Was the Friday rebound in equity markets another BTFD
opportunity, or a possible suckers rally? Certainly, the wall of central bank
liquidity over the past five years have reduced the market’s pricing mechanism
to little more than a pavlovian response to the next turn of the central tap
and where bad news can be good news for prices if it raises expectations of a
bigger flow. News however, whether good
or bad that does stimulate more liquidity may just be bad news.
Last week had a lot of ‘bad’ news. This however was not new
bad news. The US continues to goad Russia, albeit now through bombing its ally
Syria and getting its own ally Saudi Arabia to cut oil prices on which Russia
also depends. Ebola continues to spread, which is bad for airlines, but good
for pharma and security. Japan continues to struggle with radiation, a collapsing
economy, rising real inflation and what should be an utterly discredited and
failed QE policy. Europe meanwhile
continues to grind back into recession, but having approached the moment of
truth may be shying away from the full QE programme that advocates were
predicting after Draghi’s recent Jackson Hole speech. Notwithstanding a partial attempt with an ABS
programme, this fell short of expectations and so bad news was just bad news
and markets reacted accordingly.
Unfortunately, market volatility is an inevitable
consequence of the deliberate confusion about the nature of the ECB and Euro
that has been sponsored by politicians and central bankers. At the centre of
this has been Merkel who has been trying to ‘hunt with the hounds and run with
the hares’. EC treaties are clear and
indeed have been paid lip service to by Draghi when he re-iterates that the EC
is “not a transfer union”. His actions however
belie this, including advancing ECB liquidity to domestic banks who have used
this to buy local sovereign debt in the secondary market to circumvent the ECB’s
prohibition to fund primary debt. Notwithstanding the German constitutional court’s
ruling in February (which had been sat on for around 9 months) that the ECB’s
OMT plan “manifestly violates” the EU treaties, Merkel seems happy just to turn
a blind eye while playing a ‘good cop, bad cop’ game with Bundesbank president Jens
Weidmann. This, together with Draghi’s “whatever
it takes” and subsequent utterances have goosed the market into believing peripheral
EU sovereign debt is now backstopped by the ECB and therefore German
tax-payers. German tax-payers however have not been consulted and seem to be in
no mood to comply, as today’s comments from a key Merkel ally, Hans Michelbach
of the Christian Social Union (CSU) might suggest. Not only is Draghi accused
of “endangering the stability of financial markets”, but more pertinently Herr
Michelbach reminds us of the now largely ignored constitutional court ruling
and that “The ECB needs to change its policies so that they come back within
the terms of the treaties”
http://uk.reuters.com/article/2014/10/04/germany-ecb-draghi-idUKL6N0RZ07N20141004
So bad news in Europe may not be the ‘good’ bad news that
markets have run with during the US QE programme, but ‘bad’ bad news for
markets if the ECB is approaching that crisis point where it has to reveal
whether it has any real bullets in its monetary pistol or has just been fooling
us with blanks. Perhaps by taking Europe to the cliff, Draghi feels he can
present the German tax-payers with a fait-accomplie from which they dare not
refuse, as such a refusal would have devastating consequences to peripheral
bond markets and banks. Germany’s decision however, will not be telegraphed to
us muppets ahead of time. With peripheral Euros now invested back into peripheral
bonds and banks, the creation of a hard currency Northern block at this stage
would not be saddled with a mountain of peripheral euros in Germany which might
have to be converted at par into the new Deutschmark. While the ‘soft’ Euro
areas would then be free to monetise debt and devalue, yields would rise
significantly and there would be no shortage of burnt positions amongst bond
investors.
So what was the cause of Friday’s market euphoria, a cure
for Ebola, peace on Earth? No, it seems a slightly better than expected monthly
job growth figure in the US non-farm statistics for September. To qualify as a ‘good’ figure for markets
however would either be a really ‘bad’ number that would raise the prospect
that Yellen would defer the QE tapering and keep the liquidity tap and low rate
environment going indefinitely or a figure that was so good as to signal a
serious acceleration in US GDP growth prospects. Unfortunately neither of these
would apply to the September numbers. At +248k net new jobs (+236k private), US
job growth was around +30k ahead of consensus and the trailing 12 month rolling
average of approx. +213k, albeit in large part reflecting a +40k MoM swing in
retail (from -4.7k in August to +35.3k in Sept). While the numbers are ‘so..so’, they do not deserve
the praise heaped on them by political spin doctors who focussed on the flawed
unemployment ratio (-0.2ppts to 5.9%).
Perhaps a little perspective is needed for this political
hot potato. First, the context. For the year to end September, US private
sector employment increased by +2,588k/+2.25% to 117.524m versus a total civil
non-institutional population that increased by +2,278k/+0.93% to 248.446m. This is hardly spectacular given the government
and central bank largesse over the period with private sector job growth only
just exceeding population growth. But what about incomes? Average hours have barely changed at 34.6 pw
(vs 34.5 pw) while average hourly earnings are struggling to keep pace with
inflation with a +2.0% YoY increase to $24.53 p hr (from $24.04 p hr) to take
average weekly earnings from $830.07 pw to $848.74 pw, an increase of +2.2%
YoY. Multiply this by the increase in
employment and this implies that private sector wages increased by
+4.6%/+$225.8bn to approx. $5.2tn. Although this may seem ok, there are a
couple of points one may need to consider. Firstly, don’t forget that the
private sector ultimately has to support the entire working population and that
these figures are nominal. Also, remember that the US economy is worth approx. $17bn
pa, which means that the $225.8bn increase in private sector wages is equivalent
to only +1.3% of GDP. If consumption
accounts for around two thirds of GDP in the US, clearly private sector wage
growth alone will not be offering much of a boost this year!
So back to Friday’s market bounce. As the dog might utter, “Woof,
Woof”
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