Why #Clegglookingsad matters

Amid the hysteria about the European election results (Neo-nazis! Racists! Feminists! Satirists!), let’s pick out what really matters. (Though if you do want a good summary of those extremists, here’s the Guardian’s take: http://bit.ly/1hu1Ake)

The result signals a potentially destabilising period for the coalition – the first since its creation. The market has forgotten about those febrile days just after the May 2010 election, with the main political parties thrashing out a way to set up not only the first coalition since the war, but a solid one.
There have of course been strains. The failed AV referendum. The Lib Dems u-turn on tuition fees. The Lib Dems putting the kibosh on long-held Tory plans to redraw constituency boundaries. And who exactly was responsible for raising the personal allowance, taking many more people out of tax?
Now, though, it’s only a year until the General Election. Both parties will want to split before the campaign begins; neither is served by a “joint platform”. Now, the blue touchpaper has been lit for both parties’ discontented fringes. The left of the Lib Dems can call for Clegg’s head, while the right of the Tories can argue for more UKIP.
This is why the next two weeks are so important.
1) Clegg has refused to resign, but politics is moving ahead of him. Leaking, counter-briefing is already underway. Today his allies claim Vince Cable’s supporters are deliberately seeking to destabilise him: http://bit.ly/1h8OvlV
2) The Newark by-election on June 5th. This is a safe Tory seat, with a majority of 16,000, so a UKIP win is very unlikely. But that sets the bar very low for UKIP to claim they’re making serious in-roads into the Tory vote.
Volatility in the market is low: 3month EUR/GBP vol is just under 6% – it was at 7.5% at the start of this year, while 3month GBP/USD stumbles along at its 2007 lows of 5%. Politics has a habit of throwing up surprises. http://nickclegglookingsad.tumblr.com/
 
Even if Clegg survives and Cameron holds his nerve, with the coalition limping through the summer recess, then we have the small matter of the Scottish referendum ahead…

Courage, mon brave

There has been much hand-wringing of late about the US interest rate markets. How could it be that the 10yr is 2.5% when we started the year at 3%? Sure, we had some bad weather, but jobless claims just came in at their lowest level in 7 years! Non farm payrolls were almost 300k! The Fed taper will be done in just a few months! Even the soft housing data rebounded strongly in April!?
Oh but how we worry.
Various explanations have been put forward for the rally in US bonds.
1. Central Bank holdings as FX reserves go up
2. Equities wobbling (near all-time highs?!)
3. G4 central banks leaning back towards dovishness
4. Yellen winning the dovish argument on the FOMC
5. Bernanke telling people rates won’t go back to their long term average of 4% ‘in my lifetime’ http://reut.rs/TkXoy1
 
The final point makes it very clear just how much of a colossal loss of nerve is going on. Since when did we listen to the guy no longer in charge? Sure, he’s close to Yellen, but is it surprising that the man who sanctioned the biggest money drop in US history is somewhat dovish? The detail in that article says it all… some big fund managers are quoted as cursing themselves for not listening to his comments more carefully. No, they’re just frustrated that the market is moving against them, even now the weather effects are out of the way.
At the heart of this lies the expectations for the US economy. It’s not surprising that it is so hard to call. With the patient having spent 7 years on life support, just how will it manage on its own? After all that time can we really believe it will skip out of the hospital? Particularly when housing and banking, the implosion in which brought the world economy to its knees, is so sensitive to interest rates. Let’s not forget that at the same time a new chairman is in charge of the biggest central bank in the world – and only the 3rd in 30 years.
This chart is the key. It’s consensus expectations for US economic growth this year. We’ve run from one side of the boat to the other, starting the year expecting almost 3%, now down to 2.5%.
Janet Yellen is wrong. The Fed’s “dots” do matter, but only because they give us confidence in our view of the US economy. Central bankers have been performing an excellent jedi mind-trick since Lehman went under – “trust us, we will keep pumping the drugs until we’re confident you can leave the hospital”. But markets should have their own confidence now.
The response to the Bank of England Inflation Report gives the clearest signal that the market is capitulating. Every time previously that Carney has signalled on forward guidance, the market has brought forward rate hikes. This time his dovishness saw it pushed back. The guy is in place to ensure that any spike in yields is contained, which means using sterling to weigh on inflation, and macroprudential rules to weigh on the housing market. But it doesn’t mean that there isn’t underlying strength in the UK economy.
What will make the market regain its confidence? It will need something so obvious that it can be grasped with both hands and thrown in the face of the world’s central banks. The key to watch is inflation – and specifically wage inflation. Go back to the Reuters article on Bernanke, where one attendee says they’re “shocked” that 2% inflation was not considered a ceiling. How can anyone be shocked when central bankers will pat themselves on the back for averting another deflationary Great Depression! Even the ECB appear to be putting some kind of asset purchases on the table. For Central Bankers, inflation is a massive result. It’s like (pre Moyes era) Manchester Utd: having good players on the bench makes the team selection a headache you want to have -> employment, wage inflation and growth makes getting behind the curve worthwhile. Raising rates into a recovery will be accompanied by a sigh of relief.
If the central banks have told us anything, it’s that they want to be behind the curve. Markets need to recognise that this means the yield curve is ours for the taking. Courage, mon brave…

The Day Today 13 May 2014

* Ahead of the Bank of England Inflation Report tomorrow, speculation gathers about when the first rate hike will come.
– Jeremy Warner in the Telegraph warns about the housing bubble: “Enough is enough, we need higher interest rates now” http://bit.ly/SWkQS9
– Earlier rate rise may be needed, warns CBI http://bit.ly/1sHNC4Z

* The Fed are watching these 3 measures of wage inflation, no signs it’s back yet:
– Compensation per hour 2.3%, it was 2.6% two years ago
– Employment Cost Index, long the ‘favourite’ of the Fed, is 1.8%, at the average of the past 2 years
– Average hourly earnings, 1.9%, below 2.1% average of last year
* China’s Stocks Fall as Industrial Output Shows Deeper Slowdown {fifw NSN N5I5C86JIJV6 <go>}
* FT: This time China’s property bubble really could burst http://on.ft.com/1nIfLqs
 
* FT: France resists pressure to scrap €1.2bn Russian ships deal http://on.ft.com/1mQT6eB
* Der Spiegel: Why EU Sanctions are a Bluff http://bit.ly/1jBJkdk
 
* This had seen some SEK strength: Volkswagen Secures Enough Scania Stock to Succeed With $9.2 Billion Offer {fifw NSN N5I7Z86K50YW <go>}
* Sweden May Propose Tax Cut for Companies, Dagens Industri Says {fifw NSN N5HYW46S972E <go>}
* Swedish inflation data today a little higher than expected but still only 0.5% YoY
* Modi Calls for India Unity as Exit Polls Show He’ll Become Prime Minister {fifw NSN N5HWII6TTDS4 <go>}

The Day Today 9 April 2014

* Remember that Eurozone crisis? Yeah it was probably just a bad dream…. Greece Said to Plan Starting to Market Sale of Five-Year Notes Tomorrow {fifw NSN N3R8J16TTDSR <go>}
* Stocks in Europe Advance With Emerging-Market Equities as Wheat, Corn Rise
* London Bankers Opposing Britain Exit From EU Predict U.K. Losses. Goldman’s Michael Sherwood speaks out: “We want to UK to stay in Europe” {NSN N3Q0CA6S972L <go>}
* Swedish Central Bank Sees Greater Probability of Rate Cut in Near Future {fifw NSN N3R8J16TTDSR <go>}

* FT: Biggest US banks forced to hold $68bn in extra capital. A new “leverage ratio” will force the eight largest US banks to hold a minimum of 5 per cent equity to total assets to absorb losses in a crisis and proposes adopting a more stringent way of calculating the rule. http://on.ft.com/1hAZZaV

 
* WSJ: Spain’s Parliament Rejects Catalonia Bid for Independence Vote http://on.wsj.com/1g6qGrY
 
* Andrew Smithers thought-provoking blog on the fall in the US participation rate: Misinterpreting the way the BLS presents the participation rate gives an over-optimistic view of the US economy. It encourages the view that a continued growth of the US economy at recent rates will be possible with a much slower fall in unemployment than has recently occurred. This would therefore help to justify postponing a rise in interest rates for longer than would otherwise seem justified. http://on.ft.com/1iw6EW6
 
* Fed speakers:
– Plosser (voter) – low inflation is “transitory” and he’s “pretty pleased” with employment report {fifw NSN N3QAAY6KLVR7 <go>}
– Evans (nonvoter) – “one of the big risks is that we withdraw our accommodative policies prematurely” {fifw NSN N3QCZP6S9729 <go>}
* Australia inflows : AFR: Abbott set to give green light to $1bn Chinese investments http://bit.ly/OBBrrb

What happens when you’re not looking

As I write the Euro is heading towards the high printed at the end of last year, 1.3893. This just after Bloomberg’s Chart of the Day on Monday was entitled “Euro suffocated as 2014 Range is the least on record” – in other words, the Euro has never started the year in a tighter trading range versus the dollar than it has now (see attached). Ironically the previous low was 2007 and we all know how that year ended up (the words “Northern” and “Rock” spring to mind). Implied EUR/USD volatility is also back at the lows of 2007.

Frustration and disinterest abound. Today’s non-farm payrolls is the least eagerly anticipated for months, as the market has had to contend with the impact of weather on data which is apparently the key input for the Fed’s reaction function. What normally happens in markets when people aren’t looking? That’s when trends begin…

So what could we see from here? Mr Draghi yesterday sounded relatively upbeat, and why shouldn’t he. Money market rates have fallen back to their lows, peripheral yields continue to tighten (Spanish 10years now half the levels of 2 years ago), and his favourite economic measure – the PMIs – are picking up. “But what about all the deflation?” cry the doom merchants. Well that was a natural consequence of restructuring economies within a fixed exchange rate regime. If it became entrenched, Draghi would argue that they have a long toolkit of measures they can use. Indeed the open debate within the ECB over the last few months is a sign that he’s getting his ducks in a row should the need arise. Government by consensus requires that debate.
So the ECB are letting their balance sheet shrink just as others are increasing theirs. 1.4000 on EUR/USD would be a pain trade for underhedged European corporates. Alongside this, risk sentiment continues to show resilience. Despite everything thrown at it, from a Fed who reiterate their commitment to taper despite the weather, to Ukraine/Russia/WW3 worries, the stock market carries on going up regardless. The Nikkei is now down only 6% YTD, having previously been the worse performing stock market of the year. It’s all good news until it isn’t, so watch out for buyers of EUR/JPY in the near term as “Goldilocks” plays out for the financial markets – not too hot, not too cold, and don’t make me think about the 3 bears.