No respite for asset markets on Friday or overnight with the mood on global growth concerns and the ever worsening situation in Europe continuing to darken. After Friday’s troubling losses, European bourses are expected to open significantly lower today, following some heavy losses in Asia overnight. In currency markets, the euro is still sliding, now down to 1.21, a new 2yr low. EUR/JPY has fallen to a new 11yr low, EUR/AUD fell to a record low against the Aussie overnight, and EUR/GBP is at 0.7775. As usual, it is the Japanese yen that is attracting most of the safe-haven flows, followed by the dollar. USD/JPY is down near 78.0, a level that has prompted much gnashing of teeth in Tokyo overnight. High-beta currencies have also fallen back, with the Aussie down near 1.03. Meanwhile, Spanish and Italian bond yields continued to soar on Friday – the Spanish 10yr yield rose another 25bp to 7.27%. Looking forward, traders will be keenly focused on the outcome of UK and US GDP figures for Q2 due out Wednesday and Friday respectively.
The new normal – a no-yield world. We no longer live in a low interest rate environment, but rather in an increasingly NO interest rate environment. Indeed, in some jurisdictions, it has actually become a negative interest rate environment. A multitude of inter-dependent forces account for this metamorphic interest rate backdrop – a lack of growth, the threat of deflation, widespread and simultaneous balance sheet de-leveraging, a lack of investment opportunity, low return on capital, a highly developed preference for liquidity and safety, endemic doubts concerning the future of the euro, doubts about the safety of the banking system and the financial system et al. No doubt other explanations could be offered. In effect, wealth owners implicitly are of the view that the best way to safeguard their money is to give it to the government, and yet most of those governments are increasingly burdened by a mountain of future liabilities. It is a thoroughly depressing picture. In financial terms, it is as though nowhere is particularly safe these days. Be prepared – this situation is not sustainable. Ultimately, there must be a huge financial reset.
Prophetic warnings from China. Amidst the marked slowing of growth recorded in the world’s second-largest economy in the first half of this year, it is no surprise that corporate profits have been adversely affected. Of the 760 listed companies that have reported results for the first six months, more than half have registered a decline in net income from a year earlier. This in turn is weighing on business confidence. Chinese management have been berating policy officials consistently over recent months over their failure to respond more forcefully to the weakness of the economy. Although some targeted fiscal and monetary measures have been announced, it is clear that more is required. Earlier this month, Premier Wen Jiabao issued an impassioned plea for structural tax changes, which the Chinese cabinet is likely considering. As a result, it would be no surprise if Beijing announced both tax cuts and a further reduction in bank reserve requirements in the near term. The current corporate tax rate in China is 25%. Against this challenging backdrop for both the economy and profits, it is little wonder that the Shanghai Composite Index has been so disappointing this year – indeed it is one of the worst-performing bourses in the emerging-markets universe for the year to date. At the same time, policy-makers have warned that they will proceed only slowly in terms of releasing the hand-brake they have applied to the banking system, in part because they fear longer-term inflation. They are acutely aware that the housing genie could escape from the magic bottle again very quickly.
Waiting for gold. After the relatively flat performance during the first half of the year, it’s not that much of a surprise to see the World Gold Council putting forward a bullish case in its latest quarterly report. We wrote earlier this month about the struggles that gold is having currently (“Gold putting up a fight”) and the relative lack of volatility vs. the past 3 - 4 years. But beneath the surface, there is a multitude of conflicting forces. Of course, the World Gold Council’s focus is on the established theme of general currency-debasement as central banks around the world undertake ever more inventive methods of quantitative easing. Furthermore, the Council jumps on the rise in yield seen in German bonds (i.e. price fall) seen during June as a sign of the vulnerability of some safe-havens, despite the fact that the moves have all but been reversed during the course of July. It also focuses on the risks surrounding some of the safe-haven currencies such as the yen, dollar and Swiss franc. What is true in the Council’s analysis is that gold is trading less like a safe-haven asset in terms of its correlations with other markets. Gold’s inverse correlation with the dollar has certainly not been as strong as was the case in the first quarter, currently -0.46 from nearer -0.60 in Q1 (on a 3mth rolling correlation). We talked about this yesterday for the Aussie dollar as well (“Aussie losing the high beta mantle”) and its diminishing risk correlations. For gold to push to new highs however, what it needs is a weaker dollar and (related) some evidence that QE is leading to currency debasement through inflation. So far, apart from in the UK, there is scant evidence of this and even the pound has stood up well as UK inflation has pushed ahead. Gold bulls may have some more waiting to do.