Tuesday, 27 May 2014


Politics drowned out important economic news, with the Pan-European electorate taking the opportunity to deliver a message of disapproval and discontent to Europe’s political elite over the handling of European affairs over the past years. I sincerely hope that this will not drive the EU back into national parochialism, but rather give the political leadership the wake-up call they need to utilise the European potential for the greater good of its peoples rather than continue to bicker and drive apart.

Enough of politics - more important from my perspective were the latest data releases in the UK and China and the calming of bond markets. In the UK news of resurging business investment brought one of the signals the Tatton investment team had been waiting for since the end of last year. To us it is confirmation that this economic upturn is more broadly based than the much talked about housing and debt financed consumer demand. UK companies finally investing their cash piles to the tune of £33bn over the past year and thereby reaching pre-recession levels is a very encouraging sign that this expansion has further to go. Business investment is a very important component in the creation of GDP and UK companies have both the money and are long overdue for investment into modern productive capital. There is still room for further improvement given investment levels weren’t at particularly satisfactory levels back in 2007/2008, but the trend is there and has encouraging upward momentum.

China’s forward looking industrial production data improved markedly last week and confirms our view that China is less of a concern than many observers deduced from the frictions in its financial system and overheating housing markets.

Last but not least bond markets appeared to come around to the central banks’ policy setters way of thinking that interest rates and in their wake longer term yields will rise far more gradually than anticipated, because the global economy is likewise only quite gradually expanding during this economic cycle.

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Tuesday, 20 May 2014


Market action over the first part of the past week appeared to make sense – the second half left market participants wonder whether they had collectively gone slightly schizophrenic. First equity markets in Europe and the US rallied to new highs as economic data and central bank statements appeared to create the Goldilocks environment of ‘not too warm, not too cold’, stock markets like so much. In Europe equity markets seemed to ‘salivate’ over the prospect that the ever falling rate of inflation will force the ECB to finally launch its own program of quantitative easing (QE) - aka - printing money. Then on Thursday and after the Bank of England’s governor Mark Carney had talked down exceptionally good UK data they appeared to realise that monetary easing actually is a consequence of things not being quite alright. Stock markets fell quite abruptly by up to 2% and even more extraordinary, longer maturity bond yields fell back sharply. This bond rally (yield and bond values move inversely) was even more astonishing as most market participants have for a while now expected a break out from the recent tight trading range, but on the downside, not the up! On Friday stock markets came back to their senses and recovered somewhat, however, 10 year gilt and treasury yields have stubbornly remained at around the 2.5%.

It seems nonsensical that bond investors should be willing to accept less return for their locked-up money, when the economy is expanding and therefore better return alternatives are available and inflation eventually rises and eats away at the purchasing power of bond values. So what has happened? The simple answer is: The central banks got their way but market participants can’t quite explain why.
When longer maturity bond yields almost doubled last year on better economic prospects, central bankers were not best pleased, because markets were undoing their QE efforts of keeping not just short term rates, but also the longer term cost of capital low. This was to absolutely make sure that both the credit markets and the wider economy can sustainably recover. It seems that only over the past few months markets have come to actually believe central bankers’ assurances from last year that this time they will keep rates low for longer. Various reasons were banded around this week trying to explain why yields were falling when things actually look up a lot more. My humble opinion is simply that amidst last year’s euphoria over the economic recovery, bond yields overshot and what we have seen now is a re-adjustment towards a more gradual incline, as would have made sense all along. I therefore strongly disagree with those who (once again) interpret this temporary countertrend movement as heralding the end of this economic cycle. I expect that a more measured and gradual rise in yields will resume fairly soon. There is a positive here which too many market commentators have failed to mention, which is that low cost of finance is supportive for economic growth. Last week’s disappointing GDP and industrial output growth figures in the Eurozone serve as timely reminders that there is still not much reason to get carried away and to expect cyclical overheating symptoms any time soon. The gradual normalisation process is to some degree unchartered territory, because central banks have never before been as determined to see the economy and the financial sector heal, before withdrawing their support. This causes unintended side effects, the UK house price inflation pressures being one of them. However, we must not confuse cause and effect here. A house price rally in the past may have been experienced as a late cycle occurrence, which this time around is very unlikely to be the case. As such expect the UK’s Bank of England to unleash their arsenal of macro-prudential defence instruments instead of early rate rises, once they come to the conclusion that further price rises (beyond London) are posing a risk to our future prospects. Lower loan to value and/or mortgage to income ratios enforced through the banks will prove very potent means of calming things down. I now don’t expect the first UK rate rise before the general election in 2015.