Welcome to Neil MacKinnon's Market Commentary blog. This page is updated regularly to cover events impacting the global financial and currency markets.

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I have to say I don’t like the markets at the moment. I sense something nasty is brewing. Professor Krugman thinks the global economy is tipping into a "Third Depression" and Professor Roubini argues Greece should be allowed to default. Certainly, there are depressionary risks and I think deflation rather than inflation is an impending danger (the UK seems almost unique amongst the major western economies of having an inflation problem at the moment). As far as Greece is concerned, it is already bust in my view and a default or debt restructuring is inevitable. Spanish banks are lobbying the ECB for more funds.

I think the eurozone banking crisis is happening so don’t be surprised if a eurozone bank has a "Lehman's moment". Add in an Israeli attack on Iran sometime soon and stockmarkets can easily crash. Have you noticed that bond yields are at their lows for the year? The credit markets normally smell fear first. In the FX world, the yen and swiss do well in this environment and the euro gets clobbered. Sterling might just do ok as the new government is receiving plaudits by international investors for its stance on the UK budget. Stay tuned, it is going to be a hot summer.

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The G-20 Summit at the weekend, after a lot of huff and puff, agreed to compromise on non-binding proposals to halve budget deficits and stabilise debt/GDP ratios. Because it is non-binding, the G-20 meeting does not really amount to a great deal and individual economies will choose the best mix of fiscal consolidation and growth policies that suits them. This is probably not a bad idea anyway as a binding and synchronised fiscal tightening would almost guarantee a trip back into global recession. As it is, the economic situation is still uncertain. Economic data of the American economy has made for bleak reading with US new home sales at a record low and US GDP growth for Q1 revised down to 2.7%. If you strip out the impact of inventories, real GDP growth was actually below 1%. This probably explains President Obama’s preference for a maintenance of growth-oriented policies and the US authorities must be worried about the prospect of much slower economic growth during the second half of this year. This means that the Federal Reserve has little option but to effectively maintain a near-zero interest rate policy going into next year.

Here in the UK, there has been some speculation that interest rates might go up sooner rather than later. Inflation here in the UK has been higher than expected and stands out from the experience in the US and eurozone where there is a strong disinflationary trend. The markets will be keeping a close eye on developments in the economy especially for signs of strength in the retail sector. Anecdotally, it certainly looks like the good weather has got the shoppers out on the street and I wonder whether there might be a pent-up demand reflected in the next lot of retail sales figures. If so, the markets being the beast that they are will panic about a near term hike in interest rates. I suspect Mervyn King would rather not raise rates given the planned Budget tightening. Sterling has performed reasonably well in the last few weeks and there was a positive response from the City to the Chancellor’s Budget. Sterling starts the week at 1.5000 against the US dollar and is just above the 0.82 level against the beleaguered euro. Investors are right to remain worried about the health of some eurozone banks and funding difficulties are set to remain a key theme in the weeks ahead. The Swiss franc has been strong in the market place making new highs against the euro which might reflect investors taking money out of eurozone banks and putting funds/deposits into Swiss banks. They are right to do so as I think the eurozone situation has the potential to make it a hot summer for the future of monetary union.

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The G-20 kick off their Summit today and the markets are worried about possible differences of opinion between the US and the eurozone over the right balance between economic growth and austerity. President Obama emphasises the need to keep economic recovery going whereas in the eurozone, Germany is particularly resistant to spending more. I suspect that those differences will persist. However, as far as the US economy is concerned, the maximum impact of fiscal stimulus is already happening and will fade from here and it is unclear that from within Congress there is the political appetite for more stimulus given America’s own budget problems at federal and state level. This leaves it up to the Fed and the possibility of slower global growth next year means that the Fed has to keep its options open. Ambrose Evans-Pritchard in this morning’s Daily Telegraph claims that the Fed is mulling a fresh round of quantitative easing and I have some sympathy with those claims. Certainly, this week’s US housing market data makes for depressing reading. Without a recovery in the housing market, it is difficult to see much of an improvement in consumer confidence. Next Friday’s US jobs report is key also, but an already reported reduction in government census workers implies that financial markets could be disappointed with a decline in the headline rate of jobs growth.

Here in the UK, the Bank of England’s latest Financial Stability Report caught my eye with UK bank refinancing set to double in 2011 with refinancing more than double what is expected for US banks. The ongoing discussions regarding Basel capital adequacy agreements as well as the discussions on content in the US financial regulatory reform bill are crucial in terms of how well banks will be able to expand lending etc. Anything negative won’t be good news for UK banks and remember that RBS and Barclays are amongst the top 5 banks (by assets) in the EU-27 banking sector. As far as eurozone banks are concerned, funding worries remain a problem and in Greece credit default spreads have widened to a record. I think there is a grave risk that funding problems at some eurozone banks are going to become a major problem in the next few weeks.

As far as sterling is concerned, 1.5000 against the US dollar seems to be capping the upside for now following a reasonable response from the City to this week’s Budget. However, against the euro, sterling has out-performed since March. Hardly surprising given all the problems that the eurozone is contending with at the moment. I even see that the Greek government is considering putting up some Greek islands for sale (click here). Interested investors should consult ECU’s sales people!!!

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The City reaction to yesterday’s Budget has been reasonably positive so far. The bank levy is not onerous and the plan to reduce corporate tax to 24% sends the right signals to business. The increase in CGT is a welcome compromise and the hike in VAT does not take place until next January. Otherwise, the spending cuts looks as though they are for real and there is a good chance that the UK’s budget deficit might surprise everyone by not turning out to be as bad as expected. Where there is some worry is in the Chancellor’s economic growth forecasts for next year which look a tad optimistic especially given an unfavourable global backdrop where fiscal policy is being tightened generally.

Sterling is only a little firmer on the back of all of this and has so far failed to break above 1.50 against the US dollar. Financial markets are still worried about what is going on in the eurozone and the odds of a banking crisis are still high in my view. Likewise, the markets are not totally convinced that the debt crisis is fully resolved and the end-game looks like a default for Greece. So expect plenty of market volatility any time soon. The Federal Reserve hold their regular policy meeting this evening but there are unlikely to be any surprises. Worries about “double-dip” recessions, a weak US housing market and the risk of deflation is likely to keep the Fed on hold for a while yet.

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It’s Budget Day and all will be revealed shortly. As is usual with Budgets, most of the key points are leaked in the press but Chancellors always like to “pull a rabbit out of the hat” with some unexpected tax or spending measure announced towards the tail-end of his Budget speech. The essentials are well-known and the City is expecting a tough budget. Tax measures are likely to include an increase in VAT and CGT. Spending cuts are likely to be stiff but as long as investments are ring-fenced there is scope for cutbacks in the public sector. The economy is bumping along the bottom in my opinion and the level of real GDP is still way below the highs seen at the start of 2008. Professor Blanchflower thinks that the budget cuts will herald a “double-dip” recession though you could argue that we are not fully out of the first recession but I take his point.

The problem for the global economy is that everybody is cutting budget deficits and this, I think, portends a period of slower growth. Hopefully, China’s fx moves at the weekend will avert a US-China trade war which is good news. Nevertheless, investor sentiment remains jittery and equity markets look set to remain volatile and fresh corrections cannot be ruled out.

Interestingly, sterling has done reasonably well despite all the gloom and doom about the UK’s budget position. Foreign investors have actually been buyers of gilts which explains the rise in the trade-weighted value of sterling so far this year. Short term, it has to be said that sterling is likely to pause for breath against the key currencies so don’t be surprised to see some minor slippage against the dollar for example but a sterling crisis is not on the agenda by a long shot.

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Well. It’s Budget Day tomorrow and if weekend press reports are to be believed then George Osborne is set to deliver a tough set of measures designed to tackle Britain’s budget deficit. Hopefully, Mr Osborne will also signal that a punitive tax regime is not here to stay. It is important to provide encouragement to international investors that Britain is still a good place to do business.

Sterling has done well in recent weeks and I have mentioned before in the blog that international investors have been buyers, not sellers, of gilts despite all the negative news-flow about credit ratings and all the rest of it. This is encouraging and if the Chancellor can deliver a convincing Budget tomorrow then I would expect a positive reaction from markets. Obviously, ensuring that economic recovery remains undamaged is critical and in the current mood of fiscal retrenchment it is important that too much fiscal zealousness might backfire and produce a weaker economy and a higher deficit. While cutting the deficit seems to be the number one priority, it will be up to the Bank of England to maintain an accommodative monetary policy. There has been some talk that the rise in the inflation rate might result in an increase in interest rates. I don’t see this happening as the degree of fiscal stringency that is being planned will require an offset in terms of interest rate policy.

The fact is that the economy is not strong enough to withstand both a tighter monetary policy and a tighter fiscal policy. The economy has already had a sizeable devaluation of the currency and it is difficult to believe that a further 25% devaluation would do much good apart from intensifying inflation worries. Sterling, to a large degree, has been a bit of a sideshow in recent months as the main focus of the markets has been on the euro. Market sentiment seems to have improved a little towards the euro on the back of reasonable economic news out of Germany and hopes that eurozone governments have the debt and banking crisis under control. I am less convinced and will reserve judgement for now. Interestingly, I listened to the IMF at the St Petersburg Forum on Saturday identify Japan, the UK and US (in that order) as being their main concern in terms of fiscal policy. Tomorrow is an opportunity for Mr Osborne to allay the IMF’s fears.

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I am at the St Petersburg International Economic Forum today and tomorrow – all very interesting and topical stuff up for discussion. But back to the markets: retail sales yesterday were fairly decent but I remain worried about whether it can be sustained in front of stiff budget cuts. Elsewhere, data out of the US economy points to a loss of pace in the recovery and might be an augury of a double-dip.

The euro is a bit firmer against the dollar but debt and banking problems remain to be resolved and I have a feeling in my bones that equity markets are liable for a major upset. Meanwhile, the gold price reaches a new high and is telling us something about investor worries over currency debasement and sovereign debt risk.

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Mervyn King's speech last night is being interpreted as dove-ish as regards the next move in UK interest rates. However, he did acknowledge the market's concern about the overshoot in the inflation rate. A lot of this overshoot is actually to do with government-imposed measures like VAT and fuel duty. My guess is that inflation will likely ease as the economy is hardly red-hot at the moment. Nevertheless, hawkish comments from some MPC members like Mr Sentance remind investors that opinion is not uniform on this matter. My view is that putting interest rates up when fiscal policy is being tightened is a recipe for a move back into recession, so I am in Mervyn King's camp.

Elsewhere, Mr Osborne announced a raft of new commissions and review bodies staffed by the usual suspects from the ‘great and the good’, some of whom were asleep at the wheel when the financial and banking crisis started. This is all a terribly British way of doing things and can be guaranteed that, after a few rain forests have been felled to produce the stream of endless reports from these commissions, it will do nothing to avert the next financial crisis. Where does this leave sterling? Well, I think the pound is losing a bit of momentum and it will need a decent retail sales report to give it a leg-up to the 1.50 level. The market risk is that careful consumers might be more worried about next week's Budget.

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Ahead of tomorrow’s EU Summit, the market is alert to the problems facing the Spanish banking system. Last month, Spanish banks borrowed record amounts from the ECB (EUR86 billion, about 16.5% of total loans offered by the ECB) as they faced severe funding pressures, given the high degree of counter-party risk and associated lack of confidence that exists in the interbank lending market. Rumours abound that Spain will ask the EU for a bail-out, though this is denied by the EU. Nevertheless, the eurozone debt and banking crisis continues to rumble in the background. At some stage, these funding difficulties will explode into the open and the likelihood of a European ‘Lehman’ looks quite high. In addition, my view is that Greece is already bust and Greek bond yields and interest rates are heading higher. The inevitable ‘day of reckoning’ can only get closer when the EU realise that Greece cannot pay its debts and actually defaults. Debt restructuring will apply not just to Greece but also to other fiscal miscreants in the eurozone such as Belgium which faces not only political problems but high debt/GDP levels. The Belgian central bank this morning expects debt/GDP to rise to 103.1% in 2011 from 100.2% this year. Not good news.

Here in the UK, the latest reading on consumer confidence showed quite a sharp slump, which is not a surprise and is reflected in the recent soft reading we saw in the retail sales data. The focus is on this evening’s annual Mansion House speeches from George Osborne and Mervyn King. Press reports suggest that a new bank levy will be unveiled as well as new powers being given to the Bank of England to curb mortgage lending. Banks tend to be pro-cyclical as far as lending is concerned as many readers will know from experience. The banks are quite happy to give you an umbrella when the sun is shining but take the umbrella off you when it is raining torrents. What are really required are measures to prevent the type of mortgage deals that took place at the height of the ‘bubble’. At the moment, credit still remains tight and the banking sector faces a variety of regulatory and capital raising measures which will likely keep credit conditions tight for the foreseeable future. The problem is that this will likely (and inadvertently) hold back economic recovery. As a result, I think any talk of higher interest rates here in the UK looks misplaced. Next week’s Budget is likely to present plenty of stiff medicine which will force us to tighten our belts. Sterling is still managing to hold up against the dollar at around 1.48 but I fear that if the fiscal stringency is overdone and if banks are heavily constrained then this might take the wind out of sterling’s sails.

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Rather depressingly, I noted that French president Sarkozy and German chancellor Merkel have reached agreement on organising an EU-wide ‘economic government’. Their high-handedness is breath-taking but is typical of the bureaucratic mindset in wanting to impose an EU state on the rest of us. Of course, with great timing, Moody’s, the credit rating agency, downgraded Greece to junk bond status which in itself was no surprise but was a sharp reminder that the eurozone debt and banking crises have not been properly resolved. The end-game in all of this (apart from Germany winning the World Cup – Merkel has banned other teams from scoring against them) is debt default and a eurozone banking crisis. I noted a recent survey that two-thirds of Germans thought it a mistake to replace the deutschmark with the euro. I am not surprised as the German taxpayer has had to bear a heavy cost for eurofication. Ironically, it is the current weakness of the euro which is helping German exporters recover (with a little help from the red-hot China export market) and, in the process, underpin a recovery in industrial production. However, the weakness in the euro does very little to help the “Club Med” economies as their trade is mainly within the eurozone. A bigger German trade surplus means a wider Club Med deficit which means even more of a painful adjustment (in terms of real wage reduction) in order to regain competitiveness.

As far as the UK is concerned, we had better news on inflation this morning, though any VAT increase in next week’s Budget will just keep inflation elevated. Yesterday’s announcements from the Office for Budget Responsibility were well received by the market. Things could have been worse. As a result, sterling is a little firmer on the exchanges at 1.4750 against the US dollar and technically there is possibly a little more upside close to the 50- and 100-day moving averages at 1.4898 and 1.5132 respectively.

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Last week was again choppy for the financial markets and the latest data on industrial production showed that the UK economy is struggling to stage a decent recovery. The Bank of England's Quarterly Bulletin out today says investors are concerned that there could be a 20% slide in stockmarkets. For sure, there are plenty of reasons why that could happen as investors are worried about a range of issues from ‘double dip’ recessions to yet more bad news relating to the eurozone debt and banking crisis.

The main focus today is the new Office for Budget Responsibility headed by Sir Alan Budd. Press reports suggest that the OBR will deliver a gloomy but realistic assessment of the UK's economic and debt position. Thankfully, it also seems that the government is preparing a climb-down on the badly-framed CGT proposals as well as rejecting EU plans to vet our budget. No one in this country has had a vote to join the EU which is nothing more than a proto-fascist state. One thing Gordon Brown can be thanked for is that we did not join the euro.

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Overnight, there was favourable news on the Japanese economy (5% GDP growth), a reduction in Australian unemployment and confirmation of strong export growth in China which all bolstered sentiment in the equity markets. The euro is also a little firmer against the US dollar after the boss of China’s pension fund said that the euro can weather the debt crisis. I have a sneaking suspicion that the Chinese have indirectly been supporting the euro as there is increasing concern about the spill-over on to the rest of the global economy from what is happening in the eurozone. Sterling is just above 1.45 against the US dollar and the Bank of England is not expected to spring any surprises in terms of monetary policy. It is still all about fiscal policy and the Chancellor has a tough job on his hands.

I am very interested in the findings of a recent IMF research paper (click here) that looks at the impact of fiscal consolidation, and it is worth a read. The IMF focus on the loss of tax revenues that is behind the expansion in the budget deficit and notes that tax increases might be inevitable. The IMF also notes that the magnitude of spending cuts in the UK is likely to be substantial (11% of GDP in the UK compared to 6% in the US). It all makes for uncomfortable reading whatever happens and it looks that most of us are in for a (financially) hard time. As far as the Bank of England is concerned, it certainly means keeping interest rates lower for longer as well as a possible further expansion in the quantitative easing programme.

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Fitch's warning yesterday about UK public sector finances is hardly earth-shattering news but, given the nervous nature of financial markets at the moment, it was enough for FX traders to sell sterling. This morning, sterling seems to have recovered its poise and is back to where it started the week at USD 1.44-45 and EUR 0.8270. Likewise, after a choppy overnight session in Asian equities, the mood is lifting after reports of strong Chinese export growth. Having said that, a ‘double-dip’ recession for the US economy is still on the cards I think. This leaves the Fed with no choice but to maintain an accomodative monetary stance something that Mr Bernanke will likely confirm in his Congressional testimony this afternoon.

In the eurozone I see little respite and the banking system is freezing up. There was a good article in the company section of this morning's FT questioning the safe-haven status of German bunds (click here). I think the author is right and the eurozone looks like a giant CDO, rubber stamped (sub-prime style) with Germany's AAA rating. But like the sub-prime fiasco, we discovered that it wasn't AAA at all but just a pile of junk. All of this has to be properly resolved eventually but the eurozone debt and banking crisis is not yet over. In the meantime, all eyes on the ECB and BoE policy meetings tomorrow. Not much is expected to change. The BoE will presumably want to see the full details of the Budget. The FT reports that next Monday, Sir Alan Budd (whom I respect as an influential and serious economist) delivers his verdict on the state of the economy in his capacity as the boss of the new Office for Budget Responsibility (OBR). Expect a fairly downbeat (but realistic) assessment of UK economic growth prospects.

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No respite in the financial market gloom. Last Friday was a bad day with a weak US jobs report sparking investor worries that a ‘double-dip’ recession is in the pipeline. For many of us, the recovery never really got underway, so what we are talking about is just more of the same i.e., below par economic growth and continuing job uncertainty. In addition, the eurozone debt and banking crisis rumbles on. It is certainly the case in my view that we will see a full-blown banking crisis before too long. This will require the ECB to do everything necessary to support the banks including outright quantitative easing. No wonder the euro remains under pressure. At 1.20 against the US dollar this is just the mid-point of the trading range since the inception of monetary union in 1999. The French Prime Minister was quoted last Friday as welcoming parity. He should be careful what he wishes for! There is some speculation amongst currency traders that China might be lurking in the background as part of a deal with the Americans to support the euro should price action become disorderly. It can’t be ruled out, but my technical chart points to 1.12 in EURUSD being tested possibly quite soon.

As far as the UK economy is concerned, David Cameron was refreshingly candid at the weekend about the prospects for the UK economy. Instead of ‘blue sky’ economic forecasts, he painted a rather downbeat picture. It looks as though he intends tackling the budget deficit in a serious manner. So far, there is not much of a reaction in the currency markets, though sterling, on a trade-weighted basis, is at the top end of this year’s trading range.

What is interesting during this recent phase of market turbulence and volatility is the positive reaction of international investors to the gilts market. In spite of all the worries about the UK budget deficit, foreign investors have been significant buyers of gilts. Since the election on 6 May, gilts have actually outperformed German and US bond markets. It is fair to say that the gilt market has become a ‘safe-haven’ given the problems in the eurozone. Bank of England data shows that international investors bought a record £42 billion in UK government bonds and notes in February, March and April. This was enough to fully fund the UK budget deficit in those months. This is all very encouraging and suggests that bearish sentiment towards sterling might be overdone if we just look at the budget deficit alone. This week’s Bank of England MPC meeting is unlikely to see any change in policy. The economic outlook is still uncertain and the MPC (like the rest of us) will want to see what Mr Osborne comes up with on 22 June.

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The latest economic forecasts from Standard & Poors predict that the UK recovery will lag behind that of Germany and France. That is very disappointing to say the least. But the reasons are simple. The UK, along with Argentina, were the only economies not to have a fiscal stimulus last year according to the IMF. Both Germany and France put together a stimulus package (mainly tax cuts) despite the leaders of both countries calling for severe fiscal stringency elsewhere in the eurozone. Germany, as one of the world's leading exporters, has benefited from the sharp fall in the euro and the buoyancy of its export markets in China and the rest of Asia. In contrast, sterling has gone up against the euro thus depressing our export competitiveness. In addition, the UK's main export market is the eurozone where domestic demand is flat. So, no fiscal stimulus, flat export markets and a higher pound have created a triple whammy for the UK economy. The other ‘whammy’ for the UK economy is Mr Vince Cable. His tax proposals for CGT are a mistake and his new ministry, which is just a 1960s rehash of George Brown's ill-fated Department of Economic Affairs, creates more unnecessary bureaucracy and a policy mix-up with the Treasury. All of this does little to convince the City and international investors that the new government can get the UK economy back on track. Policy is not growth-orientated and the individuals with responsibility for economic policy do not impress either. As a result, international investors are unlikely to be bullish on UK markets when there are better prospects elsewhere in the global economy. Could sterling replace the euro at the bottom of the currency league table? If Mr Cable gets his way, bottom place beckons.

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After what seems to be a lengthy period of blood-letting in global equity markets, it is welcome news to see some respite in the last couple of days. Whether this is a precursor to a more sustained recovery remains to be seen. I am still worried about the eurozone banking system as well as the likelihood of further bad news with regard to the eurozone debt crisis. This story is not over and the newsflow still has the capacity to generate fresh volatility.

In the near term, financial markets will focus on tomorrow’s US jobs report and the G20 meeting of finance ministers in South Korea at the weekend. Recent economic data out of the US has been quite good and this is encouraging investors to believe that the current economic recovery is sustainable. The G20 is likely to focus on regulatory matters and bank taxes and bank levies. A draft of the G20 communiqué out this morning, not surprisingly, says they are on alert as regards developments in the global economy and will do whatever is needed to ensure financial stability. I am so glad to hear that. Here in the UK, this morning's economic data showed the PMI services index for April at 55.3, still in a recovery phase but nothing too exciting. Sterling has been quite resilient over the last few days, mainly related to the unwinding of FX hedges related to the Pru/AIA story. Otherwise, it is still all about the budget deficit.

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Sterling received a bit of a lift as the Pru retreats from the AIA deal. However, the bigger picture at the start of the month is no let up in equity market weakness. The eurozone debt crisis, alongside worries about the eurozone banking system, remain key themes for investors. The latest news that the German government is extending the ban on short selling is just typical of the bureaucratic mindset that is unable to understand that their own policies are the root cause of the problem. The joke doing the rounds in the City that Merkel intends to ban world cup teams scoring against Germany sums the mood up. As Spike Milligan said, the German sense of humour is no laughing matter.

Here in the UK, last weekend's resignation of David Laws as Chief Secretary to the Treasury highlights the risk of ‘same old’ attitudes amongst our political masters. The fact is that he broke the rules on parliamentary expenses. For ordinary mortals, such misdeeds would carry stiffer penalties and the notion that he can return to the cabinet soon just shows the lack of a moral compass at the heart of government. His successor, Mr Alexander, does not impress the City and the new government is starting to look careless and amateurish. Its proposals on capital gains tax and pensions are misguided and need to be rescinded soon. The Chancellor, George Osborne, has his work cut out to convince the City that the upcoming Budget will do the job of tackling the deficit.

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