A global crisis of confidence

The current bout of extreme hesitancy may prove to hurt more than it helps. Photo: iStock By Neil Staines As we move towards the end of the year, the next weeks will likely prove a very significant period for financial markets as global economic growth, monetary response, and investor confidence are brought more acutely into focus. “ The circulation of confidence is better than the circulation of money” — James Madison While a number of Federal Reserve speakers have maintained

their expectations that an interest rate “liftoff” is likely in in 2015, the market has lost confidence.

Modestly weaker retail sales data earlier in the week do not suggest the kind of strength in the consumer data that Dennis Lockhart (a current voting member clearly at the hawkish end of the Fed spectrum) stated would be “most telling for the October, December FOMC meetings”. A 25 basis point hike from the Fed is now not priced in fully by the market until June 2016. The reaction of the equity markets and risk assets in general is perhaps the most worrying development. The extension of the “bad news is good news” regime for global stocks indicates a market that is addicted to super easy monetary policy and its implications for discounted future earnings and thus valuations.

From where I sit, the recent disappointing global growth momentum is worrying, and global central bank reticence to remove “emergency measures” is perhaps even more so. Yesterday’s US inflation data showed core prices (which should be indicative of where headline CPI should go once the impact of oil price declines drops out of the comparison) edging up to 1.9% year-over-year – very close to target. In September, the most recent US GDP print (Q2) was a lofty 3.9%. Current nowcasts for Q3 are running at around 1.0%. It is very possible that the Fed has missed its opportunity. Ironically, in doing so it is likely that the Fed’s rationale of prudence and maintaining financial stability is viewed historically as reckless and instrumental in creating financial instability. Either way, it is likely that broad market volatility will remain elevated in the months ahead. “ If you do not change direction you may end up where you are heading ” — Lao Tzu In the UK, the situation is arguably the most rosy. Picking up the paper this morning you would be forgiven for (briefly) believing that the world was in fact fine, with stories of soaring mortgage lending, rising rents, record London tourism (and rising trip spending).

A global crisis of confidence

This week’s unemployment report would back up that view with a large jump in employment, a drop in the unemployment rate to 5.4% (5.3% for the month of August alone) and wages rising at 3.0% per year. Against this backdrop, however, the market’s expectation of the first rate rise in the UK has been pushed back to Q2’17. From our perspective, this simply does not match the economic progress made since it was deemed necessary to evoke the current “emergency” monetary stance. In Europe, the situation is very different. The first round of quantitative easing in Europe has arguably had a significant impact on lending conditions and confidence across the region and, from a very low base, Europe has made some progress over the past year. From here, however, the situation is likely to become more difficult for Europe.

A global crisis of confidence

Until now, the recovery has been driven by strength in Germany and the bounce in activity from the hardest-hit regions such as Spain and Ireland. The outlook for Germany in particular has become significantly foggier over recent months as industrial production, factory orders and exports have slumped amid declining global aggregate demand. The recall of over 8 million cars for Volkswagen and the implications for confidence going forward will only likely add to the near-term woes. As market concern drives US and UK interest rate expectations ever further away, it is likely that the expectation of the European Central Bank adjusting the “size, composition and duration” of its current QE programme grows. We would not rule out a clear intent of QE extension or intensification from the ECB as early as this year amid downside growth and inflation pressures and weakening global export demand. Ultimately, as global investor confidence falters and central bankers’ conviction wanes, we would expect that the equity and risk asset rally fades and reverses.

In FX, the fortunes of the USD have been more balanced of late. As current themes continue to play out we would expect outperformance of USD, GBP, and JPY against EUR and AUD to become more apparent. As the week draws to a close, this afternoon brings industrial production and sentiment data from the US. However, the release of a raft of Chinese data before the European market open on Monday is likely to set the tone for sentiment and risk assets for the week. As it so often does, China will set the tone next week. Photo: iStock — Edited by Michael McKenna Neil Staines is head of trading at The ECU Group Disclaimer The Saxo Bank Group entities each provide execution-only service and access to Tradingfloor. com permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Tradingfloor. com and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Tradingfloor. com is gained.

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A global crisis of confidence