MUNIX COMMENTARY – 9th December
Will this year end with a big fireworks display?
It is customary to see fireworks at the end of the year. Four of the world’s most important central banks are scheduled to light the blue touch paper at a series of important policy meetings next week, plus there is the possibility of surprise announcements from others such as the People’s Bank of China.
The Federal Reserve, ECB, Bank of England and Bank of Japan have entered their period of purdah ahead of important meetings on December 15th (USA), 16th (UK and EMU) and 17th (Japan). Starting with the Fed, it is widely expected to taper or reduce its massive monthly purchases of bonds. The US economy is growing strongly – amazingly the Atlanta Fed’s ‘GDP Now’ measure is suggesting growth could reach 10 per cent in the final quarter, whilst surveys continually warn about pricing pressures. The next CPI report is due on Friday. Tapering might only last a few months; the consensus amongst economists is that it could finish by March or April opening the way for the Fed’s first-rate increase – albeit the timing has been pushed back by the uncertainty about the new variant of the virus.
The last few announcements suggested a mixture of views at the Bank of England. Michael Saunders, who voted for a rate hike last month, said he wanted more information about the impact of Omicron before deciding how to vote this time. Conversely, Ben Broadbent warned that headline inflation might comfortably exceed 5% in the short term. Last month the first hike was delayed because of uncertainty over the impact of the end of the furlough scheme. Since then most economic data such as business surveys have been quite strong, but the government has announced new restrictions to try and control the spread of the virus. Accordingly, the decline in the pound vs the US dollar in recent days suggests that the market is swinging more towards the view that the first rate hike will again be delayed until February.
Christine Lagarde has emphasised time and again that the ECB will not aggressively follow the Fed or Bank, despite inflation running at record levels. One explanation for her caution is the level of financial risk across Europe. The ECB’s systemic risk indicator shows debt servicing pressures; it views stretched financial asset valuations as vulnerable to repricing if global liquidity conditions change too much. All in all, the bank is expected to announce that it will halt new bond purchases next spring – albeit a long time behind other banks such as the US, UK and Canada – but its’ cautious approach means it may still be well into 2022 before investors are quite certain about the precise path and speed for tapering.
Turning to Asia, no action is expected from the Bank of Japan whilst it assesses anther mega supplementary budget from the new government. China might act again, worried about the debt crisis facing the likes of Evergrande and Kaisa. Following a recent cut in commercial bank reserve ratios, in a bid to lower financing costs for businesses and offset a noticeable slowdown in the world’s second largest economy, the PBOC might act alongside any signals from December’s central economic work conference. This will outline fiscal policies for 2022 as the “policy priority is shifting from regulatory tightening to supporting economic growth”.
Even if global monetary tightening does start in December and continues into 2022, it is interesting to note that the financial markets are strongly coming towards the view than central banks will not be aggressive. Despite inflation higher for longer and a mass of asset price and debt excesses, the situation in China and the appearance of Omicron mean bond investors are not showing concern. The yield curve is flattening, that is shorter dated yields are rising whilst longer dated are declining.
US benchmark 10-year yields are trading around 1.5%, whilst 30-year yields have fallen all the way from 2.5% to 1.9% since the spring. UK gilts have declined below 0.8%, their lowest since September. Japanese 10-year yields are about zero and German stuck in negative territory. Indeed the shape of the curve suggests that the Fed rate hikes will stop at only 2%, very low versus history. Hence investors will carefully monitor the Fed’s next ‘dot plot’ showing the longer-term interest rate expectations for Governors.
Will year end see a mega fireworks display or a series of damp squibs? The economic data is easier to interpret than Omicron which is the swing factor at present; it would take considerably more positive news from pharma companies and scientists about the efficacy of vaccines to encourage yields to turn much higher.
Andrew Milligan is an independent economist and investment consultant. This note is offered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making