Two quick pointers to recommended reading, and a heads-up......

Friday 2nd December 2016

Two quick pointers to recommended reading, and a heads-up ......

Pointer No. 1, ref:- "Echoes of 2008 as danger signs are ignored", by Gillian Tett, Comment, The Financial Times

It's a widely-recognized and often painful truth that markets and investors have dangerously short memories. On reading this article, you may be tempted to place them on a par with goldfish for their powers of recollection. Last week saw the annual gathering of the world's central bankers and other heavy hitters in Jackson Hole, Wyoming and Ms Tett at least was reminded that at the same event 10 years ago, the representatives from the Bank for International Settlements (BIS)  tried to alert those that matter to disturbing new developments in the conduct of global finance. 

In particular, the BIS were concerned with the massive proliferation of the use of murky derivatives such as credit default swaps. These beasts were in widespread use but few truly understood them and even fewer could predict their effects should things turn nasty. The central bankers paid little heed to the minutiae of global finance and focused instead on the major macroeconomic issues of the "real" economy. You know the sort of thing ..... growth, inflation, employment (sound familiar?). We now know that the highly-leveraged mortgage and corporate borrowing binge facilitated by those derivatives was shortly to implode and ultimately plunge the wider economy into recession.

Don't tell me anybody's forgotten about that, surely!? Well, perhaps not and to be fair the steps taken by the various regulatory bodies do make a repeat meltdown of that precise nature less likely. But once again the focus last week was on the same issues with the "real" economy that were to the fore 10 years ago, and whether central banks needed new tools to deal with them (what, yet more monetary easing?). What was NOT discussed was the distortions created in the financial system by the unprecedented measures already taken by central bank policies. To list just a few :

* Record high levels in US equities

* $13 trillion worth of global government debt carrying negative yields

* Mortgages in Denmark for example with negative yields

* Bank of Japan's QE asset buying programme means it owns 15% of major companies, with more purchasing to come

* A "Black Hole" for pension funds and insurers created by excessively low rates

In a few years time, will people be wondering just how we could miss all the obvious signals that the world, and its markets, had gone mad ? One can argue that to some degree low rates are a reflection of long-term structural issues (ageing demographics , falling productivity), or that regulatory reforms have made the system stronger than it was 10 years ago. But that does not mean that the current state of affairs should be accepted as either normal or healthy. We could be sleep-walking yet again into a world of trouble, and once more it's only the BIS waving any red flags.

Pointer No.2, ref:- "ECB set to run out of bonds to buy under programme", Fast FT, Markets and Investing, The Financial Times

Can it really be true that the European Central Bank's QE programme may run out of bonds to buy ? According to Credit Agricole, the ECB will own half of all eligible bonds by year-end, and two-thirds of them by Sept 2017. This plainly presents a threat to the sustainability of the programme, all the more so should officials chose to extend or expand it.

The nub of the problem is Germany .... or rather the fact that since the ECB cannot purchase assets yielding less than its -0.4% discount rate, and German Bunds up to a maturity of 7 years do exactly that, about 40% of the Bund market is off limits. That's important because as things stand the proportion of the ECB's purchases of each member state's bonds must reflect that state's standing in the Eurozone economy (the capital key). In other words, the ECB buys more German Bunds than anything else because Germany has the largest economy.

The article discusses a number of ways that the ECB might wish to modify the current arrangement in order to satisfy its demand for the right sort of debt, but all of them come with problems attached. Perhaps the most interesting is the prospect of the ECB buying proportionately more of the more indebted southern nations debt and less of their more affluent, northern partners. ECB boss Mario Draghi has hinted that he is flexible in this regard, but it could turn out to be a political minefield. Bundesbank president Jens Weidmann has suggested that such a move effectively means that countries such as Germany would be funding the less well-off nations, and that the mixing of fiscal policy with monetary policy that it would entail undermines the ECB's independence. The plan has its supporters though, so we can expect a bumpy ride.

And the heads-up? Employment numbers, of course ......

They're always important, crucial even ..... yeah, they always say that so how come they haven't actually induced the Fed to do anything since last December despite some (mostly) impressive releases? Nevertheless, with the top brass at the Fed coming over a bit hawkish of late, gurus such as Bill Gross (Janus / ex - Pimco) calling for two hikes before the end of March and a rise on Sept 21st , if not exactly likely then back on the cards, this was undoubtedly an important release. US Aug non-farm payrolls were due +180,00 ..... in the event they came in at +151,000. Not disastrous and still showing reasonable growth, but in the circumstances mildly disappointing and they make the likelihood of a hike a little less likely. More of the same in store then ..... ho hum. We understand the counter-arguments but can't help wondering whether the US (and the world) might be better served by the Fed just getting it done. This repeated speculation is to say the least unhelpful, and pretty wearing to boot ......