Major economies will be saddled with ultra low rates for years

Global markets are digging themselves into a deep hole. Sheer panic seems to be setting in over the spectre of world economic slowdown, chronic deflation worries and financial markets caught in a tailspin. 2016 is shaping up as another painful phase of the seven year old global financial crisis.

The trouble is that global policymakers seem to be running out of fresh ideas to deal with this new leg of contagion. The major central banks have already deployed most of their monetary armoury in dealing with successive waves of the crisis since 2008.

Global central banks are close to running on empty. Interest rates have been slashed to rock bottom levels and a ton of quantitative easing money has already been thrown into the monetary reflation pile.

There is one very obvious clue to what happens next. Interest rates either need to go a lot lower or else the QE generators need to get cranked up again. The implication for markets is that the major economies will be saddled with ultra low rates for years.

It is causing mayhem for monetary policymaking and forcing rushed decisions. The European Central Bank is already setting the stage for another likely deposit rate cut in March, which will push euro zone rates even deeper into negative territory.

The Bank of England is also having second thoughts about monetary policy tightening and looks set to postpone a well-flagged plan to hike UK interest rates until at least 2017. The Bank believes the UK economic outlook is too fragile to sustain higher rates at this stage.

Deepening financial market turmoil will also stop the US Federal Reserve dead in its tracks on rate tightening. Despite the strength of the domestic economy and extremely positive employment trends in recent years, the US central bank is fretting again about the weakness of the global economy.

Worries about China and the fragility of emerging economies, especially Brazil and Russia, could put future US rate hikes on ice for a long while. And if conditions start to deteriorate much further, threatening to derail growth altogether, the Fed could be pushed into a dramatic policy U-turn. Last December’s rate rise would need to be reversed and the Fed might even need to consider kick-starting QE again to extend its bond-buying programme.

If the global slowdown starts to get out of hand and deeper deflation persists then interest rates around the world will continue to converge towards zero and remain that way for a long while. The Fed slashed rates near to zero at the end of 2008 and held them there for seven years. The same fate could befall other economies over coming years.

The experience of Japan in the last three decades is bound to resonate. From the mid-1990s onwards, Japan has struggled with episodes of recession, weak recovery and chronic deflation. Even after repeated rounds of government and Bank of Japan policy interventions the economy is still struggling. The legacy has been interest rates stuck at ultra-low levels for 20 years.

A global crash is not inevitable. Markets seem to be turning a drama into a crisis, but it is no hard landing yet. Growth in China may be at its weakest for 25 years, but it is still robust at 6.9 per cent. Underlying economic growth running around 2 per cent in the US and UK looks reasonable too. Even the euro zone’s underlying 1.5 per cent growth rate is far from being a disaster. Growth simply needs to be re-energised.

Global policymakers can call a halt to the slide, but they need to make a united stand, to think and act together. The ECB’s hint last week that it might add more monetary stimulus in March is a positive step, but more needs to be done by other central banks too.

The leading nations need a much more coherent and co-ordinated strategy to deal with damaging global headwinds. By working together through supranational bodies like the Group of Seven, G20 and International Monetary Fund, the leading nations can make a difference.

Better co-ordination of monetary and fiscal reflation on a broad front could turn the tide. And the major nations should avoid competitive currency devaluations which are little more than short term ‘beggar-thy-neighbour’ palliatives.

The world economy can avoid becoming a victim again. Global policymakers simply need to pull together and promote the right remedies to beat the blues. Urgency is the watchword now.

Early wake-up call for troubled global markets in 2016

Judging by the trading performance so far in 2016, it has not been the best of starts for global markets and the worry is that it sets the tone for another troubled year. Stock market mayhem and rising investor unease is not good news when the pace of global growth is starting to stumble.
 

It is hard to credit after seven years of stock market rally that the bubble is about to burst, especially considering the world economy is so flush with liquidity after years of monetary pump-priming by the major central banks.

Ever since the global financial crisis first exploded onto the scene in 2008, world policymakers have waged a fierce policy offensive with quantitative easing, ultra low interest rates and a plethora of super-stimulus to get the world economy back on its feet. Despite all this monetary balm, markets seem to have reached a crossroads.

The special measures have either run out of steam and fresh policy efforts are needed, or else global stock markets have reached their natural peak and are set for a corrective downward spell. It is a combination of both, plus the fact that the global economy is still experiencing painful aftershocks from the global financial crisis.

Reverberations of deep recession, deflation, high unemployment, austerity cutbacks and severe balance sheet restructuring are still resonating. Years of easy money from the global monetary authorities might have averted deeper disaster in the immediate aftermath of the 2008-9 financial crisis but the world economy is still far from fixed.

Stock market uncertainty is telling the world’s economic leaders some important truths. Stock prices are forward leading indicators of investors’ future expectations. If share markets are distressed it means confidence in the future has been undermined. Investors selling assets is the only way to limit anticipated risks ahead.

Central bankers have railed in recent years over ‘irrational exuberance’, excessive investor risk-taking and the dangers of stock market bubbles but the tables have now turned. Global policymakers must acknowledge the market’s rising ‘rational despair’ and do something much more meaningful to correct it.

There have been telltale signs of deepening troubles in the world economy for quite a while. Swathes of economic reports and downbeat confidence surveys have pointed to global growth losing significant forward momentum. Slower growth in China, tensions in the Middle East and the collapse in global commodity prices are all weighing on global optimism right now.

Purchasing managers reports have highlighted the weakening trend of global economic activity for well over a year. Compared with 12 months ago, many major economies have edged below the critical 50 boom-or-bust threshold, suggesting economic growth is heading into a contractionary phase.

Critically, the US manufacturing PMI has seen a sharp reversal in fortunes over the last year, with surveys suggesting the pace of US economic demand is slowing down quite rapidly. This is in sharp contrast with the picture portrayed by the fast pace of US employment expansion in last week’s 292,000 non-farm payrolls surge for December.

Right now, the US Federal Reserve seems solely focused on stronger employment trends and ignoring the unsettling PMI message. The data not only alludes to weaker economic activity ahead, but also pin-points a continuing deflation threat with price expectations running at their lowest level for nearly 7 years.

The worrying aspect is the Fed remains so dead set on pushing rates higher. The Fed’s whispering campaign suggests a number of key officials would even prefer to see 4 to 5 more rate rises this year. If the Fed is so determined to press ahead with tightening, the bigger risk is at what stage the central bank starts the ‘great unwind’ of its 4-1/2 trillion dollar hoard of QE purchases. That would spark a major blow-out in US bond yields.

It is the sting in the tail for investors. With the world’s largest economy so committed to policy tightening, it means borrowing rates for the indebted nations around the world are going up. This is bad news for global economic confidence and growth.

There are few places left for investors to run and hide. Traditional safe haven bond markets, like German government bonds, are heavily over-subscribed and carrying negative yields across much of the yield curve. The investment challenge this year will be finding secure boltholes, with negligible risk and positive expected return.

2016 has the makings of a really tough year for investors. But it will be even more demanding for global policymakers seeking solutions.

 

 

Britain heading into a sterling crisis if it crashes out of the EU

2016 is a year of reckoning for Britain as the nation heads into a crucial referendum on whether the country leaves the European Union. It is a critical vote that could seal the UK’s political and economic fate for decades to come.

British exit from Europe – known euphemistically as Brexit – would have dire consequences for the country. If the UK crashes out, vital economic links with Europe, Britain’s biggest trading partner will suffer major disruption. Droves of major companies could desert the UK for good.

In the worst case scenario, it could lead to a messy break-up of the British union. All the hard work rebuilding Britain’s recovery after the 2009 global financial crisis could be destroyed at a stroke. The UK could end up on the road to economic ruin with full-blown depression following in Brexit’s wake.

It could have dreadful consequences for UK financial markets. Some international credit rating agencies have already hinted at the risk of a significant downgrade for Britain if it leaves the EU. It would lead to a crash in UK stocks and government bonds, sparking another serious run on the pound.

The die has been cast for trouble ahead, ever since Prime Minister David Cameron made an election pledge to hold a vote on EU membership by the end of 2017 to assuage euro sceptics in his Conservative party. But the risks are rising that the poll will be held as early as 2016.

It will be a very close shave judging by recent survey results. Voter opposition to the EU has never been so high, with public opinion split down the middle on staying in or leaving. There is a growing perception that there would little systemic risk to the economy should Britain leave.

Without a doubt, the structural risks of Brexit are extremely high. The threat to national output and jobs are severe. But it also works two ways. Britain is such a large part of the EU economy, there would be negative fall-out for Europe as well.

Putting hard numbers on the potential loss to British output and jobs is an extremely contentious issue. It is often argued that as many as 3 to 4 million British jobs would be at risk if the UK leaves. In the worst case scenario, if the UK failed to negotiate a viable free trade deal with Brussels, Brexit’s impact on the economy would be calamitous.

Around 50 per cent of UK trade is with the EU, so any barrier to the free flow of British goods into the single market would hit British industry hard. There is a bigger risk that multinational companies, with European headquarters based in Britain, would be under a strong imperative to up roots and move into Europe to guarantee continuing access to the free market area.

Many foreign companies, especially Asian car manufacturers lured into Britain over the past to enjoy special regulatory and tax advantages, could jump ship to relocate operations into the EU’s cheaper manufacturing locations, especially in Eastern Europe. It would take years to replenish the loss of inward investment capital.

It would be a potential death knell for British industry, which has been struggling against a one-way tide of de-industrialisation over many decades. Ten per cent of UK national output could easily be wiped out in subsequent years following Brexit.

Britain’s pole position as Europe’s foremost financial hub would be under serious threat too. The EU would hardly stand idly by and let London’s financial markets operate in free and easy isolation. EU tax and regulatory requirements could provoke a huge exodus of major banks and financial institutions from the UK, with the loss of hundreds of thousands more British jobs.

There is also the risk that Scotland would use Brexit to call for another vote on independence from the UK to protect its own EU status. If Scotland breaks from Britain, it easily could slice a further 10 per cent off UK GDP.

The UK economy will be in extreme risk in the next few years, which will not be lost on the markets. The UK pound will be very vulnerable and could put sterling back into the grip of a major confidence crisis. A test of parity against the strengthening US dollar should not be ruled out in the future.

Brexit could be the final political act that takes the great out of Britain and casts the nation into the economic wilderness for years.