State of Play – When less is more
Central banks’ tinkering with monetary policy and frequent u-turns are seemingly doing
more harm than good. The Fed and the Bank of England have provided little clear forward
guidance and the Bank of Japan’s move into negative rates only had a passing positive
impact. While safe-haven flows may continue to appreciate the yen, a less competitive
currency is likely to ultimately weigh on the economy and in turn the yen. In contrast the
Korean won looks reasonably attractive at these levels.
Chinese policy-makers’ plethora of measures to stabilise the economy and equity market
has yet to bear fruit but the central bank’s exchange rate policy still seems geared towards
currency stability rather than outright devaluations. The CNY nominal effective exchange
rate (NEER) is back within the range in place since late-2014.
The ECB, and in particular President Draghi, have perhaps better articulated their forecasts
and goals recently and been rewarded with a EUR/USD exchange rate pegged near 1.10.
Draghi has also hit the nail on the head by flagging the need for all policy-makers,
including governments, to pull in the same direction. The concern is that the 10%
appreciation in the euro NEER since April will derail the eurozone’s fragile recovery. I
would therefore expect the ECB to announce rate cuts and/or more QE at its 10 March
meeting and for the euro to remain on the backfoot.
A good starting point for central banks would be to flag that while global growth likely
slowed to around 3% yoy in H2 2015 it has not collapsed, thanks in part to decent
household consumption. There are also some economic bright-spots such as Ireland,
Spain and India.
But with none of the larger economies in a position to single-handedly push the needle on
global growth, the risk is that if a crisis materialises it will be the first truly global crisis in
at least 20 years with an epicentre not be confined to a particularly country, region, asset
class or sector – in contrast to the 1994, 1998, 2000, 2006 and 2008-2009 crises.
So again a well-scripted, coordinated and global policy package is a necessary, if not
sufficient, pre-condition for average (rather than below average) GDP growth and more
resilient equity markets. There has been little evidence of a coming-together of minds but
Draghi seems to be on the right track.
1
Central banks’ tinker men and women
One of the main market concerns put forward is that in the face of slowing economic growth and growing
threat of deflation, central banks have run out of ammunition – or more specifically that monetary policies
are becoming increasingly ineffective. I would argue that central banks’ interest and exchange rate policies
are actually increasingly harmful. Central banks cut policy rates aggressively during the 2008-2009 crisis,
which was arguably warranted, but in the past six months they have increasingly tinkered with policy rates
already near zero percent, inducing confusion and uncertainty (not to mention adding pressure on already
beleaguered bank stocks).
The US Federal Reserve, which arguably sets the tone for other central banks, may have been justified in
hiking rates in December given a reasonably strong labour market and US core inflation exceeding 2% in
December 2015 for the first time three years. But the Fed’s historical tendency to over-estimate inflation
and thus the need to hike rates should have argued against the Fed’s forecast of four hikes in 2016 – a
forecast which now looks very difficult for the Fed to deliver on, prompting Chairperson Yellen to present a
far less hawkish outlook at her recent semi-annual testimony to the Senate. The Fed now finds itself in a
bind very much of its own making.
The Bank of England has also underwhelmed in terms of its forward-guidance. When Governor Carney
was first appointed in late 2012 he said the BoE would hike rates when the UK unemployment rate fell
below 7%. It promptly collapsed to 6% and he changed his mind, saying other variables were more
important. He then said the BoE may have to hike rates to stave off asset price inflation but performed yet
another u-turn by arguing the world was too uncertain for the BoE to hike. In H2 2015 he said the BoE
would have more clarity about when to hike in December 2015 but more recently quashed the likelihood of
any hikes near-term.
Figure 1: Four major banks are now experimenting
with negative policy rates
Figure 2: Yen has lost competitiveness,
particularly against the won
Central bank policy rates, %
6
5
Nominal ef f ective exchange rates
(23 April 2010 = 100)
Switzerland (3-month LIBOR)
Sweden (repo rate)
ECB deposit rate
Japan (policy rate on balance)
115
110
105
4
100
3
JPY
KRW
95
2
90
1
85
0
-1
Jan-99
80
Jan-03
Jan-07
Jan-11
75
Jul 13
Jan-15
Source: European Central Bank, Bank of Japan,
Riksbank, Swiss National Bank
Jan 14 Jul 14
Jan 15 Jul 15
Jan 16
Source: investing.com, www.olivierdesbarres.co.uk
2
Four major banks are experimenting with negative rates, with mixed success
The central banks of the Eurozone, Japan, Sweden and Switzerland have gone a step further, seemingly
engaged in a race towards increasingly negative policy/deposit rates (see Figure 1). And yet with each
move, markets have been less and less impressed or impressed for increasingly short periods of time.
A point in hand, after the BoJ cut its policy rate to -0.10% on 29 January, USD-JPY jumped nearly 2% from
119 to 121.3 and equities and bonds rallied sharply. But 72 hours later, during which time the market had
digested the less-impressive-than-the-headline-details, USD-JPY had dropped below the pre-cut level.
Only ten trading days later after the BoJ shocked the markets, USD-JPY is trading not far off a 15-month
low. The yen nominal effective exchange rate (NEER) has appreciated about 5% year-to-day while the
currency of a main competitor, the Korean won, has depreciated about 4.3% (see Figure 2). These trends
fly in the face of a Korean economy which grew more than twice as fast as Japan’s in Q4 (3.0% yoy vs
1.4% yoy) and likely path of the Korean and Japan trade balances.
The trade balances of Korea and in particular Japan have improved significantly in the past 18 months, with
the $-value of imports falling faster than exports thanks in part to weaker commodity prices. Japan will also
have benefited from greater currency competitiveness, with the yen NEER having depreciated about 15%
between August 2013 and August 2015 (see Figure 2). As currency moves typically impact trade with a
multi-month lag, it’s plausible that Japan was still benefiting from a cheaper yen in recent months.
Conversely, the yen’s sharp appreciation in the past six months may start weighing on Japan’s exports in
coming months, removing a source of support for the yen. Of course “safe-haven” capital flows into Japan
may well dwarf any deterioration in Japan’s trade balance near-term. But if the BoJ’s tinkering with policy
rates underwhelms market expectations, yen appreciation may in the medium-run hurt Japan’s economy,
making it a less attractive safe-haven and in turn weighing on the currency.
Figure 3: A weaker yen likely benefited Japan’s
trade balance, so be weary of yen appreciation
Figure 4: EUR-USD has been anchored around
1.10 but euro NEER has appreciated rapidly
Merchandise trade balance
3-month rolling sum, seasonally adjusted ($ bn)
40
Korea
Japan
30
115
Euro indices (23 April 2010 = 100)
110
105
20
100
10
0
95
-10
90
-20
85
Euro NEER
80
EURUSD
-30
-40
-50
Jan-11
Mar-12
May-13
Jul-14
75
Apr 10 Jun 11 Aug 12 Oct 13 Dec 14 Feb 16
Sep-15
Source: Korea Ministry of Trade, Industry & Energy,
Japan Ministry of Finance, World Trade Organisation
Source: investing.com, www.olivierdesbarres.co.uk
3
Chinese policies confusing but seemingly no desire for a renminbi devaluation
But this is not just an ill confined to developed economies. Chinese policy makers have tinkered with
policies almost relentlessly, introducing new measures to stabilise equity markets only to cancel them a few
months later. In August the central bank “devalued” the renmnbi by a paltry 2% versus the US dollar, which
had no material positive impact on the economy but caused widespread panic in equity and currency
markets worldwide.
The PBoC was on the right track when it formalised an exchange rate policy which tracks the renmnbi
against a basket of currencies of China’s main trading partners and explained that markets would have a
greater bearing on the renminbi’s path going forward. But then Governor Zhou Xiaochuan did his market
credentials little good by threatening to fight speculators trying to weaken the currency. Market participants
don’t become rogue speculators simply because they decide to sell (or for that matter buy) an asset or
currency.
The implication, in my view, is that the central bank is more likely to use still large FX reserves of $ 3.2trn
(60% larger than in late 2009) to support the renminbi NEER then to aggressively devalue the currency – a
view I have held since mid-2015 (see China trade tantrum, 13 July 2015). Indeed Figure 5 and Figure 6
suggest that while the PBoC may not be targeting a specific NEER level, it is reluctant to see a prolonged
and/or rapid weakening of the currency.
Figure 5: CNY NEER has bounced back within the
range in place since late-2014
135
Figure 6: Monthly change in CNY NEER is back
within “normal” parameters
CNY nominal ef f ective exchange rate
(23 April 2010 = 100)
5
Month-on-month % change in CNY nominal
ef f ective exchange rate
4
130
3
125
2
120
1
115
0
-1
110
-2
105
100
Apr 12
-3
Jul 13
Oct 14
-4
Apr 10
Jan 16
Source: investing.com, www.olivierdesbarres.co.uk
Jul 11
Oct 12
Jan 14
Apr 15
Source: investing.com, www.olivierdesbarres.co.uk
ECB was late to the party, but has got its act together…if it can contain the euro
The one exception I would perhaps highlight in terms of central bank efficacy is the European Central Bank
and specifically President Draghi. While the ECB was late in delivering quantitative easing (see European
Central Bank QE: a little late to the party, 8 January 2015), Draghi has in the past couple of months
communicated his intentions clearly to markets.
4
Specifically, ECB policies and statements have succeeded in anchoring EUR-USD near 1.10 for the past
year (see Figure 4) and the euro’s competitiveness has arguably been a key driver of the eurozone’s
admittedly slow recovery in H2 2014 and H1 2015. Furthermore, Draghi today articulated what few have
policy-makers have done so far:
i.
The need for all policy-makers to put in a strong effort in coming months. It was the
coordinated approach eventually adopted by the world’s major central banks and governments
in 2009 which in large part steadied the global economy and markets. A clearly out laid,
synchronised set of policies has been absent in recent months, with policy-makers in both
developed and emerging markets seemingly adopting a reactive, peace-meal approach.
ii.
The need for governments to support growth through investment and lower taxation. If a
country is going to consider looser fiscal policy, there are worse times to do so than when the
cost of debt financing is very low thanks to near-zero global yields.
The one serious fly in the ointment for the ECB is that while EUR-USD has traded in a reasonably narrow
range, the euro NEER has appreciated about 10.5% since April 2014 (see Figure 4) – a concern for a very
open eurozone economy in which GDP growth has seemingly plateaued around 1.5%. I would therefore
expect the ECB and Draghi to double their efforts in coming weeks and announce on 10 March lower policy
rates and/or a more potent QE program – avoiding the mistake it made last December of promising a lot
but delivering little.
A recalibration of expectations and policies required
While governments have a tendency to big up their achievements and gloss over their failings, central
banks if anything currently tend to be overly-reactive to negative market developments, measuring every
word with increasing surgical finesse – which arguably derives in part from the simply unrealistic
expectations which have been heaped on central bankers.
This is the time for markets to reign in these expectations, central banks to re-focus on the key variables of
inflation and growth and for governments to step up to the fiscal and reform plate. A good starting point
would be to flag that while global growth has slowed it has not collapsed, thanks in part to decent
household consumption.
Global GDP growth slowed to 3% yoy in H2 2015, but did not collapse
World GDP growth slowed to around 3.0% year-on-year in Q3 2015, based on IMF methodology, according
to my estimates. Growth in economies which have so far released Q4 2015 GDP data, which account for
two-thirds of world GDP, slowed marginally in Q4 to 3.3% yoy from 3.4% yoy in Q3. Assuming that growth
in the economies which have yet to release Q4 data was unchanged from Q3, which include Japan, Brazil,
Canada and Australia, global GDP growth in Q4 2015 may have dipped very slightly from 3.0% yoy in Q3
(see Figure 7). This would tally with global manufacturing PMI which was broadly unchanged in Q4 2015
(see Figure 8).
5
Figure 8: …which this tallies with global
manufacturing PMI
Figure 7: Global growth likely slowed marginally in
Q4 but did not collapse…
7
Global real GDP, % year-on-year
Global Manuf acturing PMI (lef t scale)
54
6
5
4.0
Global real GDP, % year-on-year (IMF
methodology)
53
4
3.5
52
3
2
51
3.0
1
50
0
2.5
-1
49
-2
1997Q1
2000Q4
2004Q3
2008Q2
2012Q1
48
2012Q4
2015-Q
4
Source: IMF, national statistics offices
2.0
2013Q4
2014Q4
2015Q4
Source: IMF, JP Morgan/Markit
Note: IMF methodology; Q4 2015 is estimate based on
GDP growth of countries which have so far released Q4
data (about 63% of global GDP)
Figure 9: GDP growth in 2015 was averagely weak
Global real GDP growth, IMF methodology (%)
6
5
1990-2014 average: 3.6%
4
3
2
1
2017f
2016f
2015e
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
0
Source: IMF
This would imply global growth in 2015 of around 3%, broadly in line with the IMF’s latest forecast and only
down marginally from 3.4% in 2014 and 3.3% in 2013 (see Figure 9). In 1990-2014, global GDP growth
was below the 3.6% average in 14 out of 25 years. In those years, growth averaged about 2.7%. If we strip
out 2009 (by far the weakest annual growth in recent decades), growth averaged 3.74% in 1990-2014.
6
Growth was again below that figure in 14 out of 24 years and in those years averaged 3.0% – very similar
to the estimated growth recorded in H2 2015. Put differently, global growth in recent quarters has been of
“average weakness”.
Global consumption resilient, Ireland, Spain and India are bright spots
Global consumption growth has held up in developed markets (see Figure 10) thanks to decent labour
markets (see Figure 11), positive if unspectacular wage growth and low interest rates (the US, eurozone,
Japan and UK account for about half of the world’s GDP). Consumption growth accelerated to a 9-year
high in Q3 2015 in both the UK and eurozone and, while still in negative territory, has seemingly bottomed
out in Japan. But the latest data refer to Q3 2015, which are now effectively six months old. Furthermore,
US consumption growth slowed sharply in Q4 to 1.8% yoy from about 2.7% in 2014 and the first half of
2015.
Figure 10: Household consumption growth has
been a brighter spot but has slowed in US
8
6
Figure 11: Unemployment has fallen sharply in the
US, UK and to a lesser extent eurozone
Household consumption
year-on-year % change
(4-quarter moving average)
13
Unemployment rate, %
12
11
4
10
2
9
0
8
7
-2
6
-4
-6
2000-Q1
5
Eurozone
2005-Q1
US
UK
2010-Q1
Japan
4
Jan-09
2015-Q1
Source: European Central Bank, UK Office of National
Statistics, US Bureau of Economic Analysis,
Government of Japan
Eurozone
Sep-10
US
May-12
UK
Jan-14
Sep-15
Source: Eurostat, UK Office for National Statistics and
U.S. Bureau of Labor Statistics.
Country-wise, Spain and in particular Ireland are recovering nicely after years of recession (see Figure 12)
and Indian GDP growth was a world-beating 7.3% year-on-year in Q4, even if doubts remain as to the
accuracy of these numbers (see Figure 13). But these positive stories are far and few between and
unfolding in economies ultimately too small to really move the global needle.
India, Spain and Ireland for example account for only 2.8%, 1.6% and 0.3%, respectively, of world GDP
and India’s economy is only a fifth of the size of China’s. To put it in context, the Chinese growth slowdown
from around 10% in 2010-2011 to currently just under 7% will have shaved nearly half a percentage point
off global GDP growth. Moreover, these bright spots are at risk of fading given the tight interconnectedness
of economies and markets.
7
Figure 12: GDP growth has recovered in Spain and
particularly Ireland
Figure 13: Indian GDP growth has overtaken
China’s but India’s economy only a fifth of China’s
16
Real GDP, % year-on-year
8
Real GDP, % year-on-year
14
6
12
4
10
8
2
6
0
4
-2
2
Ireland
-4
Q1 2013
Q4 2013
Spain
Q3 2014
Eurozone
0
2006Q4
Q2 2015
Source: Eurostat
India
2009Q1
2011Q2
China
2013Q3
2015Q4
Source: Indian Ministry of Statistics and Programme
Implementation, National Bureau of Statistics of China
If there’s a crisis, it’s likely to be first truly global crisis in at least 20 years
Indeed, if there is a crisis it’s likely to be the first truly global crisis in 20 years in the sense that the
epicentre will not be confined to a particularly country, region, asset class or sector. In contrast, the 1994,
1998 and 2006 crises originated in, respectively, Asia, Russia and emerging markets, the 2000 equity selloff was largely triggered by (ultimately unfounded) Y2K concerns and the great financial crisis of 2008-2009
was, at its source, a US sub-prime mortgage crisis which largely spared China’s economy. Of course these
prior shocks soon spread to other economies and markets to become globalised crises but they had a
specific point of origin.
The current malaise has multiple roots, which increases the risk of rapid and generalised risk aversion and
a global recession. Both developed and emerging market economies are showing signs of stress, as
exemplified by slowing growth, high indebtedness, increasingly ineffective monetary policies, dithering
governments and weak/volatile equity markets. From a sectoral perspective, energy companies, banks and
internet giants are all posting losses and tumbling share prices and are being forced to retrench by cutting
back on investment and human capital.
Furthermore, none of the major economies are seemingly in a position to single-handedly lead the world
out this current funk. So again a well-scripted and coordinated policy package at a global level is a
necessary, if not sufficient, pre-condition for average (rather than below average) GDP growth and more
resilient equity markets. There has been little evidence of a coming-together of minds but Draghi seems to
be on the right track.
8