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Global investment: lingering disappointment

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The improvement in the global economic backdrop since late 2013 has not provided the desired results when it comes to investment. Although the European recovery has shown a few positive signs, an overview of global investment trends continues to paint a disappointing picture:

  • In the U.S., where recent corporate earnings and leading indicators have fallen short of expectations;
  • In Japan, where the 2013 rally remains highly dependent on companies’ export performance, which has become somewhat of a mixed bag;
  • In the emerging world, where many Asian countries are confronted with excess capacities, at a time when most big countries are now paying the price for their structural shortcomings;
  • In Europe, where – unlike the rest of the world – leading indicators are actually encouraging: could the region rise to the challenge? Of course, such a scenario is unrealistic

The extended absence of an improvement in investment prospects is one the most troubling constraint for future economic development. We discuss this topic in further detail in « Investment inertia: what is at stake« .

Chinese slowdown: time to face the fatcs

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Excuses for China’s poor external trade figures in March were in no short supply. Exports were down sharply for the second straight month, falling 6.6% compared with March 2013. February’s 18% cliff dive was chalked up to distortions from the timing of the New Year holiday; similarly, March data was said to be the result of abnormally strong results the year before. For the 11% slide in imports, falling commodity prices are to be blamed. So there is no need to worry, China is going through a rough patch but government stimulus is already righting the ship…

Central bank’s fight against underemployment

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Janet Yellen’s insistence on the enduringly-soft job market in the US during her speech this week in Chicago and Mario Draghi’s unusual insistence on the risks associated with allowing high unemployment to remain at a high rate over a sustained period in the euro area were striking for reasons others than the quick succession of the two statements. What’s to be made of the messages?

Wind of change in Germany, and for Weidmann too…

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While encouraging euro area PMIs in March convinced a number of observers that the ECB had made the right decision (i.e. perpetuate the status quo), the statement from the President of the Bundesbank has lent credence to our scenario of additional stimulus…if not immediately, at least in the not-too-distant future. Such a possibility sends a couple of messages: 1- The euro area is far from being in the clear, 2- German growth is losing steam, 3- The ECB will do more but only because the prospect of the euro area are in fact frail.

China: desperately seeking growth drivers

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How bad has the Chinese economy gotten to warrant such a firm reaction by Chinese authorities in recent weeks? 

Since mid-January, the People’s Bank of China has orchestrated a 3% fall in the yuan. Our suspicions of a shift in currency policy are being confirmed  and if such a move was intended to spark volatility to discourage capital inflows the strategy has certainly been successful. And the movement could well continue because China seems to be in disarray as it faces a major problem: mopping up excess private debt in the economy while maintaining growth. It is a tall task and growing evidence suggests that the 2014 GDP growth target of 7.5% is becoming less and less credible.

What kind of message are bonds markets sending?

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Since the Fed began to taper in January, yields on 10-year government bonds have fallen across the board: 25 basis points in the U.S., nearly 80bp in Spain, 65bp in Italy and 30bp in Germany. Even the poor news from the latest FOMC held on Wednesday only had a marginal effect on 10Y yields in the U.S., which finished trading yesterday at 2.77%, i.e. where they were some ten days ago. 

None of this resembles the generally-accepted scenario about what would happen when the Fed began to change course on quantitative easing. In fact, the consensus was that the taper would trigger a sharp increase in long-term interest rates in the western world. This simply hasn’t played out. Why? And what should be made of it?

The Fed’s big bet

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With thirteen of its sixteen members believing that monetary tightening would be appropriate starting in 2015 and ten of those believing that the level of the Fed Funds will be greater or equal to 1% at the end of next year, the message delivered by the Fed following its meeting on March 18th and 19th breaks with its past communication. Standing in stark contrast with the bond market’s current anticipations, this shift is liable to trigger sharp reactions, which is troubling for a variety of reasons:

– for the capital markets, first, the distinct possibility that interest rates and the equity markets in the US and elsewhere in the world will overreact to this shift in tone;

– for the US economy, second, whose robustness is unclear and ability to deal with more expensive credit even more uncertain;

– and for emerging markets and the countries of southern Europe, lastly, who are exposed to the increasing risk of capital flight. 

The appreciating euro or the competitive deflation trap

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You heard it here first: the euro would not drop versus the dollar and could even increase. And here we are. During trading yesterday, the euro flirted with USD 1.40, its highest level since October 2011 after gaining in excess of 7% since the start of the year. This is a worrying development, which could erase nearly all of the support that improving global conditions have provided to exports.

Two reasons explain why our forecasts, unlike the market consensus, never strayed from the EUR 1.40/euro exchange rate in the past two years:

• the first is rooted in our skepticism with regard to 1) the consensus that the US economy is presumably in good health and 2) anticipations that the Fed would normalize its monetary policy in response to the expected improvement.

• the second is grounded in the side effects of the competitive deflation policies carried out by the EMU countries. The shrinking inflation gap between the euro area and the rest of the world, resulting from these policies, protects the currency’s purchasing power. Consequently, these policies offer de facto support to the euro, particularly versus the greenback whose value is automatically diluted by the massive scale of pump priming in recent years.

Therefore, it is hardly surprising that the recent disappointments on American growth have pushed the euro higher, especially since the ECB dashed all hopes of additional monetary easing last week.