The Barclays Global Credit index returned 2.7% (in dollars) in January with the financials component returning 4%. The alleviation of liquidity pressures on the banking sector in Europe should have knock-on positives for credit markets with banks more likely to be active participants than they were for most of 2011, even if the overall level of corporate bond inventory at banks remains in a secular downturn.
The trade-weighted euro did depreciate by 0.3% in January, but it was firmer in the second half of the month. We would like to see the euro weaken further because it is providing a stimulus to economic activity in Europe having dropped close to 10% since May 2011.
By some calculations, a 10% drop in the currency adds about 0.7% to GDP growth in the eurozone. Europe is more sensitive to exchange rate moves than the UK where a 10% depreciation of sterling only adds about 0.3% to UK growth. A weaker euro is therefore an important marginal benefit to Europe that will help mitigate the recession. A continued rise in the euro from here would concern us.
So we do think the balance of market action is constructive. Importantly, there have been three significant moves involving global central banks that we see as providing ongoing support. Combined they have reminded markets that if for many years “Don’t fight the Fed” has been a mantra worth paying attention to, then “Don’t fight the Fed and its friends” is definitely worth bearing in mind. First, the ECB’s three-year repo operation, offering money at 1% for a wide range of collateral, has provided a huge liquidity boost to the European banking system. This has very significantly reduced the probability of a major European bank going bankrupt. Although much of the European banking system is insolvent, the provision of the liquidity from the ECB will allow banks to repair balance sheets via the carry trade offered by the low ECB funding.
Secondly, the abating of inflationary pressures in the developing world has allowed policymakers to shift from tightening to loosening policy. We have seen China, Brazil and India move to easier policy in recent weeks. This is likely to mean fears of a hard landing in China will be unfounded – the emerging world remains a beacon of growth in a slow-growth world and benefits the developed world too as, for example, Germany exports the equivalent of 10% of its GDP to emerging markets.
Finally, the Federal Reserve has shown itself to be even more dovish than the market thought, pushing out the time it expects to leave short-term interest rates at current de minimis levels by eighteen months to the end of 2014. Chairman Bernanke has also made it clear that he stands ready to do more quantitative easing should the recent improvement in high-frequency economic data show any signs of weakening.
Trading Places was the sort of movie about finance that one was happier watching than Too Big To Fail, or any other of the recent movies on the financial crisis. Rather than ending with a list of jail terms and general humiliations imposed on its principal characters, Trading Places ends with the two heroes on a beach, being waited on by attentive friends and staff. “Looking good, Billy Ray”; “Feeling good, Louis” they say to each other. That is not the sort of dialogue that we have heard in a movie about finance for a while. Heck, it’s not the sort of dialogue one has heard around the office. Let’s hope we begin to hear it in the weeks ahead. It may even be time to freshen up the wardrobe in case a beach holiday becomes justified.
