“Some will win, some will lose...some were born to sing the blues"
- Journey, Don't Stop Believin'
This week has been an interesting one. It began with a near concerted lack of confidence in global growth, as the weekend press highlighted the now global spread of the Delta Covid variant. In some respects, it could be seen as the obvious progression from recent weeks, after fears of China’s growth slowdown had become the focal point for markets, now exacerbated by the Delta variant and the disappointing slow US vaccine uptake.
Overall, we think it is very important for markets not to confuse a change in the second derivative of growth (a natural and predictable phenomena, when the cause is an artificial closure and reopening of economies) for something more sinister. We continue to see global growth, and specifically US growth, holding above the historic trend or equilibrium growth rate, even if sequential growth readings continue to decline.
Interestingly, the US 10 year yield, which for many months this year was the global barometer for inflationary pressures (as a function of breakeven yields), has now seemingly become a market barometer for growth fears. As such, the correlation between price action in the 10y yield and say, high beta emerging market (EM) currencies is now the opposite that it was a couple of months ago (in short, higher US rates driven by inflation is bad for EM, but lower US rates driven by weak growth is also likely bad for EM).
However, we see several inconsistencies in this nearly universally accepted thesis. Firstly, markets continue to disregard the fact that global capital flows likely play a very significant part in the level of the US yield curve. Global safe haven demand for positive yielding assets remains high - and this is likely to only have been exacerbated by the heightened Covid concerns globally. (This capital flow or yield demand is also true in the US domestic markets, where cash rates remain punitive and cash remains in surplus).
Secondly, if global markets are so concerned about the US growth trajectory, it makes little sense that they are still pricing in three rate hikes by the end of 2023 - one more than the median dot from the June Federal Open Markets Committee (FOMC) meeting that surprised markets with its bullish economic narrative. Thirdly, the combination of global capital flight, growth fears and likely capitulation of long held positions (or even hedges that have failed to hedge), have led to a lower term structure of US rates. This is supportive for US growth, likely increasing the growth differential between the US and the rest of the world (ex-China) over coming years. We remain more positive than the current market dynamic on US growth and for that matter, over the medium term on China growth too.
This week was also the turn of the European Central Bank (ECB).
Going into the ECB meeting, it was clear that there was unlikely to be any movement from a policy perspective, but the promise to revisit the opening statement (and simplify the communication) meant that there was possibly more uncertainty than would otherwise have been, at this juncture. The meeting’s timing was also a complication, as there was some expectation that the ECB President might address the transition from PEPP to APP and other non-emergency measures as the March end date for PEPP draws closer. Instead, the President was clear that there was no discussion about PEPP other than the standard lines from the statement: “PEPP will run at least through end of March 2022, reinvested at least through end - 2023”, and that the current accelerated pace of purchases will continue, at least until the revised forecasts at the September meeting.
There were two key takeaways from this week's meeting, from my perspective. Firstly, there was a new, three part forward guidance message; that the “ECB is committed to persistently accommodative monetary policy”, and that the removal of accommodation will not occur until
i. inflation reaches 2% well ahead of the projection horizon,
ii. that it is deemed to remain durably at target for the rest of the projection horizon, and
iii. that in the judgement of the ECB Governing Council underlying inflation is consistent with sustainable medium term price stability; adding the caveat that this may also imply a period where inflation is moderately above target for a period.
It is important to note that this new forward guidance was not agreed upon unanimously (presumably the factions that disagreed also insisted on the inclusion of the line “PEPP envelope may not be used in full” into the opening statement). This is an important factor going forward. If, as we expect, economic differentiation remains at the heart of the global recovery from the pandemic, then the disagreements at the Governing Council likely increase, as the recovery matures, not decrease. Those countries that recover slower will also by definition have weaker fiscal balances, thus propagating further differentiation. This is likely one of the biggest difficulties for the eurozone over the coming decade.
If global demand for safe haven assets pushing the US yield curve lower gives the US corporates and consumers an advantage, those countries where policy is kept too tight clearly face a disadvantage. For now, markets may wish to focus on the potential for disappointments in the US and even global growth backdrop. I for one won’t stop believin’..
As a small aside, this week also saw the minutes from the BoJ outline its new climate measures within its monetary policy remit. In short, the Bank of Japan has unveiled a lending scheme, where banks are incentivised - foregoing the incursion of negative deposit rates - for 2X new green lending. In some ways, this is similar to the tiering mechanism of the ECB’s TLTRO lending programmes. I wonder how long it takes the ECB to (once again) follow the BoJ’s innovative monetary footsteps. Can we expect a new Green TLTRO after the Summer recess. A GLTRO?
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