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The parting of the ways between the USA and Europe on military matters (the USA stepping back from a leadership role in NATO over Libya) has parallels with each region’s economic policies: |
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- in the USA, the recovery, whilst real enough in terms of corporate profits and employment, is dependent on cheap money and quantitative easing
- in Europe, despite the peripheral problems, a move towards normalisation in financial markets, especially for sovereign and bank bonds, is underway, with the ECB expected to increase interest rates as we write
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The EUR is strengthening whilst the USD weakens. Yet inflation in the euro zone is higher (2.6%) than in the USA (1.6%). That is if we are to believe the official data; MIT, by contrast, puts the US inflation rate at 8.5%. The ECB accepts that it must raise rates, while the Fed fears that it cannot do so without damaging the recovery. This points to the euro zone returning to normal in terms of central bank policy. Moreover, it supports the view that Germany and the other strong economies in the euro zone are succeeding in coping with their weaker brethren. Political will is trumping market pressures on this occasion. |
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A key step in Euro zone normalisation was taken on 31st March with the new Irish Government backing off imposing haircuts on bank bondholders. Apart from an immediate rise in the price of Irish bank debt, this seems to have triggered a Europe-wide return of confidence in the banking sector. The banks have come to the market with conventional, short-dated, bonds (as distinct from further covered issues) and these have been well received. This will enable the ECB to discontinue its (reluctant) purchases of bank debt. The good news from Ireland -- we suppose it was good news – was then reinforced by Strauss-Kahn of the IMF, and the likely French presidential candidate, giving their support to Greece holding back from restructuring. That may be bad news for the Greek population (as it leaves austerity as the only option), but it is good news for the EUR. Even the CHF falling from its recent highs reinforces the picture of a return to confidence in the EUR. |
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In the meantime, in the USA, Bernanke is attempting to avoid the fray within the Fed over QE3. He does however lean to the view that inflation is not around the corner. In that respect, we disagree with him, and, more importantly, so does Wal-Mart, which of all companies, must be well informed about Chinese export prices. To quote CEO Bill Simon: ‘we’ve seen cost increases starting to come through at a pretty rapid rate. Inflation is going to be serious’. |
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For years, we have joined many other commentators in discussing the rebalancing of the global economy. The process is under way, albeit slowly. This is partly explained by a tacit agreement between the USA and China to hold the old paradigm for as long as possible. Chinese goods keep the cost of living down in the USA, while readjustment of the dollar exchange rate is delayed by China letting its reserves rise and recycling them into Treasuries. Now that China has an official policy of letting domestic consumption increase, and is taking steps to slow inflation – partly by higher interest rates, partly by revaluation – the entire paradigm is falling apart. Moreover, as Martin Wolf of the FT points out, the reserves of China, and Asia in general, proved more than adequate to deal with the Western recession; why seek to build them still more? We might add, “and especially in a weak fiat money called the US dollar”. |
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Market Focus |
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- USA: unemployment fell to a 2-year low of 8.80%. The ISM non-manufacturing index expanded less than forecast. Consumer confidence rose for the first time in five weeks. Orders placed with US factories fell, although business activity expanded at a faster pace than forecast
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- Euro zone: inflation accelerated at the fastest pace in more than two years in March (2.60% from 2.40% in February). German unemployment fell in March by a seasonally adjusted 55,000 to 3.01 million. However, German retail sales declined in February, falling 0.30% from January
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- Ireland: the Government yielded to the ECB on protecting bondholders as the bailout bill for the banking crisis moved to as much as €100 bln after stress tests. The ECB was “solidly opposed” to imposing losses on investors in senior bank debt and agreed to provide “ongoing” funding for the banks
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- Portugal: short-term borrowing costs surged at an auction of 14 month notes, yields rising by over 150 bps relative to mid March. The Portuguese Secretary for Treasury and Finance said that the country was in good condition to meet its debt maturities this year
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- Spain: banks have sold around €33.3 bln of debt so far this year. Rates have declined on growing optimism about the government’s moves to cut the deficit. Registered unemployment advanced for a third month in March
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- UK: the Chamber of Commerce estimated that the economy grew by 0.60% to 0.70% in Q1. According to the CBI, financial-services firms’ activity grew strongly for the third successive quarter. The manufacturing index fell to a five-month low in March (from 60.90 to 57.10). UK banks reported an increase in mortgage defaults in Q1
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- Switzerland: manufacturing growth slowed last month to the weakest in over a year. The SVME Purchasing Managers’ Index fell to 59.3 from 63.5 in February. Yet leading economic indicators increased in March from a revised 2.19 in February to 2.24
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- China: the government raised the benchmark one year lending rate by 25ps to 6.31%, the fourth hike since the end of the financial crisis. Manufacturing growth accelerated for the first time in four months. The PMI rose from 52.2 in February to 53.4 in March
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- Brazil: the Real appreciated sharply over the week on strong demand for emerging market currencies and only limited intervention by the Brazil central bank. The BRL also benefited from the 1 notch Fitch upgrade from BBB- to BBB
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- Bond Markets: US Corporate short term borrowing moved to the highest level in 2 years, (growth of 23% this year to $166.4bln). US speculative grade companies raised $149 bln in leveraged loans in Q1, the most since Q4 2007. Corporate bond sales worldwide also soared to the highest level in almost two years in Q1: the $983 billion of debt offerings so far this year is the highest since sales of $1.1 trillion in the three months ended in June 2009. Emerging-market borrowers completed the busiest ever start to a year, selling $197 billion of bonds on international markets
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