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2014-10-16 08:47:25
Oct 15th 2014, 15:13 by Buttonwood
MAY you live in interesting times. The old curse seems apposite today, as
markets get lively again. As I write (and things can change rapidly) the Euro
stoxx is down 2.6%, the S&P 500 has opened 1% down (and is in negative
territory for the year), ten-year Treasury bond yields are down to 2.03% (they
were more than 3% at the start of the year), Greek bond yields are getting
close to 8% (and its stockmarket is almost down 20% on the year), oil is down
in the early 80s a barrel, volatility has spiked, high yield spreads have
risen...the list seems endless.
Such jitters are a regular feature in Octobers past and have been coming for
some time. As I wrote last month, there was a mismatch between what equity
markets were implying, and the message from bond and commodity markets. It
seems to have been resolved in favour of the latter.
The big fear is deflation. We will get figures from the euro zone tomorrow for
September but even the UK, which missed its target on the upside for more than
three years, is down to an annual rate of 1.2%. US producer prices fell last
month, and are up just 1.6% year-on-year. More pertinently, perhaps, ten-year
inflation expectations (as measured by the bond market) have fallen to less
than 2%. In a sense, the falls in the euro and the yen could be seen as a way
for those regions to export deflation to the US.
Meanwhile, global economic growth forecasts have been revised down. In the
summer, people thought the strong US economy would drag the rest of the world
up; now they fear the rest of the world might drag the US down. Today's news of
a decline in retail sales and in the Empire Fed index will add to those
worries.
Julien Garran of UBS published a note in August on the "four horsemen" of the
apocalypse that might herald disaster - weakness of deficit-plagued emerging
market currencies (such as South Africa and Turkey), falling Chinese steel
prices, a drop in tech stocks like Tesla and Neflix, and widening spreads on
high-yield debt. Three of those horsemen have arrived.
But never fear. Maybe the central banks will ride to the rescue as they have so
often in the past (1987, 1998, 2002, 2009)? In a way, you could see the market
sell-off as a toddler tantrum; they want more from their Mummies and they want
it NOW.
Market expectations of Fed rate increases have been subjected to a sharp
adjustment; rates are expected to be 1.75% in late 2017, below the lowest "dot"
in the projections revealed by the Fed only last month.
Not raising rates would be a help. But it is not as good as cutting rates, or
restarting QE. And the markets would also love it if the ECB adopted QE, but
the bank may be waiting for the news to be bad enough to overcome German
objections. So that leaves the markets in a hiatus.
As Mr Garran writes
Should investors' faith in the Fed's ability to deliver us from deflation be
tested, and should they instead start to suspect that the Fed is instead
delivering us into deflation, this would risk a break in markets
Regular readers will know I am not QE's greatest fan, and it certainly
shouldn't be used to bail out the markets (which only adds to inequality). But
there is no argument for raising rates with inflation so low and falling;
central banks should make clear it's not going to happen. And there is a very
good argument for fiscal stimulus in those countries (like Germany) that can
afford it.