May 13th, 2015
- The past few weeks have witnessed reversals from trends of the past 12 months in European bond yields, the value of euro versus the dollar, and the price of oil. We investigate the factors contributing to them and assess whether they are likely to be sustained.
- The spike in European bond yields appears to be a correction to markets that had become significantly over-valued after the European Central Bank (ECB) launched its quantitative easing program at the beginning of this year. That said, the situation is very different from the “taper tantrum” that occurred in the U.S. two years ago, as the ECB is committed to buy massive amounts of bonds at least through September of 2016.
- At the same time, the euro has firmed against the U.S. dollar amid weaker-than-expected economic news in the U.S. and diminished expectations of Fed tightening. However, we believe the softening of the dollar will be temporary.
- The rebound in oil prices of $15-$20 per barrel for West Texas Intermediate and Brent crude may stem from diminished supply in the U.S. However, U.S. oil production could increase later this year if prices stay at current levels, which would renew pressures on oil prices. In any case, we do not foresee a continued rise in oil prices this year.
Spike in European Bond Yields
Over the past few weeks European government bond yields have spiked by 50-75 basis points, with the 10-year German bund yield rising from a record low of 5 basis points to as high as 80 basis points. It is currently trading around 70 basis points. According to economists at J.P. Morgan, this is one of the largest and swiftest sell-offs of bunds during the Economic and Union Government Bond (EMU) era, and it appears to reflect an unwinding of positions that investors put on when the ECB embarked on a massive bond-buying program at the beginning of this year. Read the rest of this entry »
April 13th, 2015
Remarks delivered at the International Economic Forum of the Americas on April 13, 2015.
Dear Mr. Chairman,
Thank you for the opportunity to be part of this distinguished panel and to share my views on the impact of international economic developments on Latin American economies and policies. My perspective is that of an international economist and global money manager. I am not an expert on Latin America, but I have observed the region over the past four decades both in good times and bad, including the lost decade of the 1980s, the 1994-95 “tequila crisis,” and the problems Argentina and Brazil confronted at the start of the last decade.
As the description to our session notes, Latin American economies proved highly resilient during the 2008 Global Financial Crisis. However, some observers are worried about storm clouds on the horizon stemming from falling oil and commodity prices, a strong U.S. dollar, and the prospect of Fed tightening later this year. Accordingly, the main issue I will address is: How concerned should investors and policymakers be about the external environment and its impact on the region?
An Unusually Complex Environment
In assessing the prospects for Latin American economies, one should first recognize how complex the global environment has become since the second half of 2014. Indeed, most forecasts that were made late last year are out–of-date in light of all that has transpired:
- Oil prices have plummeted by 50%+, and other commodities have softened.
- The U.S. dollar has appreciated by about 20% on a trade-weighted basis.
- Interest rates in many European countries are negative now, as the ECB attempts to lessen the risk of deflation via quantitative easing.
- At the same time, the Federal Reserve is preparing the market for an eventual tightening of monetary policy.
Normally, any one of these considerations would merit extensive analysis and debate. How, then, can anyone be confident knowing how they will play out in their entirety? Read the rest of this entry »
April 7th, 2015
- U.S. stock and bond markets fluctuated in broad ranges in the first quarter, as investors assessed a wide range of issues including the prospect for oil prices, the U.S. dollar, overseas interest rates and U.S. monetary policy. Economic news was mixed. Real GDP growth may have slowed to 1% in response to a severe winter, but jobs growth continues to be the strongest since the late 1990s, despite a softer-than-expected showing in March.
- The inter-play of forces makes the current situation unusually complex: Lower oil prices benefit U.S. consumers and most businesses, but hurt energy producers, while the strong dollar adversely impacts U.S. exporters and multinationals. Nonetheless, we look for the economy to regain momentum this spring and to sustain solid growth in the balance of the year.
- At the March FOMC meeting, the Federal Reserve signaled that it is prepared to begin normalizing interest rates later this year. However, Fed officials also lowered their forecasts for economic growth and the path of the fed funds rate. Accordingly, the bond market is now pricing in only a 50 basis point increase in the funds rate this year.
- We continue to overweight risk assets in investment portfolios on grounds that the economic cycle is likely to be prolonged and the Fed will move gradually in raising rates.
Lower Oil Prices Are Supportive
U.S. economic growth appears to have slowed to about a 1% rate in the first quarter, but we continue to believe the underlying trend is stronger and view the 50%+ drop in oil prices since last summer as supportive. Some of the factors slowing the economy — notably a harsh winter in most of the country and a West Coast port strike — are expected to be temporary. Consumer spending may have moderated somewhat after growing at nearly a 4% pace in the second half of 2014. However, we expect it to grow at a healthy pace in the balance of this year, as strong jobs growth and low oil prices boost real disposable incomes, and consumer confidence stays high: Prior to the March report, payrolls growth had averaged 275,000 workers per month over the past year, which is the strongest since the late 1990s. Read the rest of this entry »
March 11th, 2015
- A series of strong jobs reports have lowered the unemployment rate to 5.5%, which could prompt the Fed to begin normalizing interest rates, possibly in the June-September time frame. Nonetheless, the Fed has considerable leeway, because inflation measures are still well below the Fed’s 2% target and wage pressures are absent.
- Once the Fed makes its move, the markets will focus on the path of future interest rate hikes. The bond market is pricing in a more gradual path than what FOMC participants envision, with the fed funds rate reaching 1.5% by year-end 2016 compared with 2.5% based on FOMC members.
- My own assessment is the Fed is likely to proceed very cautiously initially, but I expect the funds rate to peak at a higher level than what is priced into the bond market.
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February 17th, 2015
- Based on newspaper headlines, people may have the impression central banks today are pursuing actions similar to “beggar-thy-neighbor” policies during the Great Depression, when a series of currency devaluations culminated with protectionism and trade wars.
- The situation today, however, is quite different. While monetary policy easing in Japan, the eurozone, and other countries has weakened their respective currencies, officials from the Group of 20 recently endorsed these actions as helping to boost the global economy. In this respect, currency depreciations that result from monetary policy easing are not viewed as a zero-sum game.
- At the same time, there are limits to the effectiveness of quantitative easing (QE), and currency depreciation appears to be the primary channel for jump starting the Japanese and eurozone economies.
- If so, investors need to assess when U.S. officials will object to a stronger dollar. My take is the dollar is fairly valued and will not be viewed as a problem as long as the economy grows satisfactorily and unemployment stays low. Therefore, the path of least resistance is for the dollar to continue to trend higher in 2015.
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January 21st, 2015
- The European Central Bank (ECB) is expected to announce a program of mass purchases of government bonds this week in an attempt to counter the threat of deflation in the euro-zone. Nonetheless, while this action has long been anticipated, many observers (myself included) question whether it will succeed in jump-starting Europe’s flagging economies, considering how low bond yields in Europe already are.
- The primary channel for it to operate is the currency markets, where the euro has fallen by more than 15% versus the dollar since last summer. In this regard, the ECB has taken a page out of the Bank of Japan’s (BOJ) playbook for combating deflation.
- Meanwhile, the debate rages about whether countries such as France and Italy should be permitted to run larger budgetary deficits and whether Greece should receive additional debt relief. Absent any breakthroughs, my take is that the path of least resistance will be taken for the ECB to foster additional depreciation of the euro as a way of countering deflation. However, this will pose challenges for countries such as Switzerland that previously linked its currency to the euro.
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December 23rd, 2014
- With his re-election as Prime Minister, Shinzo Abe will have a second try at jump-starting Japan’s flagging economy. The prevailing view among economists is there was progress towards combating deflation in the first term, but the decision to boost the national sales tax by 5% in April wound up weakening the economy.
- One of the purposes of holding early elections was to lay the groundwork for Abe to postpone a second round of value-added tax (VAT) increases slated for 2015, while the government embarks on a series of structural reforms. However, most economists are skeptical about what will be accomplished on this front.
- Meanwhile, the Bank of Japan’s (BOJ) efforts to expand its balance sheet in the past two months has contributed to a further weakening of the yen, which has now depreciated by nearly 45% against the dollar over the past two years. In my view, this is vital to improving Japan’s competitiveness and jump-starting the economy in 2015.
- My assessment is that the onset of deflation in Japan in the mid-1990s can be traced to an increase in the yen on a real trade-weighted basis of more than 60% over a ten-year period. Consequently, if the BOJ is able to engineer further yen depreciation, the prospects for ending two decades of deflation will be enhanced.
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December 5th, 2014
- Two prominent energy experts – Daniel Yergin of IHS and Edward L. Morse of Citi have issued reports contending the oil market is now being dominated by a much greater than anticipated surge in U.S. production since 2008. It has caught other oil producers by surprise, and the failure of OPEC to cut production at last week’s meeting sent prices for WTI plummeting below $70 a barrel — a decline of nearly 40% since mid-year.
- Investors currently are assessing who the winners and losers are. Yergin contends the main losers are Venezuela, Iran, and Russia, and he foresees a slowdown in new energy investments around the world. U.S. companies also will look hard at their plans, but Yergin claims new U.S. production is more resilient than anticipated and should continue to increase in 2015.
- It remains to be seen where oil prices will shake out, but the latest developments are positive for the U.S. on two fronts: (i) the price decline is equivalent to a tax cut for U.S. consumers of about $160 billion, or nearly 1% of GDP, which should propel real GDP growth in 2015 to 3%; and (ii) according to Citi, the U.S. oil import gap will be eliminated before the end of this decade, which bodes well for U.S. trade and the dollar.
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October 21st, 2014
- Volatility in stocks and bonds has surged recently following a period of calm. The common explanation is that investors are worried about a slowdown abroad, especially in Europe, where officials disagree openly about how to respond.
- Despite these fears, the U.S. economy is not showing signs of slowing thus far, and job market conditions are improving. Weak growth abroad may affect corporate profits at some point, but lower oil prices and financing costs will cushion the impact.
- Evidence that inflation and inflation expectations are declining around the world is more apparent and could keep bond yields low for a while longer. However, the recent gyrations in yields are largely technical in nature.
- Our bottom line: A 10% stock market correction is not surprising following two years of steady gains, but a bear market is not in the cards, as there is little risk of recession or resurgent inflation.
Worries about Global Weakness are Exaggerated
Following an unusually calm summer, investors have worked themselves into a frenzy that the U.S. economy is vulnerable to a worldwide slowdown. However, when one looks at the batch of economic releases that have come out this month it is hard to grasp why. The recent IMF/IBRD annual meetings set the tone, as the IMF staff downgraded its forecast for global growth (once again). This was accompanied by disappointing industrial production data for Europe, at a time when officials have disagreed publicly about what needs to be done to jump start the euro-zone. Read the rest of this entry »