by Damon de Laszlo, ERC Chairman
A week is a long time in politics. A month is becoming a long time in economics.
In July, there was still a feeling, in spite of the political mayhem in the US and Europe, that the third and fourth quarters of the year would probably see improvements. What optimism there was, however, has evaporated as the European Central Bank (ECB) and the Fed have indicated they anticipate a risk of recessions by cutting interest rates. The US has cut interest rates and the ECB is preparing to take interest rates further into negative territory and to expand Quantitative Easing (QE). Trump has reignited the trade war with China and Tokyo has added to Global trade problems by escalating its trade war with South Korea, and the Bank of England’s, Mark Carney, has not been able to resist predicting falling growth for Britain after 31st October if the country leaves the European Union (EU) with a deal, and a major recession and collapse of Sterling if the UK leaves without a deal; something he forecast was going to be the immediate effect of the UK voting to leave in 2016!
While there is some justification for the Fed’s action, bearing in mind the President’s zig-zagging trade policy and the economic statistics that are beginning to show some slowdown. The Bank of England’s intervention in the economy would seem to be intended to unnerve the economy and influence politically the Brexit debate at a time when the UK economy that is proving more robust than the rest of Europe.
The ECB is faced with a major dilemma in that Germany, the powerhouse and paymaster of Europe, has a rapidly slowing economy, to some considerable extent driven by the collapse in demand for its motor-cars around the world. Germany has an export-driven economy which is dependent to a large extent on the US, China and the UK for markets. The increasing demand for cars that was experienced after the downturn of 08/09 has flattened out and is being further pushed into reverse by the issues of diesel and a growth in mistrust in German technology.
A major problem for the ECB is the lack of regulatory improvement in the European banking system. By and large the US and UK banks have been cleaned up and have grown their reserves, something Europe has failed to achieve. The problem is exacerbated by negative interest rates which have a major impact on European banking profits, making it difficult to improve reserves.
A major worry in the global financial system is the inexorable rise in government debt in China, Japan and the EU which started to dip marginally after 2017, but has turned up again, particularly with Europe announcing it is turning on the tap. The rise in debt, for different reasons, is supposed to help the economy but the impact of pouring money into the economy, QE by various means, is proving less and less effective, while propping up zombie parts of the economy and it is also causing huge mis-allocation of capital.
Low and negative interest rates, along with politically generated economic uncertainty is encouraging institutional, as well as private, money to flow into Bonds. Some $487 bn. has flowed into Fixed Income funds this year, up from $148 bn. in the first half of 2018. It is also encouraging enormous investments in negative interest rate bonds, many of very long duration. This trend ignores the potential for interest rates to rise and it would seem highly improbable that this is never going to happen. If and when it does, the loss of capital in what are mostly pension and insurance funds, will be enormous. Capital is also being driven into more and more dangerous investment vehicles which purport to be liquid assets, but owing to complacency in the regulatory oversight, will fail in the face of rising interest rates or even a minor economic crisis, when liquidity is required.
Bearing in mind we are in the ‘silly season’ for news, so there are many stories being promulgated by those agencies that seek attention, one can hope that with the return to work in September the inflammatory rhetoric will die down.
Happy summer holidays.
Damon de Laszlo
12 August 2019