In this week’s bulletin:
- Central bankers are confronting market reactions to China’s liquidity challenge and the US Fed’s intentions
- Further monetary action is expected from the new Bank of England governor, Mark Carney, to help the UK economy
- Gold has lost its lustre with its 12-year bull-run now a distant glimmer as the US dollar strengthens and inflation expectations decline
- Markets mid-year seem to have stopped to breathe and attune to US Fed chairman Ben Bernanke’s QE message
Hogs and Pixiu
Beijing’s official newspaper struck one of the more colourful images in a week in which global central bankers grappled with unruly stock markets. Traders were likened by China’s People’s Daily to the mythic lion-dragon pixiu, a creature gorged on but unable to dispel wealth. The Communist Party’s mouthpiece implied that China’s markets were unable to flush out the ‘bad stuff’.
The threat of a liquidity squeeze in China and ensuing volatility in its financial markets, together with the US Federal Reserve’s intention to gradually reduce, or taper, its quantitative easing (QE) programme, dominated global markets in the closing week of June. China’s authorities assured there would be adequate liquidity for its financial system, while global policymakers strove to calm and control market reactions. Central bankers are confronting market reactions to China’s liquidity challenge and the US Fed’s intentions, and are looking to quell any threat to economic recovery this year.
In the UK, the Bank of England’s now former governor Sir Mervyn King said that markets had “jumped the gun” in thinking the US Fed was on course to return to more normal interest rates. In the US, the Federal Reserve Bank of New York’s president William Dudley reiterated that a reduction of QE hinged on economic recovery, days after his equivalent in Dallas, Richard Fischer, likened market traders to “feral hogs” seeking policy weakness. European Central Bank president Mario Draghi reiterated an exit from stimulus was “still distant”.
Markets seemed to have calmed amid this menagerie of central bank contention. The US’ S&P 500 Index closed on Friday with its first positive week since early June, up just under 1% to 1,606. Wall Street’s favoured ‘fear’ barometer, The CBOE Volatility Index, fell nearly 11% in the past week and was flat on Friday at 16.86, suggesting investors are coming to terms with the Federal Reserve’s plans for its stimulus programme.
In London, the FTSE 100 also was up 1.62% over the five-day period to 6,215. The Eurofirst 300 index notched a 1.72% gain over the period after five weeks of losses. Japan’s Nikkei 225 Average rose 3.38% to 13,667 largely on the strong message from the People’s Bank of China. Equity rallies came amid further early signs of better days for the leading economies, including the US and UK. These positive economic indicators and an anticipation of the reduction in the Fed’s $85-billion a month bond-purchase programme, however, are forcing up benchmark US yields and the value the of the US dollar. Emerging markets and the price of gold continued to take a hit from this era of ‘waiting on the Fed waiting on the US economy’.
The fighting Fed
The US Fed last week reiterated that economic growth is the central message and condition for QE policy. Senior US central banker Fisher also warned that the Fed would not be deterred by big money – the “feral hogs” – in the market place from its plan to ease support when the time was right. Dudley last week said policymakers could prolong their asset purchase programme if the world’s largest economy fails to hit its growth forecast. “A rise in short-term rates and an unemployment rate down to the 6.5% threshold for the first rise are a long way-off,” he indicated. Expectations of an early rise in US interest rates were “out of sync” with central bank thinking.
Policy depends on outlook not a calendar, reiterated Dudley. Of course, that means the earlier the recovery of the US economy the earlier the exit begins. However, the Fed has continued to assure that this will not happen in the near term. And, as we argued last week in our special investment bulletin, a strong economy has to be a goal for all.
A revision down of the US economic growth rate in the first-quarter to 1.8% from 2.4% is likely to push back the day when QE tapering begins. But, there are positive signs going forward for the world’s largest economy, including last week’s consumer confidence and durable goods orders. Data this week from the US will include employment and manufacturing figures for June. Figures from the crucial US housing sector also look positive. For example, the US’ largest homebuilder Lennar last week reported a 53% increase in quarterly sales. US Commerce Department figures showed 476,000 new homes were sold in May, the highest since July 2008. The S&P Case-Shiller index indicated metropolitan area house prices rose 12.1% in April from a year earlier.
Sir Mervyn spent his last day on Friday at his Threadneadle Street desk, following a week in which he reaffirmed his support for QE to stimulate growth. The new Bank of England governor Mark Carney takes over amid better economic data for the UK economy. However, the rise in bond yields in recent weeks poses the tricky challenge of potential increased mortgage rates in the UK house market.
More QE was Sir Mervyn’s recent mantra and one he indicated last week that governments should have pursued more fully for economic growth amid historic low rates. Many expect further monetary action from Carney to help kick-start the UK economy. The Old Lady’s new Canadian leader will hold his first policy meeting on 3-4 July, when he is expected to advocate a clearer guidance on the outlook for interest rates as the Fed had done for the US.
Despite a revision of Office for National Statistics data last week that indicated a deeper recession in 2008-2009 than previously estimated, the signs are of recovery. The ONS confirmed that GDP grew 0.3% in the first quarter on net trade. Figures for household spending, retail sales, tax revenues and industrial production are all marginally improved. There was further evidence at the start of the week that the underlying pace of the economic recovery is strengthening, if moderately. The Chartered Institute of Purchasing and Supply’s Purchasing Managers’ Index rose to 52.5 from 51.3 in June – its highest level since April 2011. And the output balance edged up to 55 from 54.7.
The housing sector in the UK, as in the US, also holds out hope. House builder Berkeley last week reported a 26% rise in pre-tax profit on growing house prices, which are only 5-10% lower than their level at the peak of early 2008. The Council of Mortgage Lenders figures indicate higher lending in May than for any month since October 2008. With the government’s Funding for Lending and Help to Buy programmes, lenders are talking of another housing boom.
There is a clear relationship between house prices and household consumption. The economy is healing. Carney will have to handle a rise in yields and interest rates with care. Guidance on interest rates – or a further expansion of QE by £75billlion – are two tools at his disposal. Much will hinge, however, on global factors beyond the control of any one central banker.
Don’t Fight the People’s
China’s president Xi Jinping took power in March with a mission to show that the Party and the state-run central bank could rein in the country’s burgeoning financial sector. One of the first challenges has been ordering the People’s Bank of China to control credit. The target in early June was the rapid expansion of unofficial interbank lending and ensuing market volatility.
Beijing’s move to control credit has pushed interbank borrowing costs in China up since the start of June. The shadow financial system redirects money borrowed cheaply from the state into riskier products. Taming a credit boom with successful regulatory tightening and restricted liquidity is tricky, with risks for exchange rates and exports.
The People’s Bank’s refusal to inject money into the system caused interbank rates to soar last month. Last Tuesday calm descended on China’s money market when the central bank assured there would be liquidity at adequate levels for its financial system. Central bank governor Zhou Xiaochuan said the tough stance had been taken to force the banks to adjust their practices – and the message has been correctly understood by the market.
Zhou said banks had already scaled back their balance sheets since mid-June. China’s central bank, as lender of last resort, would help institutions with acute liquidity shortages to maintain financial stability. Central banks would guide financial institutions to maintain reasonable credit levels to support the growth of the real economy, he added.
The CSI300 index rose 1.9% on Friday, its best day in two months, but was down 4.5% overall last week. The index of leading stocks in Shanghai and Shenzhen shed 15.6% during over the turbulent month for China’s financial markets. This action comes at a difficult time for the economies of China and those that have clung to its ascent. China’s juggernaut economic take-off is slowing, with Goldman Sachs, Barclay and HSBC cutting their growth forecasts to 7.4% for 2013. Less growth in China puts pressure on raw material export economies, such as Brazil.
Talk of a ‘Lehman moment’ for the Chinese market may be overdone. There is liquidity in the system, as Zhou claimed at the weekend, although no one quite knows where it is. “It’s not that there is no money, but the money has been put in the wrong place,” said China’s official news agency Xinhua last week.
Sino-finance specialists observe that the central bank only has experience of soaring growth. However, authorities are equipped to exert the sort of control of depositor panics only dreamt of by Western leaders. China is, of course, still a command economy that can withhold bad news. These are ‘interesting times’ when opacity and state control can in the short-term, at least, command market volatility.
Gold has lost its lustre with its 12-year bull-run that peaked in the summer of 2011 now a distant glimmer. The precious metal has shed 29.5% of its value so far this year, with the FTSE Gold Mines index of gold equities down 52 per cent. Gold closed last week at a three-year low of $1,180 a troy ounce.
The metal has lost its status as an investment hedge as the US dollar strengthens and inflation expectations decline. Gold prices tend to come under pressure when real yields on 10-year US treasuries rise. The plunge in value in recent weeks has followed the Fed’s guidance on a reduction of the QE programme.
Hedge funds betting on lower gold prices have been targeting lows of about $1,150-$1,200 an ounce, and may look to profit on these positions by buying. Asian appetite for gold also looks gorged, with India’s government restricting gold imports and Chinese investors holding back as prices continue to fall towards the $1000 an ounce mark. Gold’s fading lure, however, does hold out potential recovery in the jewellery market, and create further pressure on the scrap market.
At the mid-point of 2013, markets seem to have paused to breathe and think. Markets are attuning to the nuance of US Fed chairman Ben Bernanke’s QE message. Developed nations are displaying shoots of underlying economic recovery. China’s elites are taking steps to provide liquidity to the banking sectors. The second half of the year may finally hold more measured reaction to the large challenges still facing central banks and the global economy…