Daily Note – Return of the Bourbons

Marie AntoinetteSummary

Central Banks – The “Bourbons of the market”

United States: FOMC “taper” by $10b as expected

Australia: No rate cuts in Oz – McCrann

United Kingdom: Carney – chill out, we’ve lots of time

Eurozone:  Getting weaker more slowly isn’t the same as getting better!


Good morning.

I woke up this morning to hear that Diageo’s results in Ireland were poor because sales of Guinness were down 6% here in the final six months of the year. Even the old certainties can’t be counted on, or can they?

As we argued yesterday in response to the Turkish decision to raise rates sharply, it is always the case that an aggressive rate hike doesn’t calm investors; it scares the bejaysus out of them. When the problem is too much debt and not enough growth, hiking rates makes the problem worse, not better. The central bank tries to squeeze liquidity in the money and foreign exchange market but this sends the economy’s future growth rate on a downward trajectory and this in turn, increases rather than decreases internal defaults – which were the problem in the first place.

As the exchange rate weakness – in a floating currency environment –  is a function of, amongst other things, internal default risk, the hiking of rates ultimately makes the currency weaker not stronger.

I write here as a former central bank economist and it never ceases to amaze me how little the central bank fraternity have learned from the various currency crises over the years be it sterling in 1993, the ERM in 1993, Asian in 1997 or Turkey today.

At least the Bourbons of the financial markets, the central bankers, who “have learned nothing and forgotten nothing” can be counted on. There are some old certainties left.

The having “learned nothing and forgotten nothing” line is a quotation from Napoleon’s foreign minister Tallyrand about the Bourbons. However, the quote of the day goes to Napoleon about Tallyrand who he described, viciously, as “filth in silk stockings”!

The Bourbons present trading opportunity

Yesterday’s equity market was a throwback to the days of the 2008 & 2009 financial crisis, where after an initial positive reaction to central bank action, the market sampled and didn’t quite like the taste.

As I argued yesterday, after a massive interest rate hike in Turkey, some people thought this would stabilise the Lira, but this didn’t happen for reasons I explained above. Renewed selling of the Lira spooked global equity markets.

The S&P 500 finished down 1%. It is now down 4% for the year. Perspective here is important given the S&P was up 30% in 2013. We expect further volatility in the days ahead but (we know from experience) outright equity index shorts tend to be difficult investments to manage.

Having looked at valuations yesterday, we intend to take a long and short investment soon. We will be long China and short the French CAC. This will be done through two ETF:

iShares China Large-Cap ETF (Ticker FXI)

Lyxor CAC 40 (Ticker CAC FP).

Keep an eye on our Twitter handle for more @globalmacro360

Again like last week, we noted no great flight to quality of fixed income. The US 10 Year note held the 2.70% yield level. Yesterday’s neurosis was  more an equity market phenomenon. We added to our 5 Year note short (iPath US Treasury 5-yr Bear ETN) into the close last night at 39.32.

We got our target entry yield of 1.49% coming post the FOMC meeting.  Inflation expectations are continuing to tick higher (The 1 year breakeven is at  1.68%) and, generally speaking, US growth is still robust. The US GDP data today will be watched carefully by the market and thereafter focus will turn to next week’s US employment report.

United States: FOMC “taper” by $10b as expected, ignoring recent market volatility

Today’s FOMC policy statement indicated that the tapering process continued at $10 billion per month pace.  The reduction in the size of the QE purchases is distributed equally between Treasuries and MBS. Total monthly purchases will be reduced to $65 billion as of February. The FOMC made no changes at all to forward rate guidance.

It’s too early to judge whether or not the FOMC will taper again in March because the FOMC needs to keep an eye on domestic and international market developments and also because data in the US, although strong, needs to be stronger and more definitive.

Australia: RBA will remove easing bias – McCrann

Down under, the Australian Herald-Sun’s central bank watcher Terry McCrann writes today that the central bank will remove any hints at further easing in next Tuesday’s meeting and offer guidance toward low rates for an extended period.

Next Tuesday, the RBA will walk back from even that implicit commitment. It would now require some active – obviously, negative – change in the economic environment for the RBA to contemplate another rate cut.

McCrann is certainly not an insider nor does he have proven sources at the RBA, but he has a brain!  This is what we expect too. The housing market and associated credit growth is simply too strong to be messing around with rates.

This morning there was a very weak housing figure, see below, but still the overall market is roaring along.

Table 1 30 Jan

While some seasonal weakness is to be expected at this time of the year in Australia (their summer), this housing number is exceedingly weak. We will be closely watching next month’s data to see if a trend is developing and are prepared to change our mind if the facts on the ground demand.

United Kingdom: BOE’s Carney claims that the recovery has some way to run before rates change

  • Carney said yesterday that a few quarters of UK growth aren’t enough to change anything.
  • He reiterated that any eventual move to higher BOE rates would be gradual.

Carney is pushing back expectations of rate hikes and that is weighing on the pound.

Other comments from Carney focus on Scottish independence and how a monetary and banking union would/could work. The Brits are getting hot under the collar about the feasibility of Scotland having a monetary union with England and sterling if they do go independent. They claim there is no precedent for this. But they are wrong. Ireland became independent from the UK in 1922, but we maintained a successful and logical monetary union with sterling until 1979!

Eurozone:  Getting worse more slowly is not the same as getting better!

Table 2 30 Jan

It’s the same old tune all the time in Europe. Bank lending to non-financial corporations (seasonally adjusted) declined by €3.2billion in December. This follows a €13billion fall in November. This is the smallest monthly decline in lending since March. But remember, getting worse  more slowly is not the same as getting better.

In 2013 as a whole, the average monthly decline in lending was €11.4billion, somewhat higher than the average decline of €8.9billion in 2012.

Broad money (M3) growth continues to remain weak. M3 growth fell  in December, as did overall lending growth to the private sector.

Why is this?

In normal times, money and loan growth tend to move together (given that advancing loans should involve the creation of deposits and vice versa). However, since the end of 2011, the series have moved in opposite directions.

This is because the banks are hoarding.It is a classic Keynesian liquidity trap where the private sector has too much debt and it doesn’t want to borrow and the banks have too much bad debt and they don’t want to lend. Add to this capital hoarding ahead of stress tests and you have a massive credit crunch.

Our focus now turns to the EZ inflation data out tomorrow morning. Draghi takes to the stage this day next week. With the Fed showing no signs of pulling back from “tapering”, we expect further divergence between the monetary policies of the US (tightening) and the EZ (loosening). This is the thinking behind our bearish Euro call.

Portfolio: Euro weakness helping out with performance

The Euro moved lower over the last 24 hours which has helped to offset weakness from our fixed income investment.

Portfolio 30 Jan


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