Financial markets have normalised. Much of the dislocation has been resolved – and the more obvious opportunities provided by dislocated markets have to a large degree been exercised (think of recent moves in sovereign bonds, corporate bonds, bank credit, emerging equity markets). Equity market volatility has subsided.
The US economy will come out of recession in H2 2009: positive growth will be achieved and is well under way. Preliminary Q2 estimates of GDP will be released on Friday. Even the housing market has turned with sales of new houses off their bottom. Yesterday’s Durable Goods number – excluding volatile aircraft orders – was a good number. Such a view of recession being over is not contentious but is now consensus.
The normal forces of economic growth and earnings growth surprises (up or down) therefore take over as the main drivers of equity and bond markets. Higher short and long term interest rates – while a sign of recovery under way – will not be welcome.
The key issues will be the pace of US recovery, V or U shaped – and even it is V shaped (driven by depressed output catching up with stable final demand) – the question that will be asked of the US is: can such fast growth be sustained over the next few years? That the US recovery is ahead of Europe’s should be helpful to the US dollar/euro rate of exchange.
The answer to this issue about the long term growth potential of the US economy is for observers to expect less long term growth. Given the state of fiscal policy, higher taxes and more intrusive government will be expected to restrain growth. The ability of the Fed to withdraw the punch bowl before the party gets raucous will remain a live one – inflationary expectations remain very low and explicit real interest rates remain depressed. The bond market vigilantes are sleeping soundly at home for now. Any inflation threat to bond yields and mortgage rates will be most unwelcome but always possible. Corporate bonds remain more enticing than government bonds.
Emerging market economies offer a much healthier prospect, but their equity markets have run very hard, as have their currencies. The EM index and the JSE ALSI in US dollars are both up 80% from their lows in early March and the rand is up there with the best performing EM and commodity currencies. This is a very powerful run indeed. China has led the way and possible oriental bubbles will be of concern.
The SA economy continues to languish without active enough assistance form monetary policy. But the better state of the global economy will be helpful to SA exporters. Lower inflation and the strong rand will be helpful for consumers.
Reserve Bank Governor Tito Mboweni’s decision not to lower rates in June can perhaps be regarded as a final act of defiance. Knowing (presumably) that he was to lose his job he stuck to his inflation target guns even as his ship was sinking. He had failed to seize his opportunity to save the economy with an activist programme. Even as central bankers elsewhere put on the Superman capes he remained aloof as if all that mattered was inflation. This was not only arguably an error of judgment but obviously very poor survival tactics.
The case for lower interest rates remains as strong as ever and if Gill Marcus is in the next MPC chair – one assumes she will be – she will surely wish to distance herself from her predecessor. They apparently did not get on at all well when she worked at the Bank as Deputy Governor and resigned accordingly.
There is in this author’s mind at least a 50% chance of a 50bps cut at the August MPC meeting; and if August is too soon to signal change in direction of monetary policy then there is a much greater chance of a cut, perhaps even a 100bps cut, at the following meeting. The money market is not expecting any change in rates for now – or at least wasn’t yesterday. Watch this space.
*The author wrote this piece while on a visit to the US