(This is an unedited version of my Sunday Business Post column from last Sunday).
You know you’re living in interesting times when central bankers are objects of fascination. Normally so boring they send valium-dependent accountants to sleep, central banking is where modern monetary policy is being made at speeds that would give previous generations nightmares. The key problem is how interconnected every asset class, every currency, and every banking system is today. Complexity, contagion and the problems of coordination
The economies of the West are either stagnating or in danger of stagnating, and the Eurozone is falling slowly into deflation. The yields (or percentage return) on the sovereign debt of the periphery and core of the eurozone look very, very odd at the moment. Have a look at the chart showing yields for major and minor countries. It really shouldn’t look like this. In many cases the yields are actually negative, meaning if you invest 100 euros into the short term, 2 year, debt of a country like Germany, you’ll get something like 98 euros back. In Switzerland, you have to lend their government money for more than 9 years before you’ll see any positive return on your investment. The only places you’ll earn a positive return on your investment of any kind is the European periphery. That’s nuts. You have sophisticated investors queuing up to lose money. That’s nuttier than the stomach of a nut-loving squirrel with an appetite. And yet this nuttiness is a persistent feature of the economies of Europe.
The dullest people in the eurozone were spurred into action by the deeply dismal economic performance of the major economies of the Eurozone. Amongst other large-scale programmes, the central bankers built a large scale asset purchase programme known as quantitative easing, which is hitting the European economy hard, as predicted in this column a few weeks ago. Government are opportunistically issuing debt in this low-yield environment, including our good selves. Ireland managed to get 10 year sovereign debt out into the market for around 1.2% last week. (An aside: despite the weird pricing of these bonds, the fact that Ireland issued a bucket of sovereign debt and it didn’t make the mainstream news is a good measure of how normality is returning to our little island economy).
Big picture: Everyone for or against QE.
Back to the big picture, thanks to QE, worries about the Chinese economy, and of course the collapse in oil prices, the euro is falling against the dollar and European stock and other equities are hitting 7 year highs. QE is making investors are switching their portfolios around, hard, and these movements are affecting currencies across the globe. For example, the Canadian dollar is one of the worst performing currencies against the US dollar for the last few months, because the Canadian Central Bank have cut their main interest rates alongside the much, much stronger US dollar. The trade weighted depreciation is close to 15% since the start of 2015 for the Canadian dollar, a huge move, making for a very cheap currency relative to other giants. Another really interesting story to keep an eye on is the massive failure of Sweden’s Riksbank to help their economy grow. The ultra-hawkish central bank board has seen deflation become a serious problem in their otherwise highly prosperous economy. Sweden’s central bank has had to cut their key policy rate from -.10% to -.25% and to increase their own QE volumes from SEK 10bn to SEK 30bn, which came as a surprise to investors. Weirdly, despite taking all this action to counter the obvious problem of deflation, on the morning of the announcement, Riksbank governor Stefan Ingves told the press that ‘Deflation is not the big worry’, and by the afternoon was telling the same press corps “We need to ensure that inflation rises”. Expect more wobbles there, so.
Across the globe the Chinese renminbi has been weakening in the face of increasing worries the domestic Chinese economy’s property bubble might just go ‘pop’ in the near future. There isn’t even talk of a ‘soft landing’ yet. The currency has been falling relative to the euro and the dollar since mid 2014. Capital flight is now a real concern, as is the damage a renminbi slide would to to Chinese exports. The People’s Bank of China has recently intervened to prop the currency up, bouncing the Renminbi to its biggest weekly gain on record on Friday last since it they unpegged from the US dollar in 2005. Remembering the movements in the Swiss Franc only a few weeks ago, investors should justifiably be worried they’ll see more and more interventions.
With the largest central banks in the world intervening massively in markets across the world, nothing is normal anymore, and in fact many of the established patterns economies have built up over time and lean on to support their growth may fade away in the face of this realignment.
Exchange rates matter for trade.
Expect to see hordes of US tourists this summer, booking their flights and renting their cars over the next few weeks across Europe, enticed by the low, low exchange rates and the fact that prices are actually falling in the major economies of the Eurozone. The exact opposite movement will happen for the US, as Paddy and Mary pack their bags for Rome instead of New York. European countries will see improving trade balances, while the US, perforce, won’t.
Enter the Federal Reserve and its chair, Janet Yellen. Yellen’s recent testimony to Congress bounced markets around significantly as everyone expects the Fed to raise its main interest rate in the next few months. In the markets, timing really matters, so a June or July raise will really change how the markets see things evolving. Combined with the changes she is seeing in the dollar’s strength, and a relatively resurgent US economy, the big decision Dr Yellen has to make is how the rate increases and asset purchases might affect the economy.
Hubble Bubble Central Banker Tussle.
Where does this leave us? A tussle of the dullest people on the planet, I expect. An extremely polite and opaque contest of twiddly dinks between a resurgent US economy in need of a steady stream of trade to spur on its recovery, a Chinese economy that needs growth of more than 5% a year, every year, to maintain its coherence as a sovereign state, and a European economy that will be happy enough as long as it avoids outright stagnation. The period of ultra low rate nuttiness is here to stay.