Consolidation and talk of “exit” strategies
• World stocks have been consolidating in the past few weeks. They had earlier rallied in April and May from their March lows. The US S&P index is up 2% on the year (36% from its March low). The GCC MSCI index is up 19% on the year, 47% from its March low. News that world economies and financial sectors are stabilizing continues to come in, though the novelty has faded and seems priced in. The financial markets are now searching for their next clue for the rest of this year and into 2010. Interest rates have reacted similarly. Long-term interest rates have consolidated also, and/or come off recent highs. For example, US 10-year notes are now again around 3.75%, after hitting 4.0% in May (and threatening the housing recovery). Rising commodity prices and the (very) early “green shoots” signs had sent the market scrambling to focus on inflation and large deficits, before realizing that inflation was still a bit off and that deficits were, for now, offset, by low private credit demand. The markets are now trying to price the type of recovery and/or associated problems or lack there-off.
• Another result of those recent encouraging economic signs was the renewed worry about the dollar and a potential future depreciation. The Chinese and Russian authorities and others have been voicing concerns about the soundness of the world reserve currency. In so doing, they are trying to provide ideas for alternatives (SDR’s, new world currency etc), none of which seem very convincing or promising for the time being. Nevertheless the improved economic news has invigorated risk appetite, and the USD has suffered a bit from flows to riskier assets and regions. Furthermore, we note that discussion of the future financial architecture of the world is clearly on the table, even if a bit far off in the future for the time being.
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As the sense of crisis and fear recedes, governments with tenuous or weakening fiscal positions, in particular the US, are gearing up to reassure their investors, lenders (and citizens) that they do have an exit strategy from the mountains of liquidity and debt recently and still being created. At the latest G8 finance ministers meeting, participants stated that stabilization was taking effect thanks to the different government measures, but that it was too early to cut back on stimulus packages and/or to reverse policy. Still, the G8 official communiqué added that an exit strategy was needed and they asked the IMF to come up with recommendations. The head of the European Central Bank (ECB), Mr. Trichet, recently stated that we had reached the limit on government borrowing in many cases, and that balanced budgets should be on the table soon. Such are the first steps in the slow workings of government (and the economy) and these signals, mild as they are, are also meant to reassure investors and fend off ratings agencies. Ireland lost its AAA rating back in March. For the UK, the rating was kept but the outlook was changed to negative, meaning it could potentially follow Ireland. No one is immune anymore.
• In another sign that financial matters are less turbulent, 10 of the 19 largest US banks have paid back money they had borrowed from the TARP (Trouble Assets Relief Program). The intention is, of course, to signal financial health to the markets but also for these banks to free themselves from onerous and cumbersome rules imposed by participation in that government program. We are still however a long way from clean balance sheets and the end of deleveraging in the US and elsewhere. E.g. the Vice Chairman of the SNB (Swiss central bank) said that “the state of the Swiss and international financial system is — and remains — vulnerable overall,“ while questions remains about EU banks’ exposure to Eastern and Central European lending, where the economies are in very dire straits and unemployment rates are well above double digit levels.
• Gold remains unable to break the $1000 per ounce though it remains firmly above $900. The inflation/deflation tug of war remains unresolved. Massive easing is mostly behind us and exit-strategies are just “talk” for the time being. On the other hand, even with all the encouraging signs, the economies remain weak (though stabilizing) and the inflation reports world wide are less than tame with most major countries economies posting lower prices than year-ago levels. The US CPI was -1.0% in May 2009, though mostly thanks to lower oil prices. In the Euro zone inflation fell to almost zero as per the European Union’s statistical office, with analysts expecting negative prices from June onwards. Furthermore, employment in the 16-country fell by a record 1.22 million jobs in the first quarter of 2009, pushing the unemployment rate to 9.20% in April, its highest level in 10 years. With US unemployment at 9.4% and Japan also in deflation, all of these factors are keeping inflationary fears at bay.
• Still those inflationary expectations have come all the way from zero at the start of 2009 to about 2.0% today as measured by market spreads in the US. Nominal Treasury yields over TIPS have edged up from zero at the beginning of the year to about 1.9% in the 10-year sector. The thinking seems to be that a lot of excess capacity exists in the system and will keep inflation low for some time, but uncertainty and worries remain just below the surface.
• In GCC economies, as in the rest of the world, confidence is up, buoyed by oil prices back near $70 pb. Stock markets have also recovered nicely, outperforming major markets (like most emerging stock markets). Inflation has come down drastically in most GCC countries, and the double-digit plus rates of 2008 have given way to lower numbers (5.4% in May for Saudi Arabia, 6.8% in January for Kuwait and falling).
