No Country For Old Bulls
With global PMI rolling over again, dimming unemployment growth, and slowing EM Asia impacting global production, it is no wonder than BofAML's economics team sees a dearth of 'feelgood' factors in the market. In fact, as they note, further rate cuts in the euro area and China along with around $500bn of NEW QE in this quarter are priced into the market with any hope for risk assets to rally more consistently, investors will need to see not just willing-and-able central bankers but an abatement of the sovereign crisis in Europe and improvement in global data - neither of which they expect anytime soon. Easier monetary policy can only cushion the blow from higher uncertainty in the US and Europe. Effective policy breakthroughs would thus have to come from compromises in the European Council or in US cross-party politics. Investors have yet to zero in on the real impacts of rising economic uncertainty in the US. As Ethan Harris and Michael Hanson have argued, it is unlikely that the cliff is fully priced into the markets and US political dysfunction will share the spotlight with the European crisis over the next few months. And as last time, the joint act will likely undercut investor confidence.
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BofAML: No Country For Old Bulls
Review: policy to the rescue
Global central banks continued to ease monetary policy in response to a deteriorating global backdrop. Both the ECB and China’s PBoC cut interest rates this week, while the Bank of England kicked off another round of its quantitative easing program. As we expected, the ECB lowered interest rates by 25bp and brought deposit rates down to zero. In the UK, the BoE announced it aims to add £50bn to its balance sheet over the next four months. Meanwhile in Asia, the Chinese central bank surprisingly cut interest rates less than one month after it last lowered borrowing costs.
Most importantly, policymakers’ continued focus on downside risks backs expectations of further policy support. The ECB sounded more concerned about area-wide demand conditions and, although ECB President Mario Draghi discouraged hopes of further non-standard measures such as new LTROs, we think the Governing Council will lower interest rates once again before the end of the quarter. Likewise in China, we look for follow-ups to this week’s rate cut. Reserve requirement ratios will probably be lowered within the next few days, and we expect the PBoC to cut interest rates twice more before the end of the year. This week’s policy action was accompanied by mostly downbeat economic data.
Global confidence stumbled again, with the global PMI dropping to 49.6 in June from 50.1 in the previous month (Chart 1). In the US, nonfarm payrolls expanded by a below-consensus 80k in June, while the unemployment rate remained at 8.2%. This brings the 2Q average to 75k, well below the 226k per month seen during the first quarter. The unemployment outflow rate – a statistic tracked by Federal Reserve staff – remained close to historically low levels (Chart 2).
Hot topic: a dearth of ‘feelgood’ factors
Besides further interest rate cuts in the euro area and China, we also expect the Federal Reserve to underwrite $500bn worth of QE this quarter. If we are right, systemic central banks will have largely fulfilled recent market expectations of significant policy rescue. But for risk assets to rally more consistently, investors need to see more than willing-and-able central banks, in our view. On top of expanding liquidity, a meaningful market rally needs: (i) an abating sovereign crisis in Europe; and (ii) improvement in the global data. Are these conditions likely to materialize?
We think the crisis in the euro area will remain an open sore. The outcome of last week’s summit indeed revealed steps in the right direction. But it was no game changer. As German officials have been keen to highlight, the principle of no mutualization of national liabilities without sovereignty transfers looks intact. Moreover, the painstaking debate on what both shared banking supervision and ESM direct help to banks entail is only beginning. As Laurence Boone explains, the effectiveness of a banking union lies in the details.
The Eurogroup will meet next week, when we hope to learn more about the conditions underpinning the Spanish banking bailout. By the end of the month the Troika should unveil the magnitude of funding gaps in Greece. With policymakers still balking at prospects of another debt relief round (that is, official sector involvement), pressure on the new Greek government is likely to mount. We have seen this before: if the Troika pushes for significant adjustment over a short period of time the weakest link of Greek political stability will likely break. The well-known Greek dilemmas should resurface soon.
Better EM data to be cold comfort
As recessions in euro area countries deepen and doubts about both the crisis fighting strategy and the future institutional contours of the monetary union linger, we see no meaningful respite from the sovereign crisis. But could market perceptions brighten up once global activity data start to improve? In other words, could rebounding EM economies lighten up the mood in the marketplace and help investors tolerate foot-dragging in Europe?
Our real-time global activity gauge does suggest business conditions became less negative in June. Although activity appears to have softened further in the US, conditions seem to have improved in GEMs. This pushed the global aggregate higher. That said, the GLOBALcycle still indicates that global GDP growth likely dropped to 2.1% qoq (saar) in 2Q from 3.1% in the previous quarter. Looking ahead, wobbling global business confidence argues against a meaningful follow-up from June’s improvement. But mounting policy support in countries such as China and Brazil plus substantial recent drops in EM industrial production (Chart 3) point to a 3Q rebound in local activity. Its global reach, however, will likely be limited. As the US economy weakens ahead of the oncoming fiscal cliff and the euro area remains in recession, we expect global GDP growth to remain close to the 3% level. That is down from the average 4% seen between 2010 and 2011.
The looming fiscal fog
All in all, therefore, market respite opportunities are likely to be few and far between. On the plus side, global monetary conditions should continue to ease. Next week, whereas we now expect the BoJ to stay put, we look for the Brazilian central bank to cut interest rates by 50bp. Likewise, India’s RBI will probably reduce rates by the end of the month. However, as we illustrated last week, easier monetary policy can only cushion the blow from higher uncertainty in the US and Europe. Effective policy breakthroughs would thus have to come from compromises in the European Council or in US cross-party politics.
Investors have yet to zero in on the real impacts of rising economic uncertainty in the US. As Ethan Harris and Michael Hanson have argued, it is unlikely that the cliff is fully priced into the markets. The issue may only start to visibly influence the consensus once lumpy economic decisions – such as business investment and durable goods consumption – start being postponed in the run-up to the cliff. In all likelihood – and much like last summer – US political dysfunction will share the spotlight with the European crisis over the next few months. And as last time, the joint act will likely undercut investor confidence.