie, an economist at Oversea-Chinese Banking Corp. in Singapore. “The focus will be on wage growth in the U.S. and Europe. China’s PPI exporting inflation pressures is more a story of last year.” Stocks and bonds have slid amid emerging signs that some of the biggest economies are seeing quickening inflation that could force central banks to raise interest rates. In the U.S., jobs data for January showed a 2.9 percent year-over-year jump in average hourly earnings, the largest since mid-2009. That comes as German and Japanese labour unions demand higher wages and as higher oil and other commodity prices fuel expectations for faster inflation. At the same time the outlook for growth remains robust. The International Monetary Fund predicts a global economic expansion of 3.9 percent this year and next, which would be the fastest since 2011.