It is open hunting season on the euro as ECB hits the panic button on rates

The European Central Bank is running scared and in policy disarray. Euro zone interest rates have been cut deeper into negative territory, the QE programme has been stepped up and the banking system has been flooded with a lot more liquidity. The only unsaid ECB goal is a default target of a weaker euro to help spur faster economic recovery ahead.

The March monetary policy decision reveals the ECB in full retreat. The latest policy manoeuvres are nothing more than a rear-guard action in the face of failing policy, slowing growth and increased deflation risks. The ECB has had to slash its future growth expectations, to levels which still seem far too optimistic given the spectre of a global hard landing.

The main reason why the ECB has hit the panic button is that euro zone inflation is back in negative territory again, with the headline rate dropping back down to -0.2 per cent in the latest month. The ECB has its back to the wall and clearly deeply worried about second round effects on the economy, especially the risk that demand takes another steep nose-dive.

Clearly, the euro zone is still in the grip of aftershocks from the global financial crisis. Years of debt deflation, balance sheet-deleveraging, fiscal austerity and deep-rooted market turmoil are still taking their toll on confidence. Consumers, businesses and governments are still extremely dispirited and need a lot more than gentle persuasion to be coaxed into full recovery.

The big question now is whether the cut in the ECB deposit rate to -0.4 per cent, the 20 billion euro step-up in monthly QE purchases to 80 billion euros and the extra flood of market cash provisions will be enough to turn the tide. Given the prevailing sense of gloom in recent euro zone economic confidence surveys, it suggests a lot more needs to be done.

The ECB could be stuck with near-zero interest rates for another decade. This is no surprise considering the two-decades of recession-buffeted, deflation-bound and ultra-low interest rate afflicted woes that Japan has suffered. The euro zone is in crisis and the ECB is flying blind on policy, with no clear sense of when normal service will be resumed. Anything is possible right now.

The financial wealth destruction to Europe’s consumer, investment, banking and state sectors has been so severe in the last seven years that the yawning demand gap has had to be filled by European tax-payers and the ECB. The process of repair-work could take years to complete leaving the ECB stuck with unconventional monetary responses for decades to come.

Euro zone economic regeneration is not just going to be about Germany regaining a firmer footing over the future, but securing sustainable recovery for all, with inflation coming back to target close to 2 per cent again. It means the scourge of high unemployment in the distressed southern European nations must be quickly addressed.

Expansive deficit spending initiatives are vital to complement the ECB’s monetary stimulus. Without it, the chances of a future euro zone break up run a much higher risk.

By no means is this the last of the ECB’s rate cuts. The loss of momentum in the global economy and the slowdown risks haunting the euro zone suggest there will be more cuts to come. This will continue to put more pressure on the currency over the future, an end-result which the ECB wants and needs to jump-start faster export-led growth.

ECB President Mario Draghi has tried to draw a line in the sand to no more easing, but he still has an unfilled pledge ‘to do what it takes’ to resurrect recovery and meet the ECB’s 2 per cent inflation target over the long term. Right now there is no end in sight to the run-down in euro zone official rates. The risk of recession and the embedded threat of deflation could easily take the deposit rate down towards -1 per cent later this year.

The vultures continue to circle over the euro and the spectre of a return to parity with the US dollar still beckons. With the ECB adding its own seal of approval for a weaker currency to speed recovery through negative interest rates, the euro’s fate is set in stone.

Rising political discord, the deteriorating economic outlook and the ECB pulling out all the monetary stops underlines a treacherous future for Europe’s single currency.

New found euro stability is the quiet before the storm

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Things seem to have gone very quiet around the euro currency in recent months. It appears to have found some much needed stability after years of extreme market mayhem with its very survival on the line at times as the euro zone has lurched from one crisis to another.

This new-found stability is deceptive. The currency is not out of the woods in terms of deep rooted economic and political problems, which threaten to resurface as the euro zone stands at the threshold of another global economic slowdown. It could mark the quiet before the storm.

It is an accident waiting to happen. If the euro zone heads into another downturn, it will only heighten frictions caused by the growing wealth gap between prosperous Germany and the economically distressed nations of southern Europe, especially Greece, Spain and Portugal.

Damage caused by years of chronic austerity, rampant unemployment and crippling debt threatens to pull European Monetary Union apart at the seams. If the euro zone slips back into recession and employment conditions worsen, those tensions will boil over again very quickly.

In the last two years, euro zone economic confidence signals have been surprisingly upbeat, but not anymore. The euro zone’s bellwether economic sentiment index deteriorated sharply in January, pulled down by mounting pessimism being felt in industry, services and among consumers. It spells trouble ahead for euro zone growth.

Worries about the weakening global outlook are forcing European businesses to shelve investment plans and rein in output intentions. Consumers are shying away from spending, fretting about job prospects, the squeeze on wages and damaged wealth expectations thanks to the collapse in equity values since last year.

Even with the European Central Bank’s monetary generators running at full throttle, the boost from negative interest rates and copious amounts of quantitative easing appears to be losing impetus. The ECB already recognises it needs to step up its stimulus efforts in March.

The euro zone was created leaving too many structural anomalies and internal inconsistencies. The economy was supposed to be a level playing field, with the single market and monetary union designed to boost prosperity as equitably as possible across the 19-member area. But this has clearly not happened.

The euro zone has ended up a two-cornered stool, prone to tipping over in times of deep market instability. What it has lacked is a vital policy prop from full fiscal union acting as a market stabiliser and as a spur for fairer resource redistribution throughout the euro zone. Germany has always been bitterly opposed to European Fiscal Union, frightened of ending up having to foot the bill.

The global financial crisis in 2008 laid bare these fatal flaws and exposed striking divergences of economic performance. Through ups and downs, Germany has simply got more prosperous, while the weaker economies like Greece, Spain and Portugal have fallen further behind and into hard times.

EMU’s fixed currency regime has condemned weaker nations to lag Germany’s capital-intensive, productivity-driven economy, forcing them into self-enforced domestic deflation, with lower wages and higher unemployment as one way of staying competitive. Before EMU, weaker economies resorted to currency devaluation to keep up with Germany. Locked into the euro, this option is now ruled out.

Since the financial crisis, Greece and Spain have made some progress on improving competitiveness, but only at a terrible price to their economies. In both countries, around one in 4 workers is without a job, while youth unemployment stands around 50 per cent. It is unsustainable in the long run. Breaking point will soon be reached and countries will eventually vote with their feet.

It is already happening with many European voters turning away from mainstream politics to anti-austerity protest parties like Greece’s Syriza and Podemos in Spain. Once voters make the connection between anti-austerity and anti-EU, euro sceptic sentiment, the single currency will be in trouble.

2016 will be cathartic year for the euro zone’s future, especially as Britain squares up to a momentous referendum to stay in the EU. If Britain quits the EU, it could set a dangerous precedent for EMU countries to make a similar choice about staying in the euro.

Once one country decides to leave the euro, it will be the beginning of the end. Domino effects will take-over as more countries make the choice to live in a freer, multi-currency world.

It would mean game-over for the euro and mark a return for Greece’s drachma, Spain’s peseta and Portugal’s escudo. Others will follow.

 

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.

2016 will be another year of living dangerously for investors

2016 promises to be a tough year for investors. They will have to contend with an array of dangerous cross-currents that will test nerves to the extreme. There will be few places where investors will feel secure as slower global growth, conflicting policy signals and increased market volatility make rewarding investment opportunities even harder to pick.

Financial market confidence will be running the gauntlet. Asset allocation looks extremely overstretched right now and, with fading fundamental appeal, investor confidence in over-cooked equity markets could end up in sharp retreat next year. Anything that upsets expectations about access to cheap and easy money in 2016 will take its toll.

The global economic outlook carries lots of health warnings right now. While there has been a lot of positive carryover on growth expectations for the US, UK and Europe, thanks to QE’s legacy, the outlook still remains clouded in doubt. Risks are mounting that world growth could slip back into the doldrums in 2016.

The dramatic drop in global commodity prices this year and the 15 per cent collapse in world trade flows over the last 12 months are symptomatic of deep cracks in global demand. Certainly, the International Monetary Fund’s projection for world growth to pick up to 3.6 per cent next year from 3.1 per cent in 2015 looks highly questionable. There is a strong probability that world GDP growth will drop back below 3.0 per cent again in 2016.

The global economy is not rushing into a deep stall just yet, but the pace of economic activity definitely looks under threat, a key bearing on whether the six year old global equity rally sinks or swims in 2016. Hopes for faster growth are absolutely crucial for stock markets sustaining good forward momentum next year.

US Federal Reserve policy intentions are critical for market morale staying upbeat. Rising US interest rates are already underway, but this is only the first step back to normality. There is a bigger shock waiting in the wings from the likely changeover from quantitative easing to quantitative tightening at some future stage.

Ominously, Fed Chair Janet Yellen has already warned markets that the US central bank’s balance sheet will shrink ‘considerably’ once the US economy has reached maximum employment. We are not too far of that point right now.

As the US’s QE-driven liquidity boom was the catalyst for the post-2009 global asset rally, the market’s dread of the Fed down-sizing its balance sheet will mark a major turning point. In spite of all the continuing monetary pump-priming from other economies, any hint of a future Fed switch from US QE to QT will be cathartic.

The Fed’s 4-1/2 trillion dollar stockpile of QE assets, already accounts for about 27 per cent of US GDP, far above its historic 6 per cent holdings. When the garage-sale of QE assets starts for real, the market impact will be significant, setting off a chain reaction of rising bond yields and higher borrowing costs.

Despite all the Fed’s bravado about US economic prospects, consumers, businesses and investors are bound to feel the pinch. And there will be wider consequences too, as the world weighs up the Fed’s return to tighter policy as an iconic first retreat from global cheap money.

This is not good news for global investors who are overweight equities and banking on faster global growth and continuing cheap leverage to keep the rally extended. If risks remain tilted to the downside and investor confidence dives, then flight-to-quality flows back into safe haven government debt and a dash-into-cash could slam global stock and credit markets hard in 2016.

One thing is clear, safe haven bolt holes will stay in high demand. In a risk-off environment, investors will seek safety in the US dollar and Swiss francs. The yen is bound to get a lift as Japanese investors seek sanctuary in their home market.  Slower global growth and heightened financial market tensions will be bad news for commodity currencies like the Canadian and Australian dollars and the higher-risk emerging markets.

The return of risk aversion will be very bad news for investors generally. There will be little comfort in traditional safe haven bond markets like German government debt, where a large part of the curve is already steeped in negative yields.

2016 could mark a year for investors to hunker down and wait for better times. Unfortunately it could be a long wait before the good times roll again.

No quick fixes left as global economy battens down for the Fed’s first rate hike

 

Global policymakers might like to think they walked on water with quantitative easing, but, as Japan has shown over recent decades, once deflation gets embedded, economic miracle cures are no easy solution. The latest downturn in energy and commodity markets is another unsettling sign that the major economies and global financial markets are heading for another deflation wave and tougher times ahead.

Two decades on from Japan’s first foray into QE, the nation’s leaders are still battling to wrestle the economy from the grip of chronic recession risks and deflation dangers - and they remain a long way off from normalising policy. It has been a long hard battle and it is not over yet.

There must be many central bankers from leading industrial countries suffering acute night terrors, wondering how to retreat from zero interest rates and the explosion of QE-led bond buying since 2008 that has left them with an unfathomable puzzle. That is, how to reduce the dependency on super easy monetary accommodation without damaging growth?

This week, the US Federal Reserve will attempt to do just that when it finally lifts interest rates after seven long years at zero per cent. The Fed has decided the time is ripe to begin the return journey to neutral interest rates somewhere around the 3 to 4 per cent mark.
 
The second leg of ‘mission impossible’ comes later on when the Fed starts disposing of its huge 4-1/2 trillion dollar stockpile of QE assets. There is no date fixed for that yet, but the Fed probably wants to put it off for as long as possible. It could wreak a terrible toll on the global economy and world financial markets.

The world can do without more turmoil. Since 2008, the global financial crisis has already been through three disastrous phases. The credit crunch in the US and UK, Europe’s sovereign debt crisis and more recent emerging market mayhem have all left global confidence in a precarious state. There may be no easy way back from a ‘fourth wave’.

When the Fed eventually pares back its over-bloated balance sheet, global liquidity will feel the pinch. So too will global asset markets which have been kept afloat by vigorous QE pump-priming for the last seven years. Investors who have indulged in cheap, easy leverage will suffer severe withdrawal pains as rates go up and liquidity is squeezed.

There will be no easy fix. Markets are already bracing for the dawn of tighter money this week, while the global economy is showing worrying signs of fatigue. The US and UK economies are losing vital momentum, the euro zone is mostly struggling, China is slowing down and Japan has just avoided another technical recession. Emerging economies remain at risk.

The continuing collapse in global commodity and oil prices reveal disturbing cracks in the world economic outlook. The drop in crude oil prices to the lowest levels since 2008 is symptomatic of a growing shortfall in global demand as economic activity slows up.

The aftermath of the global financial crisis is still being felt. Balance sheet restructuring, debt-deflation and austerity cutbacks are casting dark shadows over world economic confidence. Consumer, business and investor optimism remains skittish and the spectre of rising US interest rates could be the tipping point for another major market meltdown.

The Fed is clearly being blinded by glowing US employment numbers, with the US jobless rate back to pre-crisis levels. But it is important to remember unemployment is a lagging not leading indicator. There are still weak links in the US economy and the global backdrop remains deeply unsettled.
 
World trade has already shrunk 15 per cent from levels a year ago. Global growth projections continue to be downgraded by leading forecasters like the IMF and OECD. World economic sentiment remains balanced on a knife edge.
 
If the Fed miscues and global confidence goes into knee jerk reverse, there is little to stand in the way. The world’s policymakers have run out of easy options. The global economy is building resistance to new QE initiatives and there is precious little fiscal slack left while governments continue to cut budget deficits and slash debt.

Global equity, credit and bond markets could easily be swept up into the mother of all ‘taper tantrums’ if the risk-off mentality gets a firmer grip. The danger is global policymakers will end up hapless bystanders without a cure.