• The fate of the Eurozone lies to a considerable degree in the hands of the European Central Bank (ECB). But can it do enough? Earlier this month, the ECB announced a set of measures to prevent deflation, ranging from negative deposit rates to a package of cheap loans for banks (€400bn) in the form of targeted long-term refinancing operations (TLTROs). Can these TLTROs stir banks to lend more to SMEs? Probably not: contrary to the “official” interpretation, subdued credit growth reflects low demand rather than constrained supply. Only two intertwined things can prevent deflation: (1) a “big bazooka” approach in the form of QE and (2) a much lower € (1.30 and then 1.20 to the $).
  • US inflation is starting to rise. Over the past 12 months, core inflation – that excludes food and energy – went up 1.5%, but has increased since February at a 2.1% seasonally adjusted annual rate. Economists disagree on (1) whether this is a response to increasing demand or just a temporary surge bound to recede, and (2) whether unemployment at 6.3% will limit wage inflation. Therefore, the Fed may be wrong in forecasting that inflation will remain under its 2% target until after 2016. If so, interest rates would have to rise earlier than the Fed would like.
  • With inflation picking up in the US and lowflation becoming entrenched in the Eurozone, monetary policies in the world’s two largest economies are set to diverge: more tapering and possible tightening in 2015 in the US and further loosening in the Eurozone. This will bring to an abrupt end the remarkably low volatility seen in the markets over the past months.
  • Destabilizing situations are rarely the result of a lone catalyst, but rather stem from the conflation of several elements. The geopolitical turmoil slowly engulfing large parts of the world will amplify the spike in volatility provoked by divergent monetary policies. We are now moving beyond the threshold where geopolitics only has a marginal effect on the financial markets. Candidates for chaos and policy miscalculations abound: most of the Arab world, countries bordering the East and South China seas, Russia and Ukraine, nations destabilized by the rise in fundamentalism, and so on. None of these places becomes un-investible, far from it. To succeed, however, investors require agility, deep local knowledge and support from “insiders”.
  • A new IMF “global house price index” shows that house prices are above their historical average – relative to both incomes and rents – in most of the world. It is doubtful that policy-makers will deflate this bubble by raising interest rates in a low-growth environment, preferring instead regulatory measures, which, in the past, haven’t been an effective substitute for monetary policy. They may slow down the boom but not deflate the bubble. The countries most at risk: Australia, Canada, China, Israel, Norway and the UK.
  • The expected correction in the Chinese real estate sector constitutes the greatest downside risk to the global economy. There is general agreement that it will happen, but not about its magnitude or the collateral effects. Property investment accounts for 16% of China’s GDP, 20% of commercial bank loans and a third of fixed-asset investment. The problem is overbuilding, causing housing supply to vastly outstrip demand – current supply amounts to more than four years of normal sales! Optimists point to what makes China different (rapid urbanization, increase in household real incomes), but when a property bubble bursts, the effects on the real economy are the same the world over.
  • The recent decision to wind down Hypo Alpe Adria, a midsize Austrian lender, is a taste of things to come. As most of the world is mired in over-indebtedness, governments will progressively renege on state guarantees. For the moment, some of the world’s most important central banks have already agreed that, in case of a bank failure (a “when” rather than an “if”), the bail-in model of Cyprus will prevail, with any amount in excess of the government guarantee frozen or even “confiscated” to recapitalize the bank. The morale of the story? Never leave in any one bank an amount superior to what is guaranteed (eg €100,000 in the Eurozone).
  • Albeit that the US economy has overtaken its pre-recession size, the US median household stands at $53,000, almost 8% lower than when the recession began. Clearly, lower-and middle-income earners get too little – a key reason why aggregate growth remains sub-par. It also explains a rising trend: it is only the very high end (for the 1%: Tiffany and the like) and the very low end of consumption that are booming. Dollar Tree, the US leading retail discounter, will continue to do better than Walmart.
  • Two weeks ago, Kenya’s issued 5 and 10-y bonds at yields of respectively 5.87 and 6.87%. The sale was massively oversubscribed, proving that the search for yields is alive and kicking! This largest-ever debt sale by an African country almost coincides with the first anniversary of the EM taper “tantrum”, when fears of Fed tapering triggered a major and sudden sell-off in EM debt. The outstanding volume of EM debt now stands at $6.9tn, most of it foreign-owned. As soon as US interest rates start to rise, the same cause will produce the same effect: a disorderly sell-off across all EM assets.
  • Two prevailing models currently dominate the landscape in the Arab world. An Islamic model – ISIS, expanding in Iraq and Syria, and a military one – SISI, imposed in Egypt. None has a chance to work, as coercion alone cannot succeed in maintaining power unless it delivers on what truly matters: improving people’s quality of life with jobs. This is, at the moment, a problem without a solution.
  • The war in Iraq, Opec’s 2nd largest oil producer, is a proxy for the Sunni-Shia conflict being fought between Saudi Arabia and Iran. So far, the oil market’s reaction has been rather benign, with a mere $5 premium in spot prices and much less in forward prices (around half). Real concerns are for the longer-term: volatility aside, what will happen with oil prices when Iraq disintegrates further and unrest/chaos flares up in other petro-states from the region? Global markets don’t have much room for another supply disruption.
  • The major “must-watch” issues that will affect investors’ and decision-makers’ sentiments over the next month(s) are – in no particular order: (1) the slowdown – or burst – in Chinese property prices; (2) US rising inflation – or not; (3) whether the € depreciates against the $ or not; (4) the widening of Eurozone bond spreads; (5) the US currency risk in EM corporate debt; (6) geopolitical tensions. For insights and real-time analysis on any of these, please contact us.
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