Notwithstanding the best endeavours of the world’s major central banks, the mood in asset markets remains somewhat circumspect. In Europe, a multitude of thorny issues continue to raise their ugly heads. According to Der Speigel, the Greek fiscal shortfall is around EUR 20bn, much higher than original estimates.
If this is the case, then last week’s decision by the troika to leave Athens may well reflect more fundamental differences than both sides have admitted to. Separately, Angela Merkel and Francois Hollande apparently failed to narrow their differences over how and when to introduce joint Eurozone banking oversight.
Spain meanwhile appears to be inching towards a bailout request, but Rajoy and his ministers are desperate to avoid making an application before critical regional elections next month. In Asia, the discord between Asia’s two economic super heavyweights continues, while in China the latest Beige Book suggests that the pace of expansion is the weakest for 22 years! In response to this buffet of negative news, the Aussie has drifted down to near the 1.04 level, the single currency is at 1.2940, and both Asian equities and base metal prices are lower.
Very tough choices for the British Chancellor. Friday’s public sector borrowing figures simply reiterated just how incredibly difficult the chancellor’s task will be over coming weeks as he shapes his December 5th Autumn Statement. Net borrowing by the public sector (excluding the one-off transfer of Royal Mail pension assets) rose to GBP 59bn in the first five months of the financial year, up 22% on the comparable period of 2011/12. Most troubling is the sluggish growth in revenue, a reflection of the recessed economy, up just 0.4% for the year to date (the chancellor had been banking on 3.9% for the full year). Spending is up 3% so far in 2012/13, against a forecast of 3.5% for the full year. In recent weeks, the Treasury has been besieged with recommendations for stimulating the economy and rectifying the fiscal slippage. Some members of Osborne’s own party are calling for benefit payments to be frozen, a suggestion being fiercely resisted by the Liberal Democrats. Greater spending on infrastructure, reforms to both the planning and pension laws and more stringent cuts to spending have also been put forward. Without any remedial action to correct the deficit, the chancellor will be unable to meet one of his supplementary targets, namely to reduce the public sector debt to national income ratio during the 2015/16 fiscal year. Faced with this reality, George Osborne received some encouragement from BoE Governor Mervyn King, who claimed that not meeting the debt target was understandable given the eurozone crisis and the weakness in the global economy. King also opined that the government’s fiscal approach was ‘textbook’, high praise indeed and a welcome endorsement. Also, a Bloomberg story on Friday claimed that money managers would tolerate some fiscal slippage as long as the medium-term plan was still pursued with the same vigour.
At the same time, with party conference season about to get into full swing and the Conservatives way behind in the polls, Osborne will soon be under immense pressure to soften Plan A. He will also be aware that the rating agencies, especially Moody’s and Fitch, already have the UK on negative watch, and so a confession that the original debt target is unlikely to be met could be the trigger for a downgrade. As is so often the case for a chancellor, Osborne’s task is unenviable. He will recognise that a decent growth strategy must emerge, or else the ratings agencies will definitely raise their sights. In terms of how this all plays out for the currency and gilts, it might be relatively benign given that the deterioration in the public finances is already understood. Also, it appears that the economy has recorded positive growth in the current quarter, and the chancellor must show some willingness to bed down those green shoots. A downgrade would hurt the currency, but the damage may not be terminal.
Another currency war. Not for the first time, Brazil is shouting about the impact of further QE on the dollar and suggesting that its main impact is likely to be to lower the dollar in an attempt to boost US exports. So far, there is little sign of this happening, with the dollar (index) largely unchanged since the Fed announcement. It’s probably too early to draw strong conclusions on this front, with the dollar having bounced back from some oversold conditions seen just after QE3 was proclaimed. On the face of it, one may ask what exactly is Brazil complaining about. Brazil’s currency is around levels last seen three years ago vs. the dollar and is some 16% lower vs. a year ago against the US dollar. But the Brazilian economy has ground to a halt over this time and interest rates have been cut from 12.00% to 7.50%. These rate cuts have likely come to an end, with inflation still an issue in part because of poor investment in recent years. With other central banks also expanding asset purchases (or potentially in the case of the ECB), there is a diminishing pool of currencies which is not subject to zero rates and/or potential debasement by the relevant central bank. This has the potential to pressure the real higher into the end of the year, but as always with currencies it’s not a one-sided game and Brazil would be wrong to pin the blame for any appreciation squarely at the door of the US central bank.
Spain still prevaricating over aid request. Still no real movement from Madrid in terms of officially applying for financial assistance from one of Europe’s rescue funds. There was some excitement for the euro on Friday when the FT reported that the Rajoy government was in detailed discussions with the EC regarding some structural reforms as a prelude to applying for aid. However, the EC subsequently clarified that the conversations between Spain and the EC were purely normal, and did not in any way imply that that the Iberian sovereign was imminently set to file an application. Amongst a whole raft of measures, Spain is considering a freeze on pensions, increasing the retirement age, shifting the weight of taxation from income to consumption and making the labour market more flexible. Indeed, Spain’s government remains disinclined to seek outside financial assistance. They are simply delaying the inevitable, but while the bond market allows, they are getting away with it.