Weekly Comment on the Markets, Politics and Economics by Alastair Winter, Chief Economist at Daniel Stewart
Cyprus may have been hogging the headlines but it has to be said that plenty of investors in do not seem to care and, of those that do, many remain convinced that it will all be sorted and are anxious not be caught short as in previous crises.
Then there are those (like me) who worry about the longer-term consequences of these successive ‘fixes’ and are wary of being caught long. The chances are that markets will become unsettled again as one by one the ‘peripheral’ EMU members could easily run back into trouble in the next few months but an immediate panic seems to have been averted. European bank equities, peripheral sovereign bonds and the euro itself will remain the most vulnerable but there is also a risk of a wider correction in equities in the next few months after the strong rally since last summer has run so far ahead of fundamental factors.
Equities may well bounce higher in relief today but quarter-end is almost upon us and the most obvious targets remain the Nikkei, ASX, FTSE 100 and US equities together with a fight-back by the yen and the pound.
The game of chicken between Cyprus, the rest of the EMU and Russia, which reflects ill on each of them, was resolved overnight under the threat of a total collapse of Cyprus’s banking system and its exit from the EMU. Needless to say, there are no winners but the Cyprus government had no alternative to accepting humiliating terms since most EMU leaders had decided that Cyprus’s banks need to be cut down to size and ‘cleaned up’. It is just about possible to argue that the original proposal to hit all depositors in Cyprus’s banks was a one-off and need not have derailed moves towards banking union or that a Cyprus exit would not have been fatal for the sacred cause of ‘More Europe’. The new proposals wipe out bank bondholders and could hit large (mainly Russian) deposits by 40% or more. The golden age of Cyprus’s banking industry has ended and the manner of its ending may eventually come to be seen as the second significant step in the break-up of the EMU.
The first step, of course, was the rejection of orthodox EMU austerity by a majority of Italian voters in the February election. They had duly noted that the peoples of Europe, even if they no longer want to kill each other, are unwilling to help each other out in times of distress. Mr Bersani will this week try to form a government but the chances are that he will fail and new elections will be required in which anti-EMU sentiment is likely to pick up further momentum.
In the UK, it would be nice to think that the hitherto somewhat juvenile debate over the budget could develop into a more fundamental discussion of the economy, the welfare state and public investment. Peter Mandelson (of all people) has tried to move beyond the heckling and finger-pointing and this is surely what Mr Cameron should be doing if he really wants to win the next election. Mr Miliband’s jibe that the Chancellor is ‘the wrong man, in the wrong job at the worst possible time’ may come back to haunt him if he wins in 2015.
More dreadful data from France (Consumer Confidence), Italy (Unemployment, Retail sales) and Spain (Retail Sales) should show that the recession is biting deeper and longer and while Unemployment in Germany may be reported as stable, both retail Sales and Consumer Confidence are likely to reflect the gloom from elsewhere. To borrow a phrase: ‘European Monetary Union is not working’.
In the UK, either the third cut of Q4 GDP or 2012 as a whole could be modestly revised upwards and one of the most interesting numbers will be Business Investment, which was previously reported as surprisingly soft. Also of great interest will be January’s Index of Services, which may have been depressed by the bad weather. Given all the recent bad Press coverage, Consumer Confidence is most unlikely to show any improvement.
Q4 GDP in the US may be revised upwards again and Personal Incomes and Spending should recover from the trough in January that was probably caused by the tax hikes. The Chicago PMI, Consumer Confidence and House Prices should fuel hopes for the rest of 2013.
Equities generally had a poor week with even the mighty Nikkei dipping from profit-taking on Friday. With wonderful perverseness, the best performers were Shanghai (on reduced fears of fiscal tightening) and Milan (hopes that Mr Bersani can form a government). European equities were led lower by the banking sector and emerging markets by lingering worries about the ending of QE in the US.
Bond yields were lower more or less across the board, which probably reflects poor growth prospects in Europe rather than insouciance over Cyprus. Gold bugs did try to push prices higher on the possibility of a wider crisis in Europe but this seemed only to give others a chance to unload some of their holdings.
The yen and pound both benefitted from what looked like profit-taking while the euro wobbled against all the other majors, which in turn helped the dollar, wearing its haven hat, to hold up against the less important currencies.
Someday, somebody will have to explain why Cyprus was allowed to join the EMU if its banking system is so ‘bent’ and its economy so reliant upon dubious financial services. This time Mrs Merkel and Mr SchÃ¤uble appear to have ‘lost it’, especially when the Cyprus government tried to blackmail the rest of EMU by appealing for help from Russia. It is a game of chicken in which the chickens are definitely coming home to roost.
In the UK, it turned out to be a highly political budget with little new on the economic front, especially in the short-term, and it was fiscally neutral. It makes Mr Osborne’s critics on the right (slash taxes) and on the left (ramp up spending) sounder rather imprudent. The gilt market gets something that can just about still be called Plan A and the prospect of more flexible (but not lax) monetary policy but that is probably not enough for Fitch, who are looking to remove their AAA rating. When looked at in combination with the flurry of recent government initiatives, the Budget seems to embody the government’s increasing interest in using ‘nudges’ to effect change: in this case, boosting consumption, business investment and the housing market. This could yet be surprisingly effective, especially if the economy turns out not to be as limp as the initial headline GDP numbers have indicated. The Chancellor will have enjoyed the release of continuing solid Employment data, a bounce-back in Retail Sales and an apparently genuine reduction in public borrowing in February (yes, really).
The MPC vote against more QE was again carried 6-3 but the discussion must have been overshadowed by the prospect of a change in the MPC’s remit that Mr Osborne revealed in his Budget speech. The latest minutes suggest that the majority remain unconvinced that a further Â£25bn purchases of gilts would do much good. Perhaps Sir Merv wants to pursue his own ‘nudges’, although no longer, it would appear, one to push sterling lower (because of the impact on inflation).
After the FOMC meeting, Mr Bernanke went out of his way to emphasise that there were no changes imminent. The latest forecasts from members of the Committee show more caution on GDP growth in 2013, more optimism on Employment and no increases in interest rates until 2015.
European data generally came out as soft as expected and even the German survey data has started to sag. The flash PMI surveys from the US and China offered some offsetting cheer or perhaps merely relief.