BEN BERNANKE, TAPERING RISKS, ECONOMIC CONDITIONS & GLOBAL ECONOMIC OUTLOOK
BEN BERNANKE’S HIGH STAKE POKER’S GAME
“Helicopter”
Ben Bernanke took the US and global economies on a spacewalk on 18 December 2013
– an uncharted journey of cautious optimism and a giant step into a big unknown
- surrounded by harsh economic realities engulfing all major developed
economies. The US economy is out of the
safe “protection” of space capsule or orbital space station where it was
previously fed with seemingly unending fiscal stimulus support since the GFC. The
FOMC meeting has finally decided to taper its quantitative easing by US$10
billion per month, to US$75 billion but
it is still quantitative easing and financial markets almost forgot that. US
equities market partied like Santa Claus came to town early to score a gain of
1.81% with the DJIA index closed at a record 16,167.97 and S & P 500 finished
the same at 1,810.65. Market volume was restraint though on holiday-season
trade.
The
exuberance was a little more subdued in key EU and commodity-driven markets of
Canada, Australia and Brazil, rising between 1% to 1.3% ranges. The clue can be
found in the less-than-enthusiastic Shanghai SSE Composite Index – it tumbled
for two consecutive days as short-term credit crunch takes hold in China, and
still falling. http://sg.finance.yahoo.com/q/bc?s=000001.SS&t=1m&l=off&z=l&q=l&c=
The fear is that inflow of cheap funds
is drying up with the commencement of tapering after recent months of heavy
capital inflow and year-end liquidity pressure.
Tapering may be the commencement exit point of American money printing
but leaves worrying impact across the Pacific Ocean even in China. QE3 shrinkage is intended to rid the US
economy of its dependency on fiscal stimulus by end of 2014 so long as
supporting economic data permitting, but not guaranteed. The start of this exit
came almost 6 months after Bernanke hinted of that in July. In that leap of
small faith, Ben Bernanke spoke to Janet Yellen, the widely-expected next
incumbent Fed Chairperson who has to contend with change in a few Fed governors
as well. It is a high stakes poker’s
game, not necessarily smooth ongoing progression to zero quantitative easing by
end 2014. Nor is it without risks of backtracking in the face of deteriorating
economic data or any triggered external sudden external shocks. http://www.kitco.com/news/video/show/on-the-spot/505/2013-12-16/OUTLOOK-2014-Fed-Playing-High-Stakes-Poker.
Janet Yellen knew all too well of the enormity of the risks unknown who had
said in her Senate confirmation hearing these words.
“We’re in unprecedented circumstances. We’re using
policies that haven’t really been tried before . . . We’re trying to explain to
the public how we intend to conduct these policies. It is a work in progress
and sometimes miscommunication is possible…………………………….I think there are dangers
frankly on both sides, of ending accommodation too early, there are also
dangers we have to keep in mind with maintaining program too long."
IMMEDIATE MARKET REACTIONS IN ITS AFTERMATH.
That “miscommunication” risks
Yellen spoke of includes sending an incorrect message to financial markets that
the financial crisis is behind; the US economy is on the mend, only rosy time waits.
Far from it – the mixed market
reactions in its immediate aftermath signaled financial market confusions. US dollar rallied http://data.cnbc.com/quotes/.USDOLLAR/tab/2
driving industrial metals marginally lower and commodity currencies like the
Australian and Canadian dollar to a new three-year low. Post-decision verdict
is less clear of enthusiasm, maybe already “priced-in” – they all face increasing
market finance costs forward. At 104 Yen
per US dollar, it is also the lowest Yen-US Dollar parity as Japan its own its
record quantitative easing. The Nikkei rallied 1.71% in its wake. The Fed was
first major western central bank to begin normalization. On the strength and
stability of the world’s largest economy again taking the lead engine role and
the Japanese economy – the world third largest - also growing strongly
stimulated by quantitative easing and infrastructure spending, one would expect
base metals to react positively. It was a “dead cat” bounce.
Except for
aluminum and nickel, LME warehouse stocks of base metals have been falling in
the past year and of recent months, Chinese iron-ore and copper importation
lifted higher. The spark ignited by the Fed’s tapering failed to light up the “prairie
fire” of demand optimism. Base metal
prices and base metal shares in Canada and Australia failed to react to the
bullish optimism in the US and Japanese equities markets. Even gold price
remained initially muted of response, February gold delivery finished at $1,235
per oz, up $4.90 or 0.4% on NY Mercantile Exchange even as US dollar surged
upward. http://www.cnbc.com/id/101282382. This
writer had expected some resilience of gold price given compelling
fundamentals. Spot gold did NOT decline until European market opening
much later saw selling pressure drove
its price down by more than 3.6% - much
of that due to rising US Dollar and yearend tax-loss harvesting. Hedge Funds
long liquidation added to gold’s woes. http://www.bloomberg.com/news/2013-12-19/gold-drops-below-1-200-for-first-time-since-june-as-fed-tapers.html.
Both the equities and commodities market is disbelieving of the Fed forward
guidance in the possible turnaround of the US economy. Even equities market in
developing countries failed to react positively – a surprising observation
since the rising US dollar favored more export opportunities of manufactured
goods into the US.
BOND MARKET CALLING THE EQUITIES BLUFF?
Meanwhile, we saw US Treasury yield curve flattens even a day after the
tapering announcement – despite the ample liquidity prevailing, afforded by an
environment of increased savings but not much investment. The five-year note
yield jumped 8 basis points or 0.08% reaching 1.7 per cent before finally
settling at 1.68 per cent. The ten-year note yield dropped 4 basis points to
2.89 per cent and the 30-year bond yield slipped 9 basis points to end the week
at 3.82 per cent. http://www.businessweek.com/news/2013-12-19/treasuries-benchmark-yields-set-to-rise-for-fifth-week-on-fed#p1
A month ago, the five-year, 10-year and 30-year yields were 1.37, 2.80 and 3.1
per cent respectively. Flattens of
the US treasury yield curve probably means investors believe the Fed will keep
future inflation in check with gradual rate hikes. Bond traders hate inflation.
If the curve-flattening trend speeds
up, it means that it is time to trade out of investments whose
success depends on a strong economy for both stocks and corporate bonds,"
http://georgewashington2.blogspot.sg/2009/10/what-is-flattening-yield-curve-and-what.html
The spike in 10-year bond yield suggests of inflationary expectations
ahead and that runs counter to the US equities market rally. http://video.cnbc.com/gallery/?play=1&video=3000227459The
Fed’s forward guidance presumed a stable price environment, projecting an
inflation rate running below 2% per annum, allowing economy to grow. The
expectation is that by end 2014, the economy will grow to lift employment below
6.5% and real wage growth going forward to drive consumption spending and a
sustainable growth path ahead without stimulus.
But when 10-yr Treasury note yield rises, so does mortgage-back
securities yield must rise to attract investors. Treasury yields affects only
fixed rate mortgages. Adjustable rate mortgages are affected more by the Fed
fund rate. http://useconomy.about.com/od/economicindicators/f/Relationship_Between_Treasury_Notes_and_Mortgage_Rates.htm
So rising 10-yr treasury yield will affect fixed rate mortgage of
15-year conventional loans, while the 30-year bond affects 30-year conventional
loans. Mortgages are usually longer than 10 years borrowing exposures. The Fed has set an unemployment-rate threshold of 6.5% to
consider raising its Fed fund rates – a target not too far from current 7% -
that could drop rapidly as those on unemployment insurance benefits for 99
weeks instead of the usual 26 weeks tapers off. Higher mortgage burden, if interest
rate rises, will curb discretionary consumer spending impeding the long-term
recovery path. The bond market is calling the bullish US equities reaction bluff,
and if it is correct, US equity market should correct lower in 2014 – contrary
to current bullish expectations. Insiders are selling like crazy in November http://finance.yahoo.com/video/insider-selling-spree-204700630.html
The tapering itself released headwinds of higher interests rates accompanying and
abetting a stronger US Dollar – both of which is detrimental to sustaining US
economic growth recovery and lowering employment. The QE 3 bond-buying
reduction has many moving parts and it does not guarantee of smooth workings to
theoretically underpinnings or the Fed’s forecasts and expectation. For
example, a stronger dollar sucks in competing foreign import lifting employment
and GDP growth abroad instead of the US and rising interest rate could derail
the wobbly housing recovery. Few would disagree that the European Central Bank
and Bank of Japan have a lot to lose and policy worries by their foreign
exchange appreciation as the US dollar rockets up – the inflationary pressure
dampening consumption spending. Neither Japan nor EU can afford another
downturn at this juncture which will also be adverse to the US export
sustainability to both markets. The tapering by the Fed, therefore also, is also not without its deflation risk of the US
economy “recovery” lost momentum.
IS THE US ECONOMY THAT STRONG?
If one takes a closer look at the
US Bureau of Economic Analysis (BEA) of the US economy, its third quarter GDP
growth of 3.6% was NOT as strong as the macro numbers suggested. http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm.
Here are the warning signs
v Real personal consumption expenditures increased 1.4 percent in the third quarter, compared with an increase of 1.8 percent in the second. That is falling growth in consumer spending which account for 65% of US GDP base.
v Real imports of goods and services increased 2.7 percent, compared with an increase of 6.9 percent prior. That is to say, SLOWER net imports helped by a falling US dollar in the third-quarter (which are a subtraction in the calculation of GDP) increased. This favorable US dollar exchange rate trend has now reversed in this final quarter, such that any increased in consumer spending will leak out in favor of foreign sources.
v The US BEA revamped its GDP’s methods of calculation to the cost of producing original entertainment, literary and artistic works. That adds some US$560 billion overnight to its now estimated US$16.2 trillion or 0.34 percent to its 3rd qtr GDP ‘growth calculation. http://country.eiu.com/article.aspx?articleid=1750792359&Country=US&topic=Economy&subtopic=Forecast&subsubtopic=Economic%20growth&mkt_tok=3RkMMJWWfF9wsRoivarOZKXonjHpfsX66eQpWa%20g38431UFwdcjKPmjr1YcGSsJ0aPyQAgobGp5I5FEPQrPYRK1jt6QEXw==. If I take out the 1.68% growth in inventory restocking and its 0.34% gain from revision of GDP calculation methodology, my estimate of underlying growth for US GDP is closer to a pedestrian 2% actual sustaining growth. It compared unfavorably with the annual average long-term trend growth of US of 3.4% from 1959 to 2002 and 1.8% since that year. There is a new “normal” of SLOWER sustainable growth rate of the US economy and since 2008, the growth rate is largely supported by quantitative easing of QE1, QE2 and soon to be tapered off QE3. Without those QEs, we would not be here today.
Commerce Department has
since revised the 3rd qtr GDP growth to 4.1% after its upward
revision of consumer spending growth to 2.0% instead of the BEA’s estimate of
1.4% earlier. Stronger consumer spending was due mainly in gasoline and
healthcare spending rather the discretionary. http://www.marketwatch.com/story/us-third-quarter-growth-raised-to-41-2013-12-20 Economists say GDP could fall in the final months of 2013,
perhaps sharply, if companies are unable to sell all the goods they stockpiled.
This announcement sent industrial metal prices higher.
Excluding
the GFC recession-chilled years of negative growth rate in financial years 2008
& 2009, World Bank (WB) statistics showed that the long term sustainable
growth rate of the US economy since 2004 is 2.7% per annum. http://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG
Assumed reversal to the mean of roughly 2.5% growth rate for the final qtr of
2013, the growth rate for US economy in 2013 will come in at slightly above
2.4. http://www.tradingeconomics.com/united-states/gdp-growth
That would be sub-par compared to 2.8% in 2012 and also slightly below the WB’s
estimated sustainable growth trend. The Fed is now forecasting a GDP growth of
between 2% to 2.3% for 2013 – implying a much subdued December quarter GDP growth
of between 0.8% to 2%. http://blogs.reuters.com/anatole-kaletsky/2013/09/19/the-markets-and-bernankes-taper-tantrums/.
The Fed’s monetary
meeting of 30 October 2013 – AFTER THE END OF 3RD QTR GDP measure
interval decided that “conditions remained too weak to pull back from its
bond-buying purchase program.” http://www.marketwatch.com/story/fed-says-economy-too-weak-to-begin-taper-2013-10-30?dist=tbeforebell
By a vote of 9 to 1, the Fed decided to maintain the pace of is $85
billion-per-month asset purchase plan. So what has changed since?
The simple
answer is NOTHING has changed except for Treasury yield, mortgage rates, the US
dollar and US equities market all moved up in a bubble environment. First flash
estimate of 3 qtr GDP statistics out on 7 November showed the strongest 2.8%
annual growth – the Fed’s meeting a week earlier of 30 October would have known
of this estimate or insight to it. http://www.marketwatch.com/story/us-third-quarter-gdp-climbs-28-2013-11-07?siteid=bigcharts&dist=bigcharts
The key worrying feature then was slower consumer spending growth at 1.4% than
the 1.8% in the second qtr when GDP grew by 2.5%. What was also disturbingly
weaker was business investment also weakened, up just 1.6% vs. a 4.7% gain in
the qtr preceding. The gain in third qtr GDP is NOT supported by two key
variables – the all-important consumer spending and the business investment to
create jobs to support sustained consumer spending. The implicit warning
implied is that the fall-off in unemployment is artificial i.e. decline in
employment participation rate and/or fewer are eligible for unemployment
insurance benefit to qualify as “unemployed”. The economy’s apparent recovery has got no legs. The conclusion
available is that the Fed’s decision of 18 December is behind the curve of worrying
economic condition hidden behind the money flow-driven economic statistics of rising
mortgage rate, treasury yields, stronger dollar and US equities.
BERNANKE CUTTING UMBILICAL CORD AND SET THE US ECONOMY ON THE SPACEWALK
Bernanke,
therefore, played Santa Claus before his departure in this sugar-coated
tapering of promising the Fed would not allow U.S. monetary conditions to tighten and
would keep short-term Fed fund rates near zero to 0.25% for a very long period
— at least until 2015, and quite possibly beyond. It is the best he can do. He can’t or be unpleasant
to leave an open-ended legacy of an ‘untidy desk” of QE mess to incoming
Yellen. By cutting the QE umbilical cord from his pregnant economics of money
printing, opening up the hatch of the space capsule and orbital space station –
Bernanke has set the US economy on the spacewalk into the unknown. In effect of
reality, the Fed is deftly swapping tools of its monetary policy supporting a
near zero interest rate short term market condition while tightening on longer
term QE3 easing. But that is only a promise and its success remains to be seen.
Even if the Fed genuinely has no intention of tightening up monetary policy
until 2015 at least, the mere expectations of rising interest rate may yet be
enough to drive down consumption, investment spending and crashing the housing
market.
Unless there
is a significant lift in discretionary consumer spending and/or a strong
rebound in housing recovery compensating into the start of next financial year,
I see little prospect in stronger US economy in 2014 on reduced fiscal
stimulus. Tapering has negative impact which needs compensating bolstering from
economic gains from cheaper energy, technology-driven productivity and continued
short-term near negative interest environment. The Fed’s tapering statement to
financial market holds that underlying growth trend is stronger than the fiscal
drag – but failed to acknowledge that much of it is found in the third qtr GDP
growth, attributable to necessities of increased consumer spending in gasoline
and healthcare. http://www.marketwatch.com/story/us-third-quarter-growth-raised-to-41-2013-12-20
. These are non-recurrent on qtrly basis and they deprived households of
discretionary spending elsewhere necessary to support continuation of growth
path.
SO WHAT ARE THE RISKS FACTORS FOR THE US?
There are plenty, often
difficult to manage and sometime they erupt from turbulence sown by the exit
from quantitative easing move itself. The biggest one is debt ceiling. The
excess of spending exceeding revenue inflow has to be met from Treasury issue
of bond sales but, by application of law, however, that debt funding of budget deficit can’t
proceed beyond legally mandated borrowing limit unless and until this limit is
agreed to by the US Congress. As of May 2013, the budget ceiling limit, as a
tool of fiscal discipline, stands at US$16.69 trillion dollars. Extending this
limit does NOT authorize additional spending but merely provide for financing
means to pay for spending commitments already agreed to by Congress. Budget
dispute over debt ceiling almost shut down the US government on last October 17
with catastrophic risks repercussion in global financial markets and global
economy if US Government defaults on its debt obligations. http://news.nationalpost.com/2013/10/15/from-shutdowns-to-debt-ceilings-an-explanation-of-what-exactly-is-going-on-in-washington/.
Washington is said to overspend it 2013 fiscal budget by US$1.1 trillion. http://www.globaljournalist.org/stories/2013/10/24/the-government-shutdown-explained/Who knows with any certainty till September
2014, there won’t be a repeat fight with clear risks of the same political blowback
torching from another round of budget fight over spending if there is a
blowout. Remember the QE3 reduction has no firm deadline and could stumble
along the way. In the event of budget spending blowout for whatever reason/s, there
could well be pressures to enact spending cuts by Congress - similar to the
sequestration in fiscal year 2013. The final resolution of that in 2013 saw the
debt ceiling limit extended but a spending cap is now in place even if there is
money available to spend. It funds the government until January 15 and raises the debt
ceiling until February 7. http://www.aljazeera.com/news/americas/2013/10/us-government-partial-shutdown-ends-201310162387774904.html.
Initially, that looks like kicking the can down the road but fears of fiscal
indiscipline and monetary policies uncertainty ahead diminished after US House
and Senate negotiators having reported to have reached a deal on spending
budget to 2015. This is yet to be
confirmed next year. http://www.marketwatch.com/story/house-senate-negotiators-agree-to-budget-deal-2013-12-10?siteid=bigcharts&dist=bigcharts.
That, I believe provide the impetus and encouragement for the Fed’s decision to
taper off its QE3 bond buying a week later. But will that works?
WHAT IS THE STATE OF HEALTH OF US ECONOMY NOW – SOME RECENT INDICATORS.
v Retail sales growth, ex-auto, for the month of September. October and November were 3.5%, 3.6% and 3.6% respectively. http://www.macrotrends.net/1371/retail-sales-historical-chart. The question must be asked here – who is taking the finished goods from the shopping shelves and manufacturing warehouses after the huge inventory restocking in the September qtr and further manufacturing output growth as evident from the Markit Manufacturing Index above?
v US housing sector showed mixed sentiment and cautious outlook at well. US National Association of Realtors reported three consecutive months of decline in the sales of existing homes, the slowest since December 2012 – higher median prices amid lower inventory and higher mortgage rates biting. http://www.marketwatch.com/story/existing-home-sales-fall-43-in-november-2013-12-19 What is worrying is that existing (pending) home sales has been falling consistently and dramatically in the last 12 months. New residential construction, however, picked up significantly over the last three months. http://research.stlouisfed.org/fred2/data/HOUST.txt But that optimism could be premature as new mortgage application has fallen dramatically to hit a 13 year low as bond market sell-off in the wake of the Fed’s decision to pare of its bond purchase stimulus in January. House finance costs rose as treasury yields are hitting 2-year high. http://www.reuters.com/article/2013/12/24/us-usa-economy-mortgages-idUSBRE9BH0IK20131224 US 30-year mortgage have risen from a low of 3.4% in April to currently 4.47% - that is an increase of more than 30% in home financing costs in 6 months and rising.
v US BEA/Commerce department statistics showed corporate earnings have been on a growth path since 2012. http://research.stlouisfed.org/fred2/graph/?id=CP
v Gross Fixed Capital Formation (GFCF) also showed a growth path but at a slower pace in current year than 2012, indicating corporate sector’s cautious outlook ahead. http://www.tradingeconomics.com/united-states/gross-fixed-capital-formation. GFCF have not kept pace with earning growth as well.
v The Thomson Reuters/University of Michigan's preliminary reading on overall index of consumer sentiment increased to 82.5 in December from 75.1 in November and 73.2 in October giving an average of 77 still below the average in the September qtr was 81.5. http://www.tradingeconomics.com/united-states/consumer-confidence. There was hardly any gain in consumer confidence to sustain stronger retail sales.
v November consumer goods up 1.5% advance, manufacturing output gained 0.6% and business equipment output fell 0.5% http://www.marketwatch.com/story/industrial-production-jumps-in-november-to-record-high-2013-12-16?link=MW_story_latest_news.
v orders for core capital goods, a proxy for business investment, rose 4.5% in November, the most since January. http://www.marketwatch.com/story/business-investment-rises-at-fastest-rate-since-january-2013-12-24
Overall here, the picture
painted here is modest gain consumer confidence, retail spending unlikely to be
supportable of stronger continued manufacturing gain, corporate profits and
gross fixed capital formation ahead. The most recent Fed’s Beige book reported
released in early December noted unexciting conditions seen in October
prevailing extending at least into mid-November. http://www.cnbc.com/id/101247179 That left Fed’s forward policy making
ahead in a quandary, it warned. I believe this assertion is correct. Over the
last 5 years, the Fed had injected more than US$4 trillion into financial
markets. And in that, germinates an abnormality in the homogeneity in
investment strategies & growth. Rising tide of cheap money floats all
businesses that could deliver a positive yield. Instead of picking winners,
capital incubates the same mindset of uncritical investors’ support of any even
if no decent return could be expected when normalization returns. http://www.marketwatch.com/story/there-is-no-bubble-markets-just-dont-work-anymore-2013-12-11. Artificiality of frothy returns is secured
only be accessibility to seeming permanent tidal supply of monetary liquidity.
NOW THAT FUNDAMENTAL CONDITON AND PILLAR
HAS CHANGED OR WILL CHANGE WITH THE EXIT OF QEs – no one knows which boat will
sink, which will survive and prosper and who is left struggle for oxygen in the
new tidal environment.
Fed’s Yellen believes that by historical standards, US equity market is fully valued
but not bubbly. I believe she is wrong – a lot of bubble of marginal &
speculative business is hidden below the frothy form on top of the beer.
One good example of that
is the rapidly slowing housing sector – a key critical underpinning factor in
US economic recovery – conditions therein is wobbly even before the FOMC’s
decision of 18 December. In voting balance of 9 to 1 in favor of bond-buying
reduction, the FMOC’s public statement clearly warned that “the recovery in the housing sector slowed somewhat in recent
months.” Mortgage applications, since then dramatically dived to a 13-year low.
http://www.federalreserve.gov/newsevents/press/monetary/20131218a.htm
Investors
will be watching very closely any sign of increase interest rate at the longer
end of the yield curve detrimental to housing recovery or any acceleration in
the flattening of Treasury yields as these are warning signs that looming
inflation threat will undermine capital investment and employment. Increased
interest rate will add higher expenses to US Government budget, an impediment
to US fiscal health. Even the size of the Fed’s balance sheet exposure, even a
1% increase in interest rate can have significant impact on US budget
balancing.
The effects
of this Fed’s tapering won’t be felt just in US, its repercussions with
reverberate globally. Some analysts correctly point to the orderly winding down
of QE and this is “tapering, not tightening” move. These arguments are
simplistic of uncertainty reduction – it is a DIRECTIONAL CHANGE away from the extraordinary monetary stimulus
program of no historic parallel with definite implications on interest rate
tantrum, currency flow, exchange rate adjustments sooner or later. Developing
countries have already slowed down considerably in recent months. In fact, the
OECD warned that the “uncertain future of U.S. fiscal and central-bank policies poses a growing
risk to a global economic recovery.” http://www.marketwatch.com/story/us-taper-debt-crisis-threaten-global-recovery-oecd-2013-11-19?dist=beforebell.
Countries with substantial current account deficit will remain vulnerable if massive
capital outflow chases interest rate differential. The tapering is only at its
modest beginning and much of its future impact is still largely unknown.
However, the higher the US treasury yield is, the more the downside of emerging
market’s foreign exchange. http://www.cnbc.com/id/101284261
The contra benefit of lower currency exchange may yet not translate into higher
export earnings if the stronger US economy fails to materialize.
WHAT ABOUT CONDITIONS IN OTHER MAJOR ECONOMIES?
EU was a
very sick economy through 2013 despite currency and sovereign risks of
insolvency stability. Economist and the ECB were both over-optimistic that the
restoration of stability in financial markets there will necessarily bring
economic growth and turnaround. Thanks to his massive bond-buying program that
calmed the credit market, ECB President, Mario Draghi, had confidently
predicted in January 2013 that Europe’s economy is on the mend even though Euro
zone is still shaky. Draghi prophetically said these words – I think to say the least, the jury is still
out there” http://www.eubusiness.com/news-eu/finance-public-debt.m03/
IMF had been predicting the region’s
GDP will shrink again after contracted 0.5% in 2012. http://money.cnn.com/2013/01/25/news/economy/europe-economy-draghi/.
Reality is something else. There was no momentum on the real side of the
economy. We saw EU slipped into a double-dip recession. Stagnating record
levels of unemployment continued to hold down domestic demand blocking EU economies
from recession climb up across Europe except for Germany. Twelve months on, the jury is still out there if EU is recovering
or its recovery is grinding to a halt despite its resurgent bond and stock
markets performing far better than expected confounding doomsayers. http://www.businesstimes.com.sg/premium/top-stories/eurozone-recovering-jurys-still-out-20131223
In the three months to September, the EU zone combined economy of 9.5 trillion
Euro struggled to grow by a slower than expected 0.1%. This compared
unfavorably to the 0.3% GDP growth in the June quarter, its first positive
qtrly GDP gain in 18 months – signaling a worrying fall off in recovery
strength going into the final quarter. The
quick deceleration is a major setback. The Monetary Authority of Singapore
(MAS) in its latest October macroeconomic review is forecasting a 0.3 negative
growth for EU zone in 2013. France contracted 0.1% after a robust recovery in
the previous June Qtr. German growth slowed to 0.3% compared 0.7% achieved in
the qtr preceding as a seasonal rebound in construction faded. Exports faltered
and most of the growth was fueled by domestic demand – an indication of the
extent of malaise gripping the rest of EU zone economies. http://www.irishtimes.com/business/economy/euro-zone-recovery-comes-to-near-halt-1.1594714
European households and corporate remain stuck in a pile of debt. Amid signs of
further weakening of economies, the ECB cut its benchmark interest rate to
0.25% in early November to prevent the region from slipping in deflation and
stagnation. Patchy conditions in China, a major EU export market, is not
helping the Euro zone economies struggling to hold its momentum. The European
Commission is forecasting a 1.1% GDP growth for Euro zone while MAS prefers
0.9% expansion for 2014. http://money.cnn.com/2013/11/14/news/economy/europe-economy-gdp/index.html.
There is one sign of possible pick-up next year - Markit's Euro zone Manufacturing
PMI rose to 52.7 in December from November's 51.6. That was its best showing in
31 months but it is only a MARGINAL expansion. Any measure above 50 is
expansion and that below represents contraction. New orders increase for the
fifth consecutive months is suggesting that the recovery could extend into 2014. http://finance.yahoo.com/news/euro-zone-business-recovery-ends-103006953.html
WHAT IS THE STATE OF ECONOMIC HEALTH IN JAPAN & CHINA?
Abenomics, one year on, received mixed scorecards of its “success” from analysts. It is a new bold experiment of supply-side economics but difficult of implementation follow through. That said, the Nikkei appreciates some 40% this year giving the economy much buzz of wealth effect but which has not yet translated to the same powerful impact on household spending. Proponents of Abenomics plead for patience to see its cumulative impact – even though this might turn out illusive of reality. The Japanese Yen fallen by 20% and that is helping exports but analysts questioned Abe’s capacity for substantial long-term structural reforms of deregulation, tax and labor market reforms in the face of ageing demographics. There are some signs that consumer spending is supporting the economy but who knows what will happen to demand come the brunt of new sales tax from 5% to 8% - badly needed to shore up the country’s huge debt load - to be implemented next April and its impact of consumption demand on the economy. The worrisome sign is that companies are reluctant to raise wages despite rising profits, worrying about earnings sustainability. Abe’s government targeted 2% annual growth per year. After a strong first half, the Japanese economy is also decelerating rapidly. Japan’s third quarter GDP growth grew at an annualized rate of 1.1%, a sharp contrast to 3.8% growth in the June qtr. http://money.cnn.com/2013/12/08/news/economy/japan-gdp/. Weak capital spending and slow growth in exports have hampered GDP growth despite falling Yen. A surprised pickup in export volume in volume terms in October, particularly car shipments, give a hint of gradual economic recovery in developed economies. http://www.reuters.com/article/2013/11/20/us-japan-economy-trade-idUSBRE9AJ00120131120. Is this the spark to recovery fire or is this another flash in the pan?
A prime concern working against Abenomics is
the sustainability of escalating government debt costs of continuous funding of
stimulative fiscal and monetary policy. It is expensive – the incoming Abe
administration, in January 2013, embarked on a 10.3 trillion yen Supplementary
budget to kick start the Japanese economy. http://www.questia.com/library/1P3-3057571861/abenomics-finally-a-solution-to-revive-japan Actually 10.3 trillion Yen is roughly 2% of
the Japanese GDP. http://economic-research.bnpparibas.com/Views/DisplayPublication.aspx?type=document&IdPdf=21951
. And that is not enough – the Japanese cabinet was forced to approve another
5.5 trillion Yen or US$53 billion this month to rev up its faltering economy
and to counter the effects of hits from the proposed tax hike. BOJ might be forced
to spend a lot more on quantitative easing in 2014 just as the Fed is exiting
from its extraordinary monetary stimulus. http://economic
research.bnpparibas.com/Views/DisplayPublication.aspx?type=document&IdPdf=21951.
The drag in its real economy seems to be a lot more unproductive relative to
the costs of sustaining Abenomics which has already costs more than 15.8
trillion to date. In effect, there is huge leakage in Abenomics’s hoped for
success – spending more money than 3% of its GDP base to grow just 2% in 2013
and hopefully some add-on in 2014. It is heavy frontloading of monetary
spending awaiting long-term highly uncertain return. Analysts noted these
handicaps of broken links to made Abenomics inefficient of outcome desired of pulling the Japanese economy out of it
deflation – interest rate is already near zero, financial surplus in
non-financial corporate sector still
sitting at record highs due to the lack of capital spending and weak external
demand globally. There is no pick-up from private sector to sustain the engine
of growth – that leaves Abenomics in a quandary of policy options ahead. Kochi
Hamada, Yale economists and Abe Advisor gave Abe an “A plus” for the monetary easing , a “B” for the spending
program and “E” for progress toward
reforms aimed at sustaining growth in the long run was less evident - giving it
a “F” means Hamada has to resign as his Advisor. http://www.canadianbusiness.com/business-news/japan-plans-53-billion-stimulus-to-rev-up-faltering-recovery-counter-tax-hike/
. The blunt truth is that Abenomics may be close to failure disaster.
Zerohedge.com presented a graphic illumination of why the dislocated Abenomics
has been found to be so hard at work of no success to date. http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2013/11/Japan%20Charts%20Abenomics.jpg
As BOJ fueled up the economy with huge monetary stimulus, GDP growth spiked up
sharply, only to be exhausted collapse within 2 quarters. It only flooded
domestic bank with cash beyond what they can prudently lend out, and end up
with parking it in BOJ. As one Japanese said – Abenomics “is bureaucrats
teaching businessmen how to spend money”. IT IS A BIG AND DANGEROUS GAMBLE
looks vulnerable to costly failure of economic experiment. MAS is forecasting
Japan’s GDP to grow by 1.9% this year slowing down to 1.7% in 2014 – the
cumulative impact of Abenomics notwithstanding. I believe the forecast is
over-optimistic unless US economy staged an unlikely strong rebound in 2014.
The Chinese
economy is equally fragile and vulnerable to sudden shocks. The true cash
crunch time is still to come. With the Fed quantitative easing shrinking in
2014, the cheap funds that found its way into China might reverse flow. That
could spell trouble for China’s banking system at a time when China’s Central
Bank is also reining on credit to control the runaway housing prices. Post its
national November political plenum, interest rates will be fully liberalized
and largely be determined by market forces – how is the shadow banking and
those local government borrowings using off balance sheet vehicles going to
unwind? Is that going to twist, turn and spiral into chaos after recent massive
volatility of short-term liquidity funding?
On the
economic front, the central banks'
central bank, the Bank for International Settlements (BIS), in its latest
annual report, reveals that the growth of debt in China since 2007 is an
astounding 50 percentage points of GDP. http://www.bbc.co.uk/news/business-23035230
This is the fifth largest increase in debt borrowings, surpassed only by
Ireland, Portugal, Greece and Britain – all of them faced a banking crisis
whose banks have to be rescued. Is China waiting for the same? Most of these
troubled European countries were bogged down sovereign debt but in China’s
case, most of the indebtedness is corporate borrowings.
Take a look
at China’s PMI Manufacturing index right through 2013 till November, it mirror
the Chinese economy struggle with liquidity constrained growth. http://www.stats.gov.cn/english/PressRelease/201312/t20131202_474279.html
In the first half till August, manufacturing encountered tepid expansion with
PMI readings hovering between 50.1 to 50.9. Now take a look at China’s PMI
Service Index right through 2013 till November – the same interesting pattern
emerges of PMI readings within the narrow ranges of 53.9 to 56.3. http://www.stats.gov.cn/english%20/PressRelease/201312/t20131203_474949.html.
The expansion in services sector is stronger than manufacturing indicating some
success away from export-dependent manufacturing sector performance to drive
GDP growth. China’s economy slowed down in the interval from June to August –
both for its manufacturing and services sector in parallel. In the face of and
to counter-cyclical this weakness, the Chinese government went on another “mini
fiscal stimulus” drive of tax cuts and additional railway spending but nowhere
on the scale of 2008 of 4 trillion Yuan. For one thing, Chinese banks are more
cautious now of its lending. http://www.scmp.com/article/1014334/spending-spree-begins-dont-expect-big-bang
China’s economic growth accelerated for
the first time in three quarters to register an annualized GDP growth of 7.8%
in its September qtr. http://www.bloomberg.com/news/2013-10-18/china-s-economy-grew-7-8-in-third-quarter-matching-estimates.html
The lingering positive impacts travelled into October and November gains in
China’s PMI reads for both manufacturing and services indices. PMI
Manufacturing read for October and November was 51.4 compared to its September
read of 51.1 – only marginally expansion. The corresponding PMI Services read
was 55.4, 56.3, 56 for the months of September, October and November
respectively – a sign that it is weakening again so soon after the mini fiscal stimulus. The “shocker” that followed
caught analysts by surprise – flash estimate of Chinese PMI manufacturing for
December fell sharply to 50.8 – a clear sign of weakness from 51.4 registered
for both October and November. The recovering trend since July 2013 to October,
which was an 18-month high after the mini fiscal stimulus, is now trending
down. This is a significant setback for Chinese economy and a grim sign of its
vulnerability to impeded growth or even decline on the back of weaker services
sector. One would expect Chinese manufacturing to pick-up in inventory
restocking ahead of the seasonal Spring Festival demand due end January 2014.
It is clear that the Chinese economy is weighed down by the imbalances of the
need for BPOC, China’s central bank, to restrict credit holding down its
speculative property bubble on one hand and the contradictory pressure of the
need for easy monetary stimulus to drive its economic growth hamstrung by the
weight of indebtedness.
The Chinese
government recently warned of its economy “facing
downward pressure”. http://www.bloomberg.com/news/2013-12-16/china-manufacturing-index-declines-preliminary-
reading-shows.html. Other analysts pointed to tighter liquidity and
relatively higher financing costs after interest rates liberalized. Economists
are now penning a slower rate of growth of 7% for 2014. While China’s economy
demonstrated strength in the fourth qtr aided by fiscal stimulus, its economy
over the course of the full year exhibited an overall growth slowdown as
tighter credit shrank for 7 consecutive quarters. http://www.scmp.com/business/economy/article/1385772/lack-loans-constricts-mainland-economy-beige-book-survey
Former US
Federal Reserve Chairman, Alan Greenspan, recently warned a Beijing forum that
China bubble posed further risks to China’s growth. He said –“I have no doubts that we see bubbles
arising in the current China economy, bubbles similar to the ones we see in the
West…… financial bubbles have been inevitable in the protracted periods of
economic and financial stability”. The obvious bubble in China is its
property sector and corporate leverage – which one will burst, is yet unknown
until the crash crunch time hits home.
The Chinese
version of the US QE3 tapering called “credit tapering” has already commenced
in June 2013. Liquidity is tightening but the problem is that the credit growth
is still exceeding the GDP growth and at some point forward, the deleveraging
of credit would have to accelerate to reverse this imbalance with downward
adverse consequence for economic growth. http://www.bloomberg.com/video/china-growth-may-moderate-slightly-in-2014-zhu-wOyUwHYZRd2MmUjuyXDqIg.html.
What we have been seeing of recent past is sudden spike in inter-bank market
rates forcing the China’s Central Bank, PBOC, to step in and supply short term
liquidity. With the liberalization of interest rate, the long-term bond borrowing
interest rate is moving up. Both the economy and its housing sector will be
under pressure in 2014.
KEY BAROMETERS TO WATCH & FORWARD OUTLOOK
I believe
these are two key parameters to watch going into 2014. They are the US longer
dated Treasury bond yields and its gross capital formation. The 10-year
treasury note yield which was 2.89 % immediately post the Fed’s tapering
decision has now topped over the 3% mark. http://www.marketwatch.com/story/treasurys-slip-after-jobless-claims-data-2013-12-26?link=mw_storieslike.
One of these could occur or both could occur in congruence or in opposite
direction. Increased business investment will create jobs, fire up US housing
sector demand and consumer spending. Rising 5-year, 7-year and 10-year Treasury
bond yields will have the opposite dampening effect - undermine business
investment and employment, consumer confidence, spending and GDP growth and
derail the tapering train.
Right now,
US manufacturing industry and volatile capital investment is growing, business
conditions in Europe is weakening, Chinese manufacturing momentum is reversing
downward and Abenomics is finding the
grind forward harder and harder of reversing its deflationary pressure. For
China, the liberalization of interest rate to market forces is a new spacewalk
into the unknown of unwinding the excess of monetary stimulus long overdue. To
the extent that the Japanese economy is on an expansionary quantitative
stimulus in contrast with the other major economic blocks like US, China and EU
is also a big gamble of economic unorthodoxy running against the weight of
global pressures of credit tightening. It is Japan’s economy space walk. Given
the size of US economy and some indications of its stronger economic conditions
of inflation well under control, improving labor market conditions and new
found gains in manufacturing supported by cheaper energy and productivity gain,
the QE3 reducing bond-buying program might well – if it succeeds – put the US
in the driver’s seat of leading global turnaround by taking leadership of
economy spacewalk into risks of unknown and uncertainty forward in 2014. UNTIL THEN, I SEE BIG VOLATILITY in economy
and financial market in 2014 at least as economies and tapering could
stumble from huge turbulent adjustments coming out of the worst financial
crisis.
We would not
be here today without the unprecedented scale of monetary easing globally since
the GFC and we are stuck with the challenges of being awash with this torrent
of volatile capital movement in the future. Quantitative easing floods markets
with enormous highly volatile liquidity chasing after every class of risky
assets and across borders. This will continues along with global economic
imbalances and its ever present destabilizing risks. Monetary policy is NOT the
panacea but an enduring “poisoned chalice” – no thanks to Ben Bernanke’s legacy
for a long time to come. The Fed must
have assessed the risks of tapering to be big given current global economic
conditions, hence the modest scale of retrenchment of bond-buying to just US$10
billion per month and its flexible time spacing. Global economy outlook in 2014 hinges
substantially on the success of the Fed’s graduated tapering of its
quantitative easing program and smooth adjustments within the fragile and
declining growth economies of EU, China and Japan – they are set to be key economies
taking the lead as locomotives. The evidence illuminates in this writing point
to EU and Japan as “hard basket” cases of economic fragility of deflation risks
and China is big unknown of a possible hard landing triggered by a liquidity
crunch bursting its real estate and manufacturing sector should there be
delayed big capital outflow. Emerging economies much weakened by depressed
commodity prices in overcapacity are slowing down. http://www.marketwatch.com/story/record-level-metals-storage-in-shadow-warehouses-2013-12-27?siteid=bigcharts&dist=bigcharts.
They are, therefore, are unlikely to be major supporting pillars, at least for
a while yet beyond 2014. In this harsh realities of difficult challenges, the
global economy will now gingerly inch forward -
a step at a time into the unknown of monetary policy excesses unwinding
– just like the measured gradual moves of Ben Bernanke’s tapering decision as
he will soon retires into global economic history as we do our spacewalking.
ANYONE DISAGREEING?
Zhen He
