September FOMC: Bernanke's Eastern Put

by Michael J. Howell19. September 2013 17:02

The Fed surprised markets by deciding not to start 'tapering' its QE programme at its September meeting. What does this mean? Markets read it bullishly, that the Fed will continue to buy bonds and pump in cash, probably because they sense policy-makers are concerned by recent weak-ish economic numbers. However, whatever the FOMC's internal doubts and debates, the Fed has been striving all year to divide 'forward guidance' on interest rates from 'tapering' of QE, arguing both publically and privately that the former is more important overall and anyway set more in line with economic prospects. Meanwhile, QE is thought to be more important for the finance sector, and some Fed policy-makers have been concerned over recent months by bubbles and a 'reach for yield'. This argues for tapering now. Therefore, the Fed's latest decision is puzzling because if they are concerned about economic growth they could have hinted at lower future 'forward guidance', while still making a token gesture towards some tapering. Something else may be up? This could be EM. July/ August saw a rout in several EM currencies and EM equity and bond markets because of the upcoming threat of tapering. The fragile state of EM may have convinced US policy-makers to hold fire on tapering for another couple of months. So, overall no real change in view. On balance a bit more bullish if the Fed is truly an implicit protector of EM, and on this read the Fed may not be as concerned about the US economy as some fear. Therefore, keep selling those bonds; buy back some dollars and bottom fish in EM. The Bernanke Put may have just shifted Eastwards!

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Latest GLI, Liquidity Data

by Michael J. Howell19. September 2013 16:54

This month we move to new 2010-weights for our GLI (Global Liquidity Indexes). EM get a larger share and Frontier Markets squeeze in with a 1.4% weighting.  Latest end-August 2013 data show our monthly GLI hit a reading of 59.2 ('normal' range 0-100). [Using the old weights, the GLI would be 70.8.] The overall index is one standard deviation above its rolling four-year average. The leaders in this cycle are unquestionably the US, Japan, Australia, Frontier Markets and the UK , while the Eurozone and EM are lagging. This looks to be a remarkably 'normal' cycle.

 

 

 

 

 

 

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Tapering ... Bah!

by Michael J. Howell15. August 2013 09:34
'the money here is awful ...and such small flows...' is a Groucho Marx-like reflection on the growing debate over Fed tapering. Fact #1 is that QE3 is no QE1 and never was. The $85 billion monthly Fed injections could easily be trimmed to $75 bn at the September FOMC, but these flows are anyway being swamped by buoyant private sector liquidity inflows. These private flows, not the Fed, explain the firm US dollar; the rebounding US economy and rising bond yields. In short, policy-makers have been fooling the markets this year with their power. Fact #2 most of the Fed cash is effectively going to support the still fragile wholesale money markets. Given the vast increase in OTC bond issuance/ trading since 2008, these wholesale markets are probably still vital in providing funding for market makers. Fact #3 the Fed is internally worried by growing speculative activity and needs to show its hand. We know that the key decision makers anyway prefer 'forward guidance' to 'QE', so the latter is an easy sacrifice. Bottom line? Expect a September move to reduce QE. This will not derail the economic recovery, but it is likely to help the US dollar climb higher, and most importantly it will be yet another factor leading to greater market volatility over the next 12 months. Tapering matters, but not that much.

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Slower China Means Higher World Real Interest Rates

by Michael J. Howell14. August 2013 22:28
The outlook for our least favourite asset class in 2013 - TIPS - still looks poor. China's structural slowdown, in large part the result of tight PBoC liquidity hitting capex spending, will allow capital productivity in other economies, notably Japan and the US, to pick-up. This will push up World real interest rates from the circa 0% level nearer to their 2-3% long-term average. High inflation is not the threat; higher real interest rates are. This will push nominal bonds towards a 4-5% yield base. Equities still look the best asset class, but markets are ultimately moving towards a 1987-like ending. See report: How China Sets World Interest Rates (part II).

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Latest Global Liquidity Data - August Update

by Michael J. Howell14. August 2013 09:40
The latest (end-July) Global Liquidity Index (GLI) hit 73.8% against a 'normal' 0-100 range. This is equivalent to US$145 billion pouring into World financial markets. The distribution of liquidity remains very uneven. The leading markets were again the US, Britain and Japan, with liquidity in the Eurozone and Emerging Markets weak. The data show strongly divergent trends in private sector liquidity, and warn of heightened forex market volatility.

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Global Liquidity Update

Latest GLI - June Liquidity Update

by Michael J. Howell18. July 2013 23:59
Latest end-June 2013 data show our monthly Global Liquidity Index (GLI) hit a reading of 75.4 ('normal' range 0-100). Stripping out the two weak liquidity regions, namely EM and Eurozone, the overall index would exceed 85, or more than two standard deviations above its rolling four-year average.

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Mid-Year Review: The Three Big Events So Far in 2013

by Michael J. Howell8. July 2013 22:24
Believe or not, the big events of 2013 do not nclude either the influx or proposed ending of Fed QE3? We figure that three others are more critical. Together they explain the high current level and uneven distribution of global liquidity. See our research for more information: (1) the jump in US private sector cash flow generation, which is dollar and economy bullish; (2) huge Japan QE, which smashed the Yen, hurt EM economies, but will cause a Japanese economic turnaround, and (3) the decision by the PBoC in China to remain tight, which will cap Chinese growth and limit further large-scale capex.

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Tampering Or Tapering?

by Michael J. Howell8. July 2013 22:23
Two conclusions emerge from recent US and European Central Bank policy comments: (1) the Fed seeks to clearly distinguish (a) 'forward guidance' on Fed Funds from (b) QE, which determines the risk premium on bonds. Thus taken together forward guidance and QE determine bond yields. However, contrary to popular belief we believe that QE raises and does not reduce bond yields. Rather it reduces all other risk premia. The Fed by seeking to taper QE is trying we believe to stop the hunt for yield and likely wants to fatten 'too low' risk spreads on instruments such as junk debt, (2) the decision by the ECB and BoE to include 'forward guidance' is an interesting step. The ECB is admittedly using more 'words ' and according to our earlier points cannot control risk premia without QE. Nonetheless, the important thing here is that a European 'forward guidance' clearly opens the way for monetary policies in the US and Europe to formally diverge significantly. This could be key in 2014.

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Tampering Or Tapering?

by Michael J. Howell8. July 2013 22:09
Two conclusions emerge from recent US and European Central Bank policy comments: (1) the Fed seeks to clearly distinguish (a) 'forward guidance' on Fed Funds from (b) QE, which determines the risk premium on bonds. Thus taken together forward guidance and QE determine bond yields. However, contrary to popular belief we believe that QE raises and does not reduce bond yields. Rather it reduces all other risk premia. The Fed by seeking to taper QE is trying we believe to stop the hunt for yield and likely wants to fatten 'too low' risk spreads on instruments such as junk debt, (2) the decision by the ECB and BoE to include 'forward guidance' is an interesting step. The ECB is admittedly using more 'words ' and according to our earlier points cannot control risk premia without QE. Nonetheless, the important thing here is that a European 'forward guidance' clearly opens the way for monetary policies in the US and Europe to formally diverge significantly. This could be key in 2014.

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EM Head For The Entrance!

by Michael J. Howell25. June 2013 17:57

When everyone else yells 'sell', start to think differently. EM are not yet in a sweet spot but this could come early in Q3. We figure that 'cyclical economic recovery' is the message from skidding bond markets. This is entirely consistent with our data showing rising liquidity. On top, we expect EM currencies to weaken as local policy-makers begin to ease. This may worry EM bonds, but EM equities will benefit. Third, the main historic driver of the Asian business cycle is the Yen. This plunged in Q1 and Q2, but should now stabilise. A flatter Yen is a great base for EM to build upon. What could go wrong? Our main worry concerns a too strong US dollar, but if our hunch that we are in a 'normal' economic recovery proves correct, the US dollar may soften over coming quarters as the US current account deficit again starts to swell.

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