Nearly 75 years ago to the day,Winston Churchill made his famous speech expressing gratitude to our brave airmen by saying,"never in the field of human conflict was so much owed by so many to so few"....now however,since 2008 we have seen a massive redistribution of wealth from the 1% to the 0.1%.The middle class has been destroyed to pay for the folly that caused the initial crisis in 2008 and QE seems to have done nothing to help growth and the people that is was supposed to support but instead has only helped the oligarchy.
Most of the world's financial and economic problems would be solved if there was a healthy and sustainable level of economic growth. Growth is as important to economic health as blood is to bodily health. It is no good if it is patchy, erratic and anaemic, it has to be widespread, consistent and robust.
Good quality growth is what policy makers have been searching for ever since 2008, and it is proving to be very elusive.
Now you see it….
Growth has been playing hide and seek with the global economy for a long time, in fact so long that thoughts are returning to the possibility that the financial crisis has triggered a fundamental shift to a lower growth cycle.
Just as the probability of global warming being man made has a growing number of adherents, the possibility of a paradigm shift in growth potential is gaining ground. In arguing recently that the US recovery is still too weak to justify an interest rate rise, the president of the Boston Federal Reserve said that he saw signs of a profound change in consumer behaviour towards saving at the expense of consumption. Never has so much monetary ammunition been deployed for so long, for such a small return.
The OECD added to the gloomy prognosis last week. It issued its twice yearly Economic Outlook in which global growth for this year was downgraded from 3.7% to 3.1%, including cuts for the US from 3.1 to 2% and for China from 7.1 to 6.8%. These are big reductions in only a six month period.
The eurozone is forecast to turn in a disappointing 1.4%. Next year global growth is expected to reach 3.8% with the US at 2.8%, China at 6.7% and the Eurozone 2.1%. In the words of the OECD's chief economist "we give the global economy only the barely passing grade of B minus".
The OECD sees downside to these estimates. The problem they say is weak investment brought about by a weak recovery and insufficient confidence that the self re-inforcing cycle can be broken by QE. There is ample evidence that QE generates asset inflation but no real belief amongst those taking business investment decisions that QE will generate sustainable high quality growth. Central bankers have not won the hearts and minds of those responsible for making the investment decisions. Their monetary experiments are still just that…experiments…
The fragility of global growth explains why so many people are scared about fall out from a Greek default. How can a country with only 1.7% of eurozone GDP and a miniscule 0.3% of global GDP and debts of only €240 bln be seen as such a risk to the global economy if it defaults? The reason can only be that they see the global economy as so fragile that it cannot take even a minor shock. We are told our banks are stronger and that regulators have made the global financial system safer and yet tiny Greece could bring down the whole pack of cards. How can that have come about?
The answer is that the medicine of last resort has not worked and may never do so.
Everybody knows that a long period of easy money and zero interest rates is dangerously unhealthy and that asset bubbles and resource misallocation is inevitable. We have yet to see a successful exit from QE. Central bankers know that but have no other weapons to turn to, given that spiraling debt levels make the alternative of fiscal expansion equally, if not more dangerous. If there is another shock there is no interest rate buffer to switch on when rates are already at zero.
What is particularly alarming is the constant stream of mixed messages one minute assuring us that recovery is taking hold, the next warning us of fragility such that one minor shock will bring the house down. The IMF is currently in alarmist mode. At the end of last week it all but pleaded with the Federal Reserve to delay any interest rate increase until 2016 fearing that any sharp appreciation in the dollar would create havoc in the emerging market world.
Christine Lagarde warned that "higher US policy rates could well result in significant market volatility with financial instability consequences that go well beyond US borders". Moreover the IMF believes that there are still "significant uncertainties to the future resilience of economic growth" in the US and raising rates even a small amount could cause the economy to stall. They are talking about the economy we all thought was doing better than most and leading the way!
Be afraid…be very afraid…
Should we be worried? Common sense tells us we should, and not to be comforted by strong stock markets that are rising on increasingly thin air. Mario Draghi told the markets last week that they should get used to volatility which is an inevitable result of low interest rates and reduced liquidity resulting from regulatory changes, where even the hint of a small rise has exaggerated consequences. There was another bout of extreme bond market volatility with the yield on ten-year Bunds rising to 1.00% a level not seen since last year and prior to the ECB version of QE. It may not sound a lot but in terms of % price move it was enormous, in what is supposed to be a safe-haven asset. Bunds delivered their heaviest weekly loss in more than 15 years.
However on the flipside....
After each of the QE’s yields have fallen in anticipation of action by the FED or ECB, but each time as it begins it has been a bit like trying to hold a beach ball under water as positions are unwound and there is a buy the rumor sell the fact type trade and each time once the programs have started,rates have risen.
At the end of the day for the Bund to be yielding 0.049 does not exactly offer a good risk/reward by being long, as pointed out by Mr.Gross in his “short of a lifetime” comment,so a retreat in rates should have been expected..,but once again we go back to the issue that I have stated in my previous posts....LIQUIDITY...or the lack therof...which was the predominant cause of the SPEED of the move in the Bunds.
So looking at the current yields there is still a little more upside before we can decide if we are really seeing a breakout
however given the improving US economy certainly after today’s retail sales and the ongoing Greek fiasco I expect the that spread to widen back out as the US looks to improve Vs its counterparts…
(Bund Vs 10yr Yield spread)
We also had the OPEC meeting on Friday where the subject of growth was mentioned several times by oil ministers during the OPEC seminar sessions held in Vienna prior to the main event last Friday. Ministers from Qatar, Saudi Arabia and Kuwait all professed optimism, citing improving global growth prospects as one of the reasons. They are making the mistake of attributing increased global oil demand to GDP growth when it is really due to plain and simple demand elasticity. Cut prices and people consume more. In fact demand has increased despite global growth headwinds in emerging markets.
The chart below shows how closely the WTI has been tracking the 5/30yr yield curve and the 5yr breakeven yield which I feel that it may continue to do…however you need to be cognizant that oversupply and geopolitical issues will play a part in that spread too
So what next spoiler boy...?
Watch technical levels,watch the outcome of the Greek dramedy
The truth is that nobody has yet to experience what happens on the ending of the QE programs and how spreads can be effected due to lack of liquidity.
What we have seen so far,bond volatility aside,should not have been unexpected but remember,when holidaying in your hotel looking out to the sea...you may not realize what could be going on right behind you.....
So lets just be careful out there :)
In regards to more detailed options and futures advice volatility analysis etc ,please contact Darren Krett through www.maunaki.com or firstname.lastname@example.org ,Im still looking for liquidity providers and someone who would be interested in an excellent experienced senior option trader
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