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Three quarters of the world (in economic terms) is pursuing a road to normalisation of fiscal and monetary policy, aiming to restore fiscal balance, positive real interest rates, moderate inflation and the discontinuation of emergency measures. Japan is, understandably, the exception to the last of these measures. The road back to steady and sustainable growth often passes through austerity, as epitomised by the economic programmes of the UK and the euro zone peripherals. Canada, from where this Weekly is written, may be the Western world’s exception in not having to make the austerity detour, and its government has been duly rewarded at the polls. |
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One quarter of the world is following a road all of its own, a road that is only accessible because of the international role of its currency. The United States continues to spend more than it earns, a path which we have often described as an impasse, as there is no way out other than reversal. Many American commentators are well aware of this, yet the political leaders are deaf, or choose to be deaf, to their warnings. The two political parties make noises about cutting the budget deficit, but pull in different directions so that no viable plan emerges. |
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Yet market forces are powerful and persistent; ignoring them may delay their impact but they will have their way in the end. That end is to force a country, even a super-power, back on to the road to normalisation, including the inevitable passage through austerity. Last week we pointed out that household purchasing power had declined over the preceding year, and the ongoing decline of the dollar can only exacerbate the decline in spending. The pretence that rising prices of food and energy do not somehow “count” as inflation is being seen for the nonsense it is. Like it or not, the USA will eventually be forced back out of the impasse as there is no exit at the end of this road ! |
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Part of the inability of Americans to put their own house in order is a reflection of their political system. The famous “checks and balances” have actually become a mechanism for gridlock. California has taken the principle to such an extreme that it is actually impossible to balance the State budget. The Federal Government is not much better, with the added complication that the Fed does not just implement policy, but also creates it. Who is really in charge of economic policy ? Which entity is supposed to look after not only the nation’s money, but also its (un) employment ? The unelected Fed, of course! |
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Into this mess however comes a new factor: the elimination of Bin Laden. “That does not change any of the above”, our kind readers might say, however we would disagree, for President Obama now has (albeit potentially for a short period of time), a credibility and prestige which no one can or dare challenge. We are optimistic that he will use this newly-found authority to accept the inevitability of the action of market forces as described above, and even to persuade the American people that a passage through austerity will lead to a return to growth, and renewed external respect for the country’s economic policies. |
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We shall have to deal with Europe next week. Suffice to say that political will and economic forces will avoid a “credit event” for Greece, but at the price of “Europeanization” of the peripherals’ debt and greater euro zone, if not EU, centralisation. |
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Market Focus |
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- USA: economic expansion has moderated with consumer spending rising 0.6% and the ISM Chicago business barometer dropping to 67.6 from March’s 70.6 level. Durable goods orders are doing well, suggesting businesses intend to keep spending to update equipment. US banks are buying government securities at the fastest pace in nine months as lenders retreat to Treasuries with the economy expanding slower than forecast and loan demand dormant
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- Euro zone: producer-price inflation accelerated to the fastest pace in 2 1/2 years in March, as factory-gate prices in the euro region jumped 6.7%. European manufacturing growth accelerated more than estimated in April rising to 58 from 57.5 in March. New Bundesbank President Jens Weidmann called for more policy tightening by the ECB linked to “formulating a return to monetary policy normality”
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- UK: Britain’s economy rebounded in Q1 by 0.50% from the final quarter of 2010, enough to erase the contraction of Q4 on the strongest surge in service-industry growth for four years. However, the manufacturing index fell to a seven-month low in April amid declining consumer confidence and falling construction orders. The BoE seems unlikely to raise rates this year or even next, as the underlying momentum of the economic recovery looks weak
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- Switzerland: Swiss manufacturing growth slowed last month to the weakest in more than a year. The SVME Purchasing Managers’ Index fell to 58.4 from 59.3 in March. Swiss exports rose in Q1 by 6.1% over Q4 on demand from Asia and the USA
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- Japan: The country’s sovereign-rating outlook was cut to “negative” by Standard & Poor’s as the nation’s reconstruction needs will likely add to what is already the world’s heaviest debt load
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- US Bond Markets: Commercial-mortgage bonds are rallying the most in 10 months. The riskiest junk bonds are again producing the biggest gains in speculative-grade debt as demand meets a shrinking pool of distressed securities and rising optimism the Federal Reserve will not tighten credit this year
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- Bond Market Global: Russian, Australian and Chinese companies are all selling increased amounts of bonds in local currencies
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