|
Our sanguine view last week of the economic impact of the Japan tragedy has already become the general market perception. The swing back from “flight to quality” to “search for yield” has happened more quickly than we could imagine, and even while the consequences of the nuclear plant accident are still unclear. |
|
|
|
Likewise Libya, which dominated the news for three days after the UN vote, no longer garners front page headlines. The Arab Awakening is, however, far from over. We lean towards a certain optimism that the popular revolts are genuine attempts to create open societies (rather than fundamentalist Islamic ones), and that the world will benefit, so long as the Tunisian or Egyptian models are followed rather than the Libyan. |
|
|
|
With the relative calm that has returned to financial markets, the major trends we have identified over many months and years have returned to the fore. The USD is extremely weak – our first instinct was to use the term “incredibly weak”, but it is not incredible at all. It is simply the inevitable corollary of printing money and maintaining a huge current account deficit. What is incredible – or at least inexplicable in our eyes – is how inflation has not yet taken off in the USA. We can only suppose that the employment market is so weak that the higher costs for imports have, so far, been prevented from washing through to general prices. |
|
|
|
The higher-cost imports obviously include oil and other raw materials, as well as finished goods from any country which has not pegged its currency to the USD, and even from countries, notably China, which have. A Bloomberg Businessweek article details how the Chinese labour market has reached a point (called the “Lewis turning point”) where surplus labour disappears, and wages rise multiple tens of percent. Moreover, the Chinese Government is encouraging the growth of domestic consumption and the spreading of prosperity to the hinterland. They are in fact doing what Western politicians have been demanding for years. However, the saying "be careful what you wish for” comes to mind, as Chinese popular prosperity will mean higher prices for their exported goods. The article cited gives examples of price increases for Chinese imports, especially clothing, in the range 8%-15% for 2011. |
|
|
|
We can only conclude that the inexplicable absence of US inflation may soon be neither inexplicable, nor absent! |
|
|
|
Last week, we argued that the repatriation of funds required to rebuild Japan would result in net sales of Treasuries by the BoJ. The BoJ will not be the only previous buyer of T-Bonds with a declining appetite. The encouragement of domestic consumption in China -- generally positive for Western countries, including the USA, which are relying on exports to pull out of recession – can only mean a reduced Chinese trade surplus, and a lesser need to recycle dollars into T-Bonds. The Arab Awakening has similar implications. Whether the current authoritarian rulers fall and popular governments take over, or whether they stay but hold off revolt by greater sharing of wealth, the people will see their standard of living rise. Petrodollars will have to be spent more on imports (good for Western economies), and less on T-Bonds (bad for interest rates and the dollar). |
|
|
|
These considerations reinforce our suspicion that June will not see the end of quantitative easing, that yield curve steepening is round the corner, and that the US Government, rather like the UK’s, will quietly accept inflation as a partial exit route from indebtedness. |
|
|
Market Focus |
|
|
- USA: sales of previously owned homes dropped in February and housing starts plunged to the lowest level in almost a year. Moody’s maintained a negative outlook on U.S. state and local-government bonds for a third year, projecting fiscal strains in 2011. The Fed confirmed that they will disclose details of emergency loans made to banks in 2008 and now authorise banks to restart dividend payments, buy back shares, or repay government capital
|
- Euro Zone: bad loans as a proportion of total lending at Spanish banks climbed to 6.10% in January, the highest level since 1995. European inflation accelerated at the fastest pace in more than two years in February rising to 2.40% from 2.30%
|
- Portugal: Prime Minister Jose Socrates raised the spectre of needing a bailout and Moody’s Investors Service cut the country’s debt rating
|
- UK: CPI inflation rose to 4.40% and the short end of the gilt curve moved sharply higher. Consumer confidence fell to a record low in February, although unemployment claims declined by the most in eight months. The OECD cut its forecast for U.K. economic growth in 2011 from 1.7% to 1.5%
|
- Switzerland: investor confidence improved for a second month from -17.2 in February to -13.5 in March. The SNB left its target for 3-month Libor at 25bp, raised its 2011 growth forecast to “approximately 2%” and edged up its 2011 CPI inflation forecast to 0.8% YoY
|
- Bond Markets: of the 26 sovereign debt markets tracked by Bloomberg/EFFAS indices, UK bonds have generated the biggest gains over the past six weeks, while in contrast EUR sovereign bonds are performing poorly owing to the hawkish rhetoric from the ECB
|
- Credit markets: companies are selling the fewest bonds in Euros since 2008: €125.5 bln of investment-grade bonds to date this year, down from €193.7 bln in the same period of 2010. Risk appetite is back in credit markets, with high yield and low investment grades spreads tightening. However, spreads on euro zone peripherals have widened on concerns over Portugal and Ireland and division among EU Finance chiefs about getting the rescue fund to full capacity
|
- China: the Government raised banks’ reserve requirements for the third time this year, along with nominal lending rates
|
