After a week with the family in a cottage in Sweden Alpha Sources is ready to get back into the grind. Returning from holiday as a macro analyst is always daunting given the barrage of news and data that you will have inevitably “missed”. From reading the news and last week’s sell and buy side research this morning Alpha.Sources sees a bit more positive note. Apparently, the significance of recent months’ very aggressive monetary policy easing around the world seem to be having their slow, but predictable effect. A few more sell side notes than Alpha Sources had expected are now looking towards the second half with a bit more optimism.
There is still the strange feeling among many investors however that 2012 will be a repeat of 2011 and that sideways movement into the summer will eventually be released in another sharp draw down in global risk asset prices. As always, the extent to which this remains the consensus among investors even as monetary policy continues to ease in both conventional and unconventional fashion, Alpha Sources is getting more confident that bears may just get caught out.
It is important though to be extremely sensitive to the data at this juncture with key economies such as China and the US at obvious inflection points.
In the US and despite the visible deterioration of the data in the past month, the call for a recession is still at risk. An ISM at 49 is normally not associated with a recession and further deterioration into the mid 40s in July would be needed to give a recession signal. Still, global bond markets continue to predict a very dire future with more and more investment grade yields going into negative territory and anything generally assumed safer than handing over your money to a teenager in a department store, seeing bid. Still, I am skeptical that such signals from an essentially manipulated and stretched market are all they are made out to be and prefer to stay close to the real economic data for now. This week sees a big chunk of data releases as well as the Fed chairman is scheduled to speak, so watch out for direction.
China Rising or Falling?
In the case of China, Prime Minister Wen recently warned that positive momentum is not yet visible in the economy. This suggests more stimulus is on its way beyond the two rate cuts already implemented.
But, is this bullish because monetary stimulus in China will lead the economy up and indeed lead a general continuation of the global EM easing cycle? Or is it bearish because it suggests that conditions in China are worse than expected?
Alpha Sources would lean towards the former, but unless the data starts to turn this remains a hope and perhaps even a fool’s one as it depends on the authorities’ ability to micro manage the economy. As ever, the discourse on China is stretched by unrealistic expectations. On the one hand there are those who believe that China is able to reach pre-crisis growth rates of 10-12%. It isn’t and there is no doubt that many global commodity producers have too much capacity relative to the growth level that China is able to attain. On the other hand, the chorus of those calling for a hard landing and essentially a collapse of the Chinese economy has, at times, been deafening. Alpha Sources finds it difficult to see exactly why this is supposed to happen now. China may be headed for a big crash, but such things rarely occur on the back of and in the midst of extreme euphoria and not excessive pessimism.
Alpha Sources’ base case scenario is that more stimulus from China will be able to drive positive sentiment forward, but also that between those calling for status quo and a crash, China is likely to achieve neither and in stead simply achieve a new trend growth level much lower than before.
Upside surprises in Europe?
Despite the perceived victory of the periphery in the recent EU summit Merkel remains resilient in her demand that if Spain and Italy eventually will need bailout, the price has to be considerable handover of sovereignty to EU and Germany on the fiscal side. This is a reasonable claim even if the message to the outside is that Spain will avoid direct involvement in sovereign affairs due to the technical nature of the bailout money being distributed to its banks.
Still however, the recent sharp reversal in the rhetoric by the Spanish Prime Minister Rajoy and the promise of yet another round of cuts come in nicely on the back of the market finally starting to see signs that perhaps even senior creditors of Spanish banks be forced to take losses. Alpha Sources welcome such realism by part of the periphery, but is still left with the bitter taste in the mouth from watching drastically different measures being applied to the little ones (Greece and Ireland).
In this sense, the ever eloquent Chris Wood is spot on in his recent juxtaposition between the situation in Spain and Ireland.
GREED & fear has been calling for losses to be imposed on subordinated bank bondholders for some time as the best way of imposing a loss, and allowing the capitalist system to start working again. It is, therefore, encouraging that this approach may actually be adopted as already discussed in the case of Spain as one of the Eurozone’s preconditions for recapitalisation, which by the way means a significant diminution in Spanish sovereignty. Still, given that so much of this subordinated debt has been sold to retail investors as savings products, such a policy is going to create a firestorm in Spain politically. It must, therefore, be wondered if the loss ends up being imposed anyway on the sovereign balance sheet of Spain as buyers of these products demand to be made good. The Spanish owners of junior bank debt may also wonder why he or she is being treated so differently from Ireland where the ECB seemingly forced the Irish Government not to impose losses on subordinated bondholders thereby putting the Irish taxpayer on the hook. GREED & fear would not like to be viewed as a cynic. But the difference could be that the Irish subordinated debt was owned by big institutional investors whereas in the case of Spain it appears to be the little guy.
Another case in point that I feel the need to elaborate on is Greece. Only two months ago did the consensus hold that Greece would leave the Eurozone or perhaps even that the country would be forced out. Alpha Sources always thought that this was mad and we know now that it was. The difference between the first PSI and the warmongerings from Merkel and the EU were clear.
In the case of the former, the risk was chiefly that Greece would not accept the terms under the restructuring (laid out by the IMF and the EU) and simply apply a unilateral haircut. In the case of the latter however, Greece was seen being in the corner pleading that the country would not want to leave but simultaneously also getting starved of essential liquidity to keep the country running.
Investors should remember that differential treatment between large and small economies in what has become a near perpetual bailout effort by part of the EU, the IMF and the ECB is a mistake that may eventually become the problem itself.
Finally, it is important to dwell a bit on the recent ECB meeting where not only the main refi rate was reduced but also, and much more significantly, where the deposit rate was cut to 0%. This marks the first major central bank trying to take a stab at the problem of a slump in velocity and essentially a broken monetary policy transmission mechanism. As such, bulging reserves without a corresponding pick up in lending to the real economy remains one of the main problems in the developed world (from the point of view of monetary policy makers that is). Sweden enforced negative interest rates on reserve balances in 2008, and now the ECB is essentially following in the Riksbank’s food steps.
In this way and just as Alpha Sources has spent the last couple of days catching up with the news, so it seems that European policy makers with Spain now apparently open to imposing losses throughout banks’ capital structure and the ECB delivering the boldest monetary policy step since the Fed opened up the QE bag in 2008, Europe may finally be catching up.