15/4/17: Unconventional monetary policies: a warning

Just as the Fed (and now with some grumbling on the horizon, possibly soon, ECB) tightens the rates, the legacy of the monetary adventurism that swept across both advanced and developing economies since 2007-2008 remains a towering rock, hard to climb, impossible to shift.

Back in July last year, Claudio Borio, of the BIS, with a co-author Anna Zabai authored a paper titled “Unconventional monetary policies: a re-appraisal” that attempts to gauge at least one slope of the monetarist mountain.

In it, the authors “explore the effectiveness and balance of benefits and costs of so-called “unconventional” monetary policy measures extensively implemented in the wake of the financial crisis: balance sheet policies (commonly termed “quantitative easing”), forward guidance and negative policy rates”.

The authors reach three main conclusions:

1. “there is ample evidence that, to varying degrees, these measures have succeeded in influencing financial conditions even though their ultimate impact on output and inflation is harder to pin down”. Which is sort of like telling a patient that instead of a cataract surgery he got a lobotomy, but now that he is awake and out of the coma, everything is fine. Why? Because the monetary policy was not supposed to trigger financial conditions improvements. It was supposed to deploy such improvements in order to secure real economic gains.
2. “the balance of the benefits and costs is likely to deteriorate over time”. Which means that the full cost of the monetary adventurism will be greater that the currently visible distortions suggest. And it will be long run.
3. “the measures are generally best regarded as exceptional, for use in very specific circumstances. Whether this will turn out to be the case, however, is doubtful at best and depends on more fundamental features of monetary policy frameworks”. Wait, what? Ah, here it is explained somewhat better: “They were supposed to be exceptional and temporary – hence the term “unconventional”. They risk becoming standard and permanent, as the boundaries of the unconventional are stretched day after day.”

You can see the permanence emerging in the trends (either continuously expanding or flat) when it comes to simply looking at the Central Banks’ balance sheets:

And the trend in terms of instrumentation:

The above two charts and the rest of Borio-Zabai analysis simply paints a picture of a sugar addicted kid who locked himself in a candy store. Good luck depriving him of that ‘just the last one, honest, ma!’ candy…

15/4/17: Thick Mud of Inflationary Expectations

The fortunes of U.S. and euro area inflation expectations are changing and changing fast. I recently wrote about the need for taking a more defensive stance in structuring investors' portfolios when it comes to dealing with potential inflation risk (see the post linked here), and I also noted the continued build up in inflationary momentum in the case of euro area (see the post linked here).

Of course, the current momentum comes off the weak levels of inflation, so the monetary policy remains largely cautious for the U.S. Fed and accommodative for the ECB:

More to the point, long term expectations with respect to inflation remain still below 1.7-1.8 percent for the euro area, despite rising above 2 percent for the U.S. And the dynamics of expectations are trending down:

In fact, last week, the Fed's consumer survey showed U.S. consumers expecting 2.7% inflation compared to 3% in last month's survey, for both one-year-ahead and three-years-ahead expectations. But to complicate the matters:

• Euro area counterpart survey, released at the end of March, showed european households' inflationary expectations surging to a four-year high and actual inflation exceeding the ECB's 2 percent target for the first time (February reading came in at 2.1 percent, although the number was primarily driven by a jump in energy prices), and
• In the U.S. survey, median inflation uncertainty (a reflection of the uncertainty regarding future inflation outcomes) declined at the one-year but increased at the three-year ahead horizon.

Confused? When it comes to inflationary pressures forward, things appear to be relatively subdued in the shorter term in the U.S. and much more subdued in the euro area. Except for one small matter at hand: as the chart above illustrates, a swing from 1.72 percent to above 2.35 percent for the U.S. inflation forward expectations by markets participants can take just a month in the uncertain and volatile markets when ambiguity around the underlying economic and policy fundamentals increases. Inflation expectations dynamics are almost as volatile in the euro area.

Which, in simple terms, means three things:

1. From 'academic' point of view, we are in the world of uncertainty when it comes to inflationary pressures, not in the world of risk, which suggests that 'business as usual' for investors in terms of expecting moderate inflation and monetary accommodation to continue should be avoided;
2. From immediate investor perspective: don't panic, yet; and 
3. From more passive investor point of view: be prepared not to panic when everyone else starts panicking at last.

12/4/17: Incoming Inflation Uptick: Gear Up

My contribution for Manning Financial on the topic of gearing investment portfolios against incoming uptick in inflation is now available here: https://issuu.com/publicationire/docs/mf__spring_2017?e=16572344/47063502.

12/4/17: European Economic Uncertainty Moderated in 1Q 2017

European Policy Uncertainty Index, an indicator of economic policy risks perception based on media references, has posted a significant moderation in the risk environment in the first quarter of 2017, falling from the 4Q 2016 average of 307.75 to 1Q 2017 average of 265.42, with the decline driven primarily by moderating uncertainty in the UK and Italy, against rising uncertainty in France and Spain. Germany's economic policy risks remained largely in line with 4Q 2016 readings. Despite the moderation, overall European policy uncertainty index in 1Q 2017 was still ahead of the levels recorded in 1Q 2016 (221.76).

• German economic policy uncertainty index averaged 247.19 in 1Q 2017, up on 239.57 in 4Q 2016, but down on the 12-months peak of 331.78 in 3Q 2016. However, German economic uncertainty remained above 1Q 2016 level of 192.15.
• Italian economic policy uncertainty index was running at 108.52 in 1Q 2017, down significantly from 157.31 reading in 4Q 2016 which also marked the peak for 12 months trailing period. Italian uncertainty index finished 1Q 2017 at virtually identical levels as in 1Q 2016 (106.92).
• UK economic policy uncertainty index was down sharply at 411.04 in 1Q 2017 from 609.78 in 4Q 2016, with 3Q 2016 marking the local (12 months trailing) peak at 800.14. Nonetheless, in 1Q 2017, the UK index remained well above 1Q 2016 reading of 347.11.
• French economic policy uncertainty rose sharply in 1Q 2017 to 454.65 from 371.16 in 4Q 2016. Latest quarterly average is the highest in the 12 months trailing period and is well above 273.05 reading for 1Q 2016.
• Spain's economic policy uncertainty index moderated from 179.80 in 4Q 2016 to 137.78 in 1Q 2017, with the latest reading being the lowest over the five recent quarters. A year ago, the index stood at 209.12.

Despite some encouraging changes and some moderation, economic policy uncertainty remains highly elevated across the European economy as shown in the chart and highlighted in the chart below:

Of the Big 4 European economies, only Italy shows more recent trends consistent with decline in uncertainty relative to 2012-2015 period and this moderation is rather fragile. In every other big European economy, economic uncertainty is higher during 2016-present period than in any other period on record. 

12/4/17: German Economy Forecasts 2017-2018

The latest joint economic forecast for German economy is out and, in line with what Eurocoin has been signalling recently (see post here), the forecast upgrades outlook for Euro area's largest economy.

Here's the release, with some commentary added: Germany's "aggregate production capacities are now likely to have slightly exceeded their normal utilisation levels. However, cyclical dynamics remain low compared to earlier periods of recoveries, as consumption expenditures, which do not exhibit strong fluctuations, have been the main driving force so far. In addition, net migration increases potential output, counteracting a stronger capacity tightening."

• German GDP) is expected to expand by 1.5% (1.8% adjusted for calendar effects) in 2017 and 1.8% in 2018
• Unemployment is expected to fall to 6.1% in 2016, to 5.7% in 2017 and 5.4% in 2018 
• "Inflation is expected to increase markedly over the forecast horizon. After an increase in consumer prices of only 0.5% in 2016, the inflation rate is expected to rise to 1.8% in 2017 and 1.7% in 2018". This would be consistent with the ECB starting to raise rates in late 2017 and continuing to hike into 2018. The forecast does not cover interest rates policy timing, but does state that "In the euro area, the institutes do not expect interest rates to rise during the forecast period. However, bond purchases are likely to be phased out next year." In my view, this position is not consistent with forecast inflation and growth dynamics.
• "The public budget surplus will reduce only modestly. Public finances are slightly stimulating economic activity in the current year and are cyclically neutral in the year ahead." In simple terms, Germany will run budget surpluses in both 2017 and 2018, with cumulative surpluses around EUR36.6 billion over these two years, against a cumulative surplus of EUR44.6 billion in 2015 and 2016.
• Current account surpluses are expected to remain above EUR250 billion per annum in 2017 and 2018, with cumulative current account surpluses for these two years forecast at EUR508 billion against EUR521 billion surpluses in 2015-2016.

Slight re-acceleration in both budgetary surplus and current account surplus over 2017-2018 will provide a very small amount of room for growth in imports and capital investment out of Germany to the rest of the euro area. 

11/4/17: S&P 500 Concentration Risk

Concentration risk is a concept that comes from banking. In simple terms, concentration risk reflects the extent to which bank's assets (loans) are distributed across the borrowers. Take an example of a bank which has 10 large borrowers with equivalent size loans extended to them. In this case, each borrower accounts for 10 percent of the bank total assets and bank's concentration ratio is 10% or 0.1. Now, suppose that another bank has 5 borrowers with equivalent loans. For the second bank, the concentration ratio is 0.2 or 20%. Concentration risk (exposure to a limited number of borrowers) is obviously higher in the latter bank than in the former.

Despite coming from banking, the concept of concentration risk applies to other organisations and sectors. For example, take suppliers of components to large companies, like Apple. For many of these suppliers, Apple represents the source of much of their revenues and, thus, they are exposed to the concentration risk. See this recent article for examples.

For sectors, as opposed to individual organisations, concentration risk relates to the distribution of sector earnings. And the latest FactSet report from April 7, 2017 shows just how concentrated the geographical distributions of earnings for S&P 500 are:

In summary:

• With exception of Information Technology, not a single sector in the S&P 500 has aggregate revenues exposure to the U.S. market that is below 50%;
• Seven out of 11 sectors covered within S&P 500 have exposure concentration to the U.S. market in excess of 70%; and
• On the aggregate, 70% of revenues for the entire S&P 500 arise from within the U.S. markets.

In simple terms, S&P 500 is extremely vulnerable to the fortunes of the U.S. economy. Or put differently, there is a woeful lack of economic / revenue sources diversification in the S&P 500 companies.

11/4/17: Euro Area Growth Conditions Remain Robust in 1Q 17

Eurocoin, Banca d'Italia and CEPR's leading indicator of economic growth in the euro area has slipped in March to 0.72 from 0.75 in February, with indicator remaining at its second highest reading since 2Q 2010.

Combined 1Q 2017 growth indictor is now signalling approximately 0.7% quarterly GDP growth rates, carrying the breakout momentum from previous quarters (see chart above). This brings most recent growth forecast over the 2001-2007 average.

From growth dynamics perspective, the pressure is now on ECB to start tightening monetary policy:

Inflationary pressures are still relatively moderate, but rising:

10/4/17: BRIC Composite PMIs 1Q 17: Not Keeping Up With Global Growth

In two previous posts, I have covered the 1Q 2017 data for Manufacturing PMIs and Services PMIs for BRIC economies. Both indicators provided little hope that world's largest emerging economies are generating a positive growth momentum consistent with stronger global economic growth.

The same is confirmed by the Composite PMIs:

Brazil's 1Q 2017 Composite PMI came in at 46.7, up on 46.1 in 4Q 2016, but still below the stagnation line. In simple terms, Brazil's Composite PMIs have now signalled negative growth for 12 consecutive quarters. Improved 1Q 2017 reading is consistent with continued and strong contraction in the economy, albeit a contraction that is less pronounced than in previous quarters.

Russia's Composite PMI posted a reading of 56.7, marking the strongest growth performance for the economy since 4Q 2006. Predictably, given both Manufacturing and Services PMIs as discussed in above-linked posts, Russian economy has outperformed in 1Q 2017 global economic growth momentum and is currently the strongest BRIC economy for the fourth consecutive quarter.

India's Composite PMI came in at 50.8, up marginally on 50.7 in 4Q 2016. This marks the second consecutive quarter of Composite PMI readings for India that are statistically indistinguishable from the stagnation line of 50.0. There is little good news in the data from India, where the fallout from the disastrous de-monetisation campaign by the government has been taking its toll.

Chinese Composite PMI stood at 52.3 in 1Q 2017, down from 53.1, but still the second highest since 1Q 2013. In simple terms, this means that the Chinese economic growth is not accelerating off 4Q 2016 dynamics, suggesting that the economy has now exhausted any momentum gained on foot of a massive credit bubble expansion in modern history.

Chart below illustrates the dynamics:

As shown above, Russia is the only BRIC economy currently generating upward supports for global growth.

When we consider individual sectoral indices, as shown in the chart below, BRIC Manufacturing sector is now pushing global growth momentum down, while BRIC Services sector is co-moving with the global growth, but provides no positive momentum to global economic expansion:

Finally, using monthly data (100=zero growth) for the BRIC economies index of economic activity (computed by me based on Markit and IMF data), the chart below shows just to what extent does Russian growth momentum dominates rest of the BRIC economies dynamics:

In summary, BRIC economies remain negative contributors to the global economic growth, with BRIC economies posting overall positive, but weak growth across the two key sectors.

10/4/17: BRIC Services PMI 1Q 2017: Another Weak Quarter

Yesterday, in my analysis of BRIC Manufacturing PMIs for 1Q 2017, I showed that 51.1 for 1Q 2017, BRIC Manufacturing PMI average came down marginally on 51.2 in 4Q 2016, although up on 49.2 reading for 1Q 2016. Russia was the only economy posting Q1 2017 Manufacturing activity in line with Global Manufacturing dynamics and BRIC as a group were exerting downward pressure on global manufacturing sector.

The news, therefore, were not great for the global manufacturing economy (stalled growth momentum in 1Q 2017), and for the BRIC economies.

Looking at Services PMIs next:

Brazil's Services PMI for 1Q 2017 averaged at 46.4, which is somewhat better than 44.5 average for 3Q 2016 and 4Q 2016 and stronger than 40.0 average for 1Q 2016. In simple terms, Brazil's Services activity continued to shrink and shrink rapidly in 1Q 2017, although the rate of contraction moderated. All in, Brazil's Services PMIs have now been in sub-50 territory for 10 consecutive quarters, two quarters shorter than Brazil's Manufacturing sector. The long-running and deep recession in Latin America's largest economy is continuing, although there are some very fragile signs that it might come to an end in the foreseeable future, as both Manufacturing PMI (at 49.6 in March) and Services PMI (at 47.7 in March) are showing signs of recovery.

Russia Services PMI for 1Q 2017 came in at a blistering pace of 56.8, up on already significant growth in 4Q 2016 at 54.6 and significantly above 1Q 2016 reading of 50.0. All in, this is the fourth consecutive quarter of Services PMIs above 50.0, with all four quarters reading statistically significant for positive growth. Russia is leading BRIC contribution to global growth in both Manufacturing and Services sectors, judging by PMIs.

Indian Services PMI was at 50.2 in 1Q 2017, which not statistically distinct from zero growth marker of 50.0, but up on 49.3 in 4Q 2016. In 1Q 2016 the Services PMI averaged 53.6 which was positive for growth. Indian economy has been hitting some trouble waters for the last two quarters, something I remarked upon in the post covering Manufacturing PMIs linked above. While Services are showing signs of stabilisation, the recovery is not yet evident in the data and is lagging Manufacturing sector performance.

China's Services PMI reading in 1Q 2017 disappointed those who hoped that 2016 credit explosion would set stage for a robust economic growth recovery. With Manufacturing PMI growth signal stuck at the same level in 1Q 2017 as in 4Q 2016, Services PMI reading for 1Q 2017 was actually below the 4Q 2016 reading (52.6 vs 53.0). Given that the index never once slipped below 50 in the history of the series, as well as given the moments of the underlying distribution, 52.6 reading is statistically indistinguishable from zero growth conditions. Thus, although posting the second strongest, amongst the BRIC economies, PMI reading for 1Q 2017 after Russia, Chinese Services sector was a relative negative for global growth momentum.

Chart and table below summarise some of the dynamics discussed earlier:

In summary, as shown above, global PMIs are supported to the upside only by Russian Services PMI dynamics, with Chinese Services PMIs providing virtually no momentum to global Growth, and both India and Brazil contributing negatively. Overall, thus, BRIC economies remain weak and under-perform global growth.

9/4/17: JTCI Article on Cybercrime & Financial Markets Contagion

Our paper on cybersecurity risks spillovers across financial markets was published in the JTCI: http://www.terrorismcyberinsurance.com/. You can access full paper here: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2892842.

9/4/17: BRIC Manufacturing PMIs 1Q 2017: Stalling Momentum

1Q 2017 PMIs for Manufacturing are painting a mixed picture for the world's largest emerging economies, the BRIC group.

Brazil's Manufacturing PMIs averaged 46.8 in 1Q 2017, compared to 45.9 in 4Q 2016 and 46.0 in 1Q 2016. All in, 1Q 2017 marked 12th consecutive quarter of Manufacturing PMIs signalling contraction in activity. Although 1Q 2017 reading was the highest since 1Q 2015, current indicator simply implies that the rate of Brazilian manufacturing sector contraction has abated somewhat, even though the downward momentum remains in place. This means that Brazil remains the worst performing BRIC Manufacturing sector for the eighth consecutive quarter. One relatively brighter spot is that March Manufacturing PMI for Brazil came in at 49.6 - the highest monthly reading since February 2015 and relatively close to zero growth line of 50.0. It is worth watching in months to come if there is a sustained momentum in Manufacturing activity up, and if Brazil finally starts showing signs of an economic recovery from what has proven to be a horrific recession so far.

Russian Manufacturing PMIs averaged 53.2 in 1Q 2017, unchanged in 4Q 2016 and up on 49.1 average for 1Q 2016. This marks the third consecutive quarterly PMI reading for Manufacturing that sits above 50.0 marker. As Russian economy gained significant recovery momentum in 4Q 2016 and into 1Q 2017, Russia now leads BRIC Manufacturing PMIs for the second consecutive quarter, providing solid upward support for global manufacturing growth. Still, despite robust numbers and despite three consecutive quarters of growth, Russian manufacturing sector and the economy at larger remain relatively exposed to the downside risks, including risks relating to energy and commodities prices, as well as to the lack of structural reforms within Russia. We have been awaiting for some time now for the long promised Government plans for achieving sustainable growth in the economy into the early 2020s, and the plan is still lacking.

Indian Manufacturing PMIs averaged 51.2 in 1Q 2017, down from 52.1 in 4Q 2016 and worse than 51.5 reading for 1Q 2016. 1Q 2017 was the weakest of three consecutive quarters, suggesting that the economy is having difficulty recovering from the botched de-monetization experiment by the Indian Government. Few outside India are willing to call the experiment botched, primarily because it involved advice and partial funding from the U.S. agencies, but the process was a disaster for the Indian economy.

Chinese Manufacturing PMIs also came with a disappointing whimper. PMIs averaged 51.3 in 1Q 2017 on par with 4Q 2016, quashing the hopes that the credit stimulus of the 2H 2016 will translate into domestic demand uplift. Current index reading for China is not statistically significantly different from 50.0, implying a general lack of growth momentum in the Chinese manufacturing. So far, Manufacturing PMIs managed to stay above 50.0 marker (nominally, not statistically) for three consecutive quarters, but the total average for these quarters is coming in at only 51.0.

Table and charts below summarise BRIC Manufacturing PMIs dynamics through 1Q 2017:

Overall, BRIC Manufacturing PMI Average (a metric computed by me using Markit data) came in at 51.1 in 1Q 2017, down marginally on 51.2 in 4Q 2016, although up on 49.2 reading for 1Q 2016. As the chart above clearly shows, of all BRIC economies, only Russia is posting Q1 2017 Manufacturing activity in line with Global Manufacturing growth and dynamically, BRIC as a group is exerting downward pressure on global manufacturing sector.

The news, therefore, are not great for the global manufacturing economy (stalled growth momentum in 1Q 2017), and for the BRIC economies.

Stay tuned for analysis of Services and Composite figures.

9/4/17: Nama's Missed Opportunities

My Sunday Business Post article on Nama and the 'value-destruction' : https://www.businesspost.ie/opinion/nama-missed-opportunity-profits-paying-price-384584.