By David Llewellyn-Smith, founding publisher and former editor-in-chief of The Diplomat magazine, now the Asia Pacific’s leading geo-politics website. Cross posted from MacroBusiness
PIMCO famously coined the phrase to “the new normal” to capture what it saw was a structural change to global markets in the wake of the GFC. It was to be period defined by lower returns on assets owing to a combination of delevering, deglobalization, and reregulation. Today that looks like fantasy.
Last night, the Obama Administration proposed its new budget plan for the years ahead with significant austerity measures already embedded. From Bloomie:
The administration forecasts that the federal budget deficitfor the fiscal year that begins Oct. 1 will be $744 billion, or 4.4 percent of the economy. The Office of Management and Budget estimates that the shortfall this year will be $973 billion, or 6 percent of the economy. The budget projects the deficit will decline to 2.8 percent of the economy by 2016 and 1.7 percent by 2023.
Administration forecasters cut their estimate for U.S. economic growth this year to 2.3 percent, matching last year’s rate, down from the projected 2.7 in July. For all of 2014, the economy may expand 3.2 percent, budget figures showed. Private forecasters surveyed by Bloomberg put growth at 2 percent for calendar year 2013 and 2.7 percent for calendar year 2014.
Equities shrugged this off. Public deleveraging? Phht!
Last night also witnessed the Fed Minutes via the FT:
The US Federal Reserve was ready to slow down its QE3 programme of asset purchases in the summer or early autumn but weak payrolls data may already have changed its plans.
According to the minutes of its March meeting, released early on Wednesday after an accidental leak, “many” participants at the rate-setting Federal Open Market Committee said that continued labour market improvement should prompt a QE slowdown “at some point over the next several meetings”.
According to two sources in Congress, the accidental release came from Brian Gross, a special assistant to the Board of Governors who works on government relations.
The next meetings of the FOMC are in April, mid-June, late July and then mid-September. Only a “few” participants thought that the economy would be weak enough to keeping QE going at its current pace until late in the year.
The minutes show that the Fed was gearing up for a tapering of the QE programme at its last meeting, much earlier than markets had expected, but that debate may already be out of date after feeble jobs growth of just 88,000 in March.
Given the latest data, the Fed is likely to wait and see whether the March figures were just a blip or a sign of deeper weakness in the labour market before deciding how long to keep buying assets.
Equities plowed straight through this event as if it were not even there, signaling decisively that the share market no longer fears monetary tightening. Private delveraging? Phht!
Also fueling the last week’s rally has been the excitement generated by the monumental act of monetary intervention by the Bank of Japan. Currency wars are nationalist endeavours aimed at seizing production from other countries by manipulating interest rates. For Japan, the domestic efficacy of the measures are highly questionable given thirty years of the same approach has failed. But the external effects have already been spectacular and will continue to be so with the yen collapsing across the board and big profitability and competitiveness boosts pouring in for exporters.
This is an outright good for Japan but one has to wonder why anyone else, especially American markets, are excited about it. Currency devaluation is a zero sum game and Japan is simply going to take more from a pie that is no bigger than yesterday, meaning American firms will eat less. Those most impacted in American markets will be manufacturers, supposedly the key recovery sector for any sustainable US economic renaissance. Deglobalisation? Phht!
The real explanation for why markets have so loved the Japanese intervention is that it means more free money via excited carry trades and forex volatility. Even the IMF is warning about it. From the FT:
Speaking ahead of the International Monetary Fund’s spring meeting in Washington next week, Ms Lagarde said that the world was dividing into three groups – some countries doing well, some on the mend and some still in trouble.
Her speech highlights a new phase for the global economy in which the uneven pace of growth around the world is creating new financial imbalances that could sow the seeds of a future crisis.
“We do not expect global growth to be much higher this year than last. We are seeing new risks as well as old risks,” Ms Lagarde told an audience in New York on Wednesday. “In far too many countries, improvements in financial markets have not translated into improvements in the real economy.”
Emerging economies were growing fast, she said, but low interest rates in advanced economies were prompting them to build up debt and foreign exchange exposure that could cause trouble.
“Over the past five years, foreign currency borrowing by firms in emerging markets has risen by about 50 per cent,” said Ms Lagarde. “Over the past year, bank credit has increased by 13 per cent in Latin America and 11 per cent in Asia.”
She said that developing countries needed to respond by beefing up bank supervision, restricting credit to fast-growing areas, imposing capital requirements that changed with the economic cycle and monitoring their foreign exchange exposures.
The tenets of the new normal are crumbling. Asset returns are accelerating. Enjoy it while it lasts but don’t forget where it ends.