John Clarke, Chief Investment Officer at GHC Capital Markets, comments on Sir Mervyn King’s last meeting as Governor of the Bank of England and Chairman of the MPC
‘We note with some regret that Sir Mervyn King’s last meeting as Governor of the Bank of England and Chairman of the Monetary Policy Committee should have found him—according to yesterday’s meeting minutes—in a minority of three calling for an extension of the Bank’s asset purchase programme. We say this because we firmly believe he is—and has been in each of the previous three meetings—entirely correct. Although the MPC meeting minutes, including the section headed “Money, credit, demand and output”, makes no mention whatsoever of recent trends in the broad measure of the quantity of money (which is slowing), we know from various speeches and meetings that the governor has, albeit belatedly, become a convert to the monetary way of thinking. By forcing through an asset purchase programme from March 2009 that focussed on buying bonds from the non-bank private sector he fully understood the need to “circumvent the banking system”. Indeed, I attended one such presentation in the North West a couple of years ago when he stated categorically that the problem with the UK economy was that there “wasn’t enough money in the economy”. The annual rate of growth in M4X is currently running at around 5%, but in the last three months it has slipped to less than 2% at annualised rates. This simply isn’t consistent—were it to be sustained—with self-sustaining, above trend economic recovery. The outgoing Governor will have understood this.
Financial markets are now at a cross roads. We have argued vociferously that QE—in the US and the UK, and more recently in Japan—was unambiguously good news for equities. Our view on this remains as solid as ever. However, over the last few weeks financial markets have presumed—with increasing degrees of confidence—that the US Federal Reserve is not only about to “taper” its asset purchases, but it is also considering selling back some of its existing Treasury bond holdings to the secondary market. Indeed, some have gone further arguing that the Fed is only a “stone’s throw” away from hiking interest rates. True, the Fed has never given an explicit target for ending its own version of QE, but it has stated on numerous occasions that it would continue with its asset purchases until the labour market “improved substantially”. It said this when unemployment was 7.8% of the labour force in November last year and yesterday it stood at 7.7%. But more fundamental than this, there really is no need for the Fed to suddenly “slash” its balance sheet by selling its existing holdings of Treasuries back to the market. Instead all it needs to do is hold these assets to maturity, at which point the government repays its debt and the Fed then transfers the proceeds back to the Federal government. It really is a simple as that! If most financial commentators and financial market practitioners didn’t understand QE to begin with, what hope do we have that they will appreciate the nuances of its subsequent unwinding? What’s more, on interest rates the Fed has been even more explicit, emphasising policy rates would remain between 0-0.25% until unemployment fell beneath 6.5% or inflation threatened to rise by at least half-a-percentage point above its definition of price stability (2% on the core PCE deflator).
Investors have therefore—in our opinion—in suddenly taking risk off the table got it wrong. Central bank policy is all about generating growth, whilst the inflation threat—as revealed by the difference between conventional and index linked government bonds in the US and the UK as well as surveys—has been massively overstated. With valuations a fraction of what they were ahead of the 1987 crash, we are sticking with our long held view that we will see substantial gains from equities over the next 12-24 months.’
John Clarke Biography
John Clarke writes macroeconomic research for GHC Capital Markets www.ghcl.co.uk
John Clarke was previously Chief Economist at Norwich Union Management Limited – responsible for developing the House view on global economy and the provision of top down framework for asset allocation. Director of NU's Â£21 billion With Profits Fund.
He is also the founder of his own independent forecasting consulting John Clarke Economics in 1999 providing economic and financial market research and advice to private client portfolio managers
GHC Capital Markets supply investment services through IFAS and other professional intermediaries. They provide risk graded portfolios based on an extensive investor appraisal – backed up by their own macroeconomic research. (thanks to John Clarke)