Guest Post: Keep The Faith....
From Strategic Alpha
Keep The Faith....
Bernanke is obviously as confused as we are over the state of the US economy: QE is coming but not yet:
Again from the Fed I hear a lot of hope rather than substance about the ability of the US to recover in Q2. It is far from clear, even to them, that this will happen and thus monetary policy is on hold and it appears to me that QE will run its course to the end of the month and be kept as a backup in case equities dump, which actually looks quite likely to me. You can tell the markets are as confused as Bernanke is, as the reaction to his speech was a big fat zero! Equities could start a rather nasty slide now and to me QE3 will be seen very quickly if it looks like a rout. Bernanke needs to keep the next launch a surprise in my view and he may not communicate its use to gain maximum impact. To me equities still hold the key to a lot of this in his mind and they simply cannot sustain these crazy levels without his liquidity feed. Mind the gap as the crutch is being taken away!
Bernanke was certainly not bullish on the economy (I am sure you have all read the speech by now) and it was interesting to hear his views on inflation but I think he is playing lip service to the hawks and politicians who are worried about letting the Genie out of the bottle. Reading between the lines, he has failed his mandate and needs to invigorate both employment and housing and that is not going to happen at all if rates go up and he knows it. He must also be aware that QE2 failed to stimulate either! But what other options does he have? Trash the Dollar I guess but they are in no position to allow a collapse as the holders of US assets would dump the lot and so they will not talk it lower. More benign neglect as it quietly falls. I reiterate that the world is very aware that it needs a healthy US economy and that applies to the EU, China and all the world’s exporters and this is why I believe there is an accord to allow a controlled fall in the Dollar. Don’t for one minute believe that Geithner and Bernanke want to pursue a stronger Dollar. That is total garbage. Even he admitted that the only way the Dollar will rally is if he fixes the economy and we are a very long way off that!
Bernanke sees growth as "likely to pick up somewhat in the second half of the year" as manufacturing activity normalizes and gasoline prices ease a little”. That doesn’t sound very reassuring to me and what if gas prices don’t? More hope. Whilst he calls for a fiscal consolidation plan, he made it quite clear that a draconian move would kill the economy. (Are you listening Mr. Osborne!). He was certainly not able to answer which he would prefer; a short term stimulus or long term tightening! I do not however believe that he sees inflation as a problem for the US (as he hasn’t created it yet) in the data he considers important and with weakness in the jobs and housing markets coupled with rising food and fuel costs, the consumers earnings continue to fall. Demand will fall and consumers may decide to deleverage at the same time. This will create the opposite; deflation in the near-term. If we do not see data improve into September then I fear that the hope will disappear and that is what happened in 1932 after the ’29 crash! He cannot and will not allow that and he believes that equities hold the key to stability and confidence. QE will be back if data doesn’t turn soon.
The UK economy scares me as utility bills rise and wages stagnate: Job losses look inevitable:
To my mind the weakest economy in the developed world is the UK and actually most of the global economies look more solid than this one. The data is beginning to ring alarm bells for me and surely investors are being advised away from here, as if we look at the headwinds the consumer has to face, there must be better alternatives elsewhere and GBP will surely fall. We are now seeing another rise in utility bills as gas and electricity bills are set to rise by 20% and 10% respectively from one of the largest suppliers so others will surely follow. This could not come at a worse time as the poor (that is exactly what he is) consumer is faced with higher VAT, higher utility costs, higher essential costs and stagnant wages! It is a nightmare scenario that will spark a collapse in demand and a change in spending and saving habits. Do you still think they can raise rates at year-end? No nor do I. Bernanke is concerned that any drastic attempt to cut the deficit could kill the US economy and the government in the UK seems hell bent placating rating agencies at the cost of the economy. This will not help. I am bearish GBP still. Quite why the UK has an AAA rating is beyond me as Osborne will fail in his attempt to reduce the deficit!
The economists were telling us that the private sector would pick up the slack from the public sector job cuts that were needed to help reduce the rise of the deficit. (Again they are still not reducing the deficit, just the speed of its rise). This is not happening and to me there is a disturbing trend that suggests unemployment here is about to pick up. There has been a "worrying" slowdown in the number of new jobs being created in the UK in the last month, a new report shows. The latest figures from REC/KPMG, covering mid-April to mid-May, reveal the slowest growth of permanent and temporary appointments in seven months and more disturbing was that pay growth is actually falling! Earnings will certainly not pick up if unemployment goes up and competition for jobs increases.
The lack of confidence in the consumer is beginning to show up in sales data, as we suggested it would, even with some signs that shop inflation is beginning to fall. To me we have a situation here where inflation is purely generated externally in essential costs and the consumer will adjust and put off any unnecessary purchases of non-essentials. The retailers are going to find this very tough to deal with and earnings will suffer and the High St could become rather quiet. With falling demand the BoE has a very tough battle on its hands but any hike in rates would finish this economy off and we are already seeing house prices begin to slip and that is the last bastion of confidence for most. GBP crosses look set to fall further in my view.
The global economy looks set to stall:
Why are economists so convinced that the world faces just a “soft patch” as to me the signs look dreadful and the policy tools are all blunt. Rates in the UK and US are pinned to the floor and there is little that can be done if the rise in food prices is driven by natural demand as the global population explodes. The room for macroeconomic policy to engineer a rebound is much more limited. Everyone I hear talks of commodities stabilising but what if they don’t? It is far from evident that things will change, especially in food prices so consumers will be forced to change. The percentage of earnings spent on food and utility costs is spiralling higher and something will have to be sacrificed as earnings are still not keeping up. This is going to be extremely tough as consumers are going to have to change their lifestyles and credit is not going to be offered or indeed wanted!
Just look at the data, as PMI’s are rolling over and manufacturing and IP looks to have peaked and most of the recent strength was due to inventory build. China has had to bail out its local governments to the tune of $463bln! That is a financial crisis in itself and I and the clever guys at SocGen think that this may be an issue going forward. China is fighting inflation because it has to, otherwise civil unrest over food costs will be destabilising. Further rate hikes and possible adjustments to the peg are on their way and don’t forget that China is trying to manufacture a slowdown. The world is paying more for food and raw materials and does no one think that this may affect demand and therefore global growth? Again the world needs a healthy US and a healthy EU and we have neither. I will expect to see economists start to revise their global growth forecasts soon but they are always late.
What happens if energy and food prices keep going up? Can we be sure that this won’t happen? No of course not so these markets are far too complacent in my view and are not pricing enough risk premium. I am not even convinced that a lot of higher input prices have been passed on yet so the consumer will either face higher prices or the producer will see margins collapse and neither is good for equities. Europe is in a mess and it looks increasingly likely that a restructuring WILL happen somewhere at some point, whilst Trichet seems determined to jack up rates on principle. Don’t forget that even though European politicians want to help for fear of the consequences, ultimately the outcome will be decided by backbench politicians in PM Papandreou's parliamentary party. If austerity measures are not approved by parliament on Jun 28, then all hell could break loose. And just look at the EUR; what’s it doing up here? There is little risk priced here it seems and yet the risks are huge.
Central banks are sucking volatility from these markets in a bid to create a false sense of security. This covert intervention is very clever as it’s tough to fight. Without doubt G20 is behind this and the accord is strong. They need a stable equity markets and stable FX markets to help buy time. Very clever.