This essay is full of contradictions and loose ends, so I might as well start with one in the title. This cycle is not over yet, and I am not sure that I have the definitive answer for when it will end. It is, however, well advanced with some themes and narratives. I am writing this in an attempt to make sense of and to explain, a world, which to my despair is increasingly devoid of reason. As a finance geek, I can’t get anywhere without first establishing the state of play in the economy and markets. The most salient feature since the financial crisis has been the unprecedented activism of monetary policy. In 2006, Alan Blinder described central banking in the 21st century. It is a brilliant paper but in dire need of an update given actions taken by policymakers since 2008. Central bankers were first called into action to prevent a collapse. The destruction in markets after Lehman’s failure showed that timidity or firmness in the face of moral hazard risk was impossible. Interbank markets were seizing up, banks were running out of liquidity, and the chaos quickly was spreading to the real economy. Decisive action was needed to avoid the situation spiralling out of control. Central banks had to take their role as lenders of last resort seriously.
Read MoreOne of the more enjoyable aspects of being an independent macroeconomic researcher—at least for a geek like me—is the road trips when you get to speak to clients and prospects. Sure, you see more airport lounges and hotel rooms than you need to. But there is no better way to gauge the zeitgeist than to spend a week in meetings with portfolio managers and asset allocators. I have done just that in New York, and I sense a cautious optimism that the positive trend in equities and credit and the economy will continue for a bit longer. In my capacity as a Eurozone economist, my central message to the wardens of our capital was that the European economy is just fine. But I also spent time floating the following proposition: Monetary policy divergence is back with a vengeance, and macro traders will make, or lose, their money on this theme in the next 12 months. The ECB and the BOJ recently have signalled to markets that they will be stuck with negative interest rates for a while. Meanwhile, the the Fed is on the move, a point highlighted by Friday’s robust advance Q3 GDP report, which suggests that growth in the U.S. economy was a punchy 3% annualised, despite a drag from two hurricanes.
Read MoreIt’s been a while since I had a look at financial markets. But I am happy to report that the laws of the natural world, inhabited by investors, are undisturbed. Volatility across most asset classes remains pinned to the floor, equities have pushed on—with the annoying exception of the majority of the portfolio’s holdings—and short-term rates in the U.S. also have crept higher. In this environment, the DXY has regained its footing, although it still looks vulnerable relative to many of its G7 sisters, and the yield curve in the U.S. is still not sure whether to steepen or flatten. It seems to have settled in the middle; a small rise across the curve. Political risks have returned to Europe—did it ever go away?—but I am unimpressed with the bears’ attempt to kick up a fuss. In Germany, I am reasonably certain that a government is formed, eventually. In Spain, I think the Catalan separatists are on the road to nowhere. Their leader Carlos Puidgemont is caught between a rock and a hard place, and I think they will need to have regional elections to settle what precisely the mandate is. Finally, we are supposed to worry about Italy leaving the Eurozone. Break-up risks in the euro area, however, is the dog that never barks. The periphery wants to use the euro, not jettison it for their own.
Read MoreMarkets were focused on one of their favourite pass-times last week; fed watching. The FOMC underlined that it considers recent softness in core inflation to be transitory, and also defied uncertainty over two hurricanes which battered the U.S. earlier. Mrs. Yellen informed markets that the run-off of the Fed’s balance sheet will begin in October and that the Fed believes the economy is strong enough to warrant a continuation of the so far slow, but steady, hiking cycle. The peanut gallery saw this as a moderately hawkish statement, but this was because markets had been pricing out a December rate hike going into Wednesday’s meeting. Fed funds futures and front-end rates have since corrected to reflect a near certainty that the Federales will raise rates one more time this year, likely in December. In effect, though, the Fed merely confirmed the path that it set out 12-to-18 months ago. Last week’s signal to markets from the Fed led punters to re-evaluate a vexing question; does the market lead the Fed or the other way around? The vibe I am getting from the veterans on FinTwitter is that the Fed laid down the gauntlet, signalling that it intends to push on. If that is true, trades are there for the taking.
Read More