By Neil Staines
Earlier this week ex-Fed chairman Ben Bernanke said that he is among those forecasters predicting faster (US) growth.
A position that we have a great deal of support for and one which, we feel, will ultimately result in a significant rise in the USD. The issue, however, has not necessarily been the direction of the economic indicators, but the pace of the recovery and the many areas of uncertainty in the global economy that have cast doubt over this view and spurred inaction from an increasingly apathetic market.
We discussed last week (the Goldilocks Antithesis) that the clear economic (and ultimately monetary policy divergence) between the US and the eurozone have been damped by the fact that the US data has been ‘not too hot’ and the eurozone data has been ‘not too cold’ – at least relative to consensus – which in itself has fuelled uncertainty and inactivity.
This morning’s much awaited PMI highlights some interesting conclusions. While the French data disappointed expectations and points to continued stagnation, the German (and subsequent eurozone aggregate) continued to show encouraging improvement. However, while the German recovery strength may be viewed by many as a positive for the eurozone, in terms of monetary policy it has far more complicated connotations – as far as interest rates are concerned ‘one size fits… none’
Indeed, the divergence between the eurozone’s biggest states is likely increasing at the current juncture. Fiscal policy may counter some of this economic divergence but in doing so it highlights it further. Germany has recently suggested that it will lower its target for debt to GDP, while reports overnight suggest that France intends to raise its deficit target for 2014 by 0.2 percentage points (much to the chagrin of the ECB and the other more austere states).
We maintain the view that the risks to broader austerity trajectories and the finances of the eurozone will become acute surrounding next month’s European Parliamentary elections. Further, we have highlighted our concerns over the ‘risk premia’ (or lack thereof) in eurozone government bond yields, which has diminished sharply despite the fact that the debt burden continues to grow appreciably.
Inflating expectations
The core debate, however, in interest rate and currency markets at the moment is inflation. Bernanke suggested last night that “neither inflation nor deflation are big risks to the US” and in the UK, while inflation is at its lowest level since 2009 (and at a level that indicates real wage growth for the first time in just as long), it remains broadly in line with target. In the eurozone, however, deflation is a real risk, and a risk that is already a reality in some parts of the periphery. From our perspective, however, it is the risk of a “prolonged period of low inflation” that will drive the ECB into action and while the market and ECB officials look for a bounce in the headline inflation print at the end of the month, the ECB policy response is more dependent on the new projected path of inflation. This may lead to increased volatility around month end.
On the macro data front, this morning also witnessed the release of the UK public sector finances, where the deficit came in lower than expected for the month but consistent with the OBR estimates for the full fiscal year 2013-14 of GBP 107.7B.
At the same time the release of the Bank of England minutes for April portrayed a relatively upbeat assessment from the MPC. The committee suggested that the “UK recovery is building momentum” and showing signs of “modest rebalancing”. In addition to this the committee saw the “prospect of a sustainable rise in real wages” and expect growth in both Q1 and Q2 to be around the 1% level. This is consistent with our view of sustained UK economic outperformance and will likely bring rate hike expectations forwards, possibly into 2014, from early 2015 as the forecasts are realised.
New Normal Ultra loose global monetary policy conditions have significantly distorted the investment backdrop over recent years, spurring a robust rally in equities and risk assets (based more on cheap money than earnings). As the focus of markets moves more acutely towards monetary normalisation we expect significant adjustments in FX rates. The pace of this shift in focus has been disappointingly slow (amid falling volatility), yet the prospect remains. Tonight will likely bring the second rate hike in as many months from the RBNZ and while this event would bear little economic correlation to the leading major economies, it highlights the fact that rates cannot remain at their current levels forever and also that differentiated economic characteristics bring differentiated normalisation timing (and pace). In Q2 and beyond this is likely key.
In the immediate term things remain very subdued, with focus increasingly shifting to the eurozone inflation print for April and the ECB response at the start of next month, along with the US employment report for April. The old equity adage “sell in May and go away” may apply to a broader array of assets and currencies this year. Don’t go too far, things could be about to get interesting!
Neil Staines is global macro team head of trading and execution at ECU
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