Saturday, 21 July 2018

On Goldilocks and Magic Mark

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Anthony Peters suspects the BoE chief needs to be slightly more hawkish.

Tuesday was a bit of a failed day. Monday had seen a strong reversal of Friday’s rout in risk markets but by Tuesday there was no conviction left, either way. 

The situation was highlighted by one iTraxx trader who wrote in his end-of-session comment last evening: “If I got a £ every time I say ’I don’t understand’ during the day, at the moment I’d be rich… Let’s leave it at that…”.

The difficulty to understand is not all that difficult to understand. If the economic outlook is good, risk assets should do well, but if it is too good, there is an enhanced probability that the central banks – that being the Fed and the BoE in this case – will begin the tightening cycle, which is bad for the pricing of risk assets.

Somewhere there has to be the Goldilocks sweet-spot where things are progressing well enough to keep the economy on a mild upwards trajectory but not quite that well that the Fed and the Old Lady think it’s time to reverse the money-for-nothing interest rate policy.

Slack watch

Today will see the BoE publish its Quarterly Inflation Report followed by Governor, Mark “The Magician” Carney presenting its findings to the assembled press. The buzzword all and sundry will be looking for is “slack in the labour market”, the definition of which sits in the dictionary of concise measurements right next to that of “the length of a piece of string”. The UK labour market is currently the best of breed with the velocity of job creation still seemingly picking up. The Bank is, however, along with the rest of us, faced and duly perplexed by the absence of the concomitant increase in wage pressure which the textbooks would have predicted for this point on the growth trajectory.

Should the Bank now assume that the relationship between falling joblessness and rising wages has been swept away in the new digital age or should it be bracing itself for a sudden surge at some time in the near future? I have lived through too many assertions that “This time it is different…” to believe them. I love to recall and repeat the line from the height of dot-com boom when we 40-somethings were all being blithely accused by 21-year-old graduate trainees of not grasping that things had changed that “The new economic paradigm ain’t worth a pair of dimes”. How true did that prove to be.

Carney will need to spell out whether he and his merry men of the MPC are going to believe that we are in a new, persistent low wage environment or whether they suspect that wage pressures are building up and that there might be a sudden jerk in pay levels which the Bank needs to be ahead of. On one hand, they won’t want to jump the gun, only to later find themselves accused of having been fighting windmills. On the other hand, this is not as bad as missing the inflection point and later being exposed to the criticism of having been behind the curve.

If my reading of Carney is right – it’s not easy given the amount of talking he does – he is acutely aware of the growth in household indebtedness which is outstripping both jobs growth and wage growth and therefore points to problems down the line when the cost of borrowing will almost certainly rise.

Before trying a shot across the bows – if misdirected it can hit and sink the ship – he might attempt to launch a simple ranging shot. Hence I’d expect him to be a little more hawkish than usual in order to see what the reaction will be. No day is a good day for one-handed central bankers but he could well decide to sit on one of them if only to gauge the reaction. It’s a big day for the Bank of England.

Taxing times

Meanwhile, Japan delighted with its Q2 preliminary GDP release which displayed more minus signs than you can shake a stick at. Annualised QoQ shrinkage was 6.8% which is awful, but which still beat consensus expectations 0f -7.0%. However, consumer spending undershot even the most cautious of forecasts at -5.2% vs -3.7% which was marginally compensated for by business spending being down a mere 2.5% as opposed to the consensus of a decline of 3.0%. Ugly as she goes.

The increase in consumption tax is being blamed for the distortions which somewhat mirror the pre-emptive leaps in the same indicators in Q1 so we’ll probably have to wait another one or even two quarters for the aftershocks to abate and for us to gain a more realistic view of how and whether head-line grabbing Abenomics is having a lasting effect on the Japanese economy.

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