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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The gold price has hit the $1,000 level and new highs are likely soon. This has little to do with worries about inflation. If you look at all the official measures of consumer and producer prices for the major economies, it is deflation rather than inflation which is the immediate concern. Anyway, gold has historically been a poor hedge as far as inflation is concerned. I think the recent move in the gold price has more to with worries of currency debasement and it is interesting to note that the recent increase in the gold price has been associated with slippage in the US dollar. The Chinese are worried that the Americans will print more money and deliberately devalue the dollar thus hurting China’s investments in America. China is America’s largest creditor as well as the world’s largest holder of foreign exchange reserves. I also notice that Russia has overtaken Saudi Arabia as the world’s largest oil producer (and Russia is also the world’s biggest energy exporter) and this would no doubt focus the debate on whether oil should be priced in dollars or other currencies.

All of this will only underpin the debate as regards the future of the dollar as a reserve currency. But for as long as America retains military dominance and its financial markets remain the largest and most liquid then it will be difficult to seriously undermine the dollar. UNCTAD in its latest Trade and Development Report for 2009 is worth a read especially Chapter 4 as it highlights the key issues relating to reform of the international monetary system (click here) and Edmund Conway in the Daily Telegraph also considers this subject (click here).

Overnight, Asian equity markets recovered following on from the gains posted in the US and Europe yesterday. The G20’s desire to maintain accommodative monetary policies is clearly helping to bolster investor sentiment. However, equity markets are not cheap (click here) and the economic outlook does not look great for next year. I noticed that German 2 year bund yields fell to a record low of 1.05% yesterday and in the US, the 2 year yield is below 1.00%. What this is telling us is that the bond markets do not believe a sustainable above-trend economic recovery is imminent or that inflation is a problem. Next year, fiscal policy in the major economies is likely to be a drag on growth. Chancellor Darling in a speech today is set to outline plans for cuts in public spending despite the fact that an election has to be called by May next year. Cuts in spending would appear inescapable given that the UK budget deficit is heading towards 12% of GDP. In the US, the Bush tax cuts expire next year and against competing demands for increases in healthcare programmes, US policymakers face similar budget constraints. It is also interesting to note that despite all the “hairshirt huff and puff” from Angela Merkel, the Germans have had the biggest fiscal stimulus of the major economies (ex-China) this year amounting to around 3.5% of GDP. No wonder recent numbers on the German economy have been good so far.

In the UK, the latest report from the British Retail Consortium wasn’t so great and featured a dip in like-for-like retail sales (click here). The UK consumer is still cautious it seems and it is difficult to see what can turn things round here anytime soon. Unemployment is still rising and households are repaying debt. Ahead of this Thursday’s Bank of England meeting, the Monetary Policy Committee are left with little choice but to maintain and extend its policy of quantitative easing.

Finally, and on a completely different note, I would like to introduce readers to Kit Juckes, who is joining ECU as Chief Economist. I have known Kit personally and professionally for the best part of 20 years and I can assure you that he will be a tremendous addition to ECU and its Investment Team. I am remaining as a consultant to ECU as well as a member of the Investment Committee and will continue to write the daily blog, and I am pleased to say that Kit will be making regular contributions to it.

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Well, the G-20 meeting came and went without too many surprises or upsets for the financial markets (click here and here). There was the usual populist stuff about curbing bank bonuses but the details were vague. There was more focus on raising capital requirements for banks and there is a worry that European banks might have to make more write-downs and raise more capital. But I guess the important part of the G-20 meeting was that they agreed to maintain accommodative monetary and fiscal policies for some time. This will help reduce the risk of a “double-dip” recession and, as far as investors are concerned, can help underpin risk appetite and reduce the risk of sharp pullbacks in the equity markets.

The main focus for the UK financial markets will be the regularly scheduled meeting of the bank of England’s Monetary Policy Committee (MPC). I think the MPC will maintain the extension in their quantitative easing programme given that lending to businesses is still tight. There are tentative signs, admittedly, that the MPC’s preferred money supply measures are showing signs of improving but it is early days yet. We know that Mervyn King favours more quantitative easing and I think that’s what we will end up getting.

There is also the possibility that the BoE could cut the interest rates it pays on reserves that commercial banks hold with them. One of the key problems at the moment is that commercial banks are simply “hoarding” the liquidity that is supplied to them by the BoE at the BoE itself. Clearly, this reduces the effectiveness of QE and means that the real economy is excluded from the benefits either of lower interest rates or excess liquidity. So, I think there is a good chance that the BoE might announce a cut in rates on reserves this week and I would welcome this as a way of kick-starting bank lending (click here) .

The latest survey from the EEF highlights an “anaemic recovery” in the manufacturing sector (click here). I feel that things will get better here given the lagged effects of sterling depreciation and also the recovery that we are seeing elsewhere in manufacturing, in the US and Germany for example. See Professor Eichengreen’s chart updates which feature an uptick in global industrial production and the volume of world trade “A Tale of Two Depressions” (click here).

 I also noted over the weekend plenty of reports highlighting a pick-up in M&A activity (Krafts bid for Cadbury, HSBC bid for ING, Vodafone/Telefonica bids for T-Mobile). All of this is an indication of a revival in corporate risk appetite which might benefit the clearly “under-valued “ currencies like the US dollar and sterling. M&A activity will start to become a much more important indicator to watch as a determinant of exchange rate moves in the short to medium term.

Friday’s US jobs report was more-or-less in line with market expectations but it was still a weak report. Employment is still declining and employers are not hiring despite the uptick in manufacturing production. Manufacturing employment  fell 63,000 in August to its lowest level since April 1941. Hours worked still remain near record lows and wage disinflation continues. On a comparative basis, the current recession is one of the worst in terms of employment losses (see some interesting charts here).

Finally, as US markets are closed today, I came across some interesting articles which question the effectiveness of economic theory in understanding and explaining the financial and economic crisis. There is considerable dissatisfaction in the “free-market” theories that have dominated academic thinking in the last 20-30 years especially the idea of “efficient markets”. I recommend Professor Krugman’s latest thoughts “How Did Economists Get It So Wrong“ (click here).

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Yes, it’s that time of the month and all eyes in the financial markets are on this afternoon’s release of the US jobs report. Everyone is hopeful of some good news here as employment is crucial not just to the prospects for economic recovery(more jobs equals more spending power) but also as regards the feedback loops onto banks where more employment equals less loan default and home foreclosures. There is no doubt that the worst of the declines in economic output and employment are behind us but this does not mean that all is well.

The fact is that that the pace of employment declines is decelerating, but as yet it is not increasing.  In the US, non-farm payroll employment is lower than when President Bush entered office in January 2001. In addition, longer term unemployment is rising and people are dropping out of the labour force because it is still difficult to get jobs. Employers are simply not hiring and they won’t resume hiring until they are certain that a recovery in demand is sustainable. Until then, employers will work their existing labour force harder (so that productivity as measured by output per head) goes up thereby contributing to a “bottom line” improvement in profitability.

In the US, it is worth noting that hours worked (data which is included in today’s report) is close to record lows and that hourly wage growth continues to decline. Less hours and less money is not the recipe for a consumer-fuelled economic recovery. Some commentators are looking for a “V-shaped” recovery in employment but I have to say I don’t see the evidence for it. The same applies here in the UK and the OECD’s interim assessment on the UK economy was not that optimistic (click here). However, activity in the UK’s service sector has reached a 2 year high and the expectation is that UK real GDP growth will turn positive in Q3 (click here)

Yesterday, the ECB kept interest rates unchanged as expected and Mr Trichet said that the recession in the eurozone is probably over. There is much talk of so-called “exit strategies” which refer to how central banks will return to a “normal” monetary policy once the economic situation recovers. Mr Trichet says the ECB has such plans ready though he says that “it is premature to declare the financial crisis over” and “today is not the time to exit” (click here). Indeed, the ECB in their latest economic forecasts see eurozone real GDP growth expanding by a meagre 0.2% next year. Overly-cautious or an accurate assessment?

 I do agree with Mr Trichet’s assessment  and while it is sensible to look ahead and think about “exit strategies”, I also think it could be dangerous to “tighten” policy at this juncture. There are historical precedents like the US in 1937 and Japan in the 1990’s where an early tightening of monetary and fiscal policy capsized a nascent economic recovery and plunged everyone back into recession (note that in the US, the “cash for clunkers” programme has already expired and the homebuyer credit scheme is set to expire end-November).  I also think that still-tight credit conditions together with potential supply-side constraints need to be taken into consideration as these factors are likely to act as drags on prospective recovery. In the ISM index for the US economy published this week, I noted that “supplier deliveries” are at their highest level since 2006 and this is very revealing of potential bottlenecks already (click here). In addition, there is plenty of talk at the G-20 of tighter financial market regulation and tighter control of bank bonuses and of foreign currency lending in the EU that all adds up to a “regulatory constraint” on potential growth as well.

Today’s US jobs numbers will therefore be very interesting not only for clues on how the labour market is doing but also in terms of the markets’ reaction. The gold price is a footstep away from the $1,000 level and the gold/dollar ratio is back at July 2008 levels. Stockmarket investors are uncertain of the next move and markets seem nervous while the US junk bond default rate jumped to 10.2% in August from 9.4%.

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Timothy Geithner, the US Treasury Secretary, says that it is too early for central banks and finance ministries to exit current policy. Ahead of Friday’s G-20 meeting, the same view has been echoed by the UK Chancellor, Alistair Darling, especially as it turns out there has been a $200 billion shortfall in the $1.1 trillion global rescue package agreed by the G-20 back in April. As far as the financial markets are concerned , “better” economic data inevitably increases speculation of an early end to QE and/or increases expectations of early increases in interest rates. For a useful comparison of where the major economies stand with respect to the various policy moves they have made, I suggest you look at some interesting chart comparisons here.

My own view is that it is too early to exit current policy as the main driver of economic growth, consumer spending remains quite sluggish and the “better” economic data is the result of inventory build, various stimulus initiatives that have boosted auto output etc. If you look at the weekly and monthly data on consumer spending there is not a great deal happening except that American and UK consumers are saving more, spending less and repaying debt. Last night’s FOMC minutes (click here) contained few surprises though the minutes did confirm that the Fed plans to phase out its purchases of US Treasuries by the end of October.  As an aside, I note that US commercial banks have near record-low exposure to US Treasuries. In previous credit contractions, the banks have bought Treasuries (i.e they lend to the Government, while at the same time they cut back lending to the private sector) and I wonder whether this can maintain the current bull market in bonds despite upcoming issuance. Separately, the FOMC minutes also mentioned that they have a forecast of stronger foreign economic growth which implies that they would prefer their foreign counterparts to maintain an easy monetary policy for a while yet.

All this gives the ECB an opportunity at its regularly scheduled meeting today to clarify its position on exit strategies. Mr Trichet will highlight new economic projections though I think he will deliver a “cautiously optimistic” view of the prospects for eurozone growth going into next year. Markets have been relatively quiet in the last 24 hours or so, though the gold price has jumped the most in five months. I wonder whether some of this is down to Chinese buying. Either way, Philip Manduca and I are bullish about gold, and I recall Philip earlier in the year forecasting an eventual move to $2,000 in the gold price.

Stockmarkets remain in an uncertain mood but after a 50% rally this is not a surprise and the market does look expensive in terms of p/e multiples (click here). Stockmarket technical analysts are keeping an eye on the 200 day moving average in the Shanghai Composite at 2493 and the 50 day moving average in the Hang Seng index at 19500. In addition, it is worth noting that the percentage of stocks in the S&P index above their 50 day moving average has dropped from 93% to 78% currently and could go much lower in this corrective phase (click here).

Yesterday’s ADP employment report which is closely watched for clues as regards the outcome of tomorrow’s all-important US jobs report was disappointing. The ADP fell by 298k in August and suggests that conditions in private sector employment remain sluggish. The market generally expects the broader non-farm payroll employment data out tomorrow to fall by 250k. Anything worse than that will be a disappointment for the markets. I came across a set of interesting charts which compares how the labour market has performed in previous recessions and you won’t be surprised to hear that the current recession is experiencing one of the worst set of job losses (click here).

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In yesterday’s blog, I said that September was historically the worst month for equity markets (losing 1.0% on average) and sure enough equities did their thing on cue with many indices losing more than 1.0% just in the day. Overnight, Asian equity markets have slipped further. This is despite the release of more economic data which points to a “recovery” from the very sharp declines in activity that were recorded during the second half of last year and into the early part of this year.

Yesterday’s economic releases which were positive included a 0.7% gain in German retail sales, a sharp jump in the ISM manufacturing index to 52.9 in August from 48.9 in the previous month and a 3.2% gain in the month for US pending home sales. The ISM index is at its highest reading since June 2007 and export orders hit a 12 month high. Overall, the reading on the ISM index is consistent with 3% real US GDP growth. It was not all one-way traffic though. Eurozone unemployment in July moved up to 9.5% from 9.4% and the ECB’s Nowotny warned against an early exit from policy stimulus. US construction spending fell 0.2% in July to stand some 10.5% lower than a year earlier and non-residential construction slipped 1.2% in the month. The bright spot though was a 2.3% gain in residential construction which was the biggest increase since July 2005 (click here). In the UK, the data was not so encouraging with the PMI manufacturing index in August slipping to 49.7 from a downwardly-revised 50.2. UK consumers are also repaying debt (a good thing) and personal borrowing fell £600 million in July. Reports this morning claim that UK insurance companies may be forced to seek more than £50 billion in fresh equity as a result of proposed new European rules.

However, the markets ignored the good data and equity markets, I think, are re-assessing the economic outlook. After equities’ recent performance, you could argue that equities are now starting to discount a “double-dip” recession which is what the bond market is looking for anyway. US 2 year yields, which are a good indicator of short term interest rates and economic growth sentiment, dipped back below 1.0%. Other indicators like the VIX index shot up and euro/yen (our FX equity market indicator) slipped below its 100 day moving average. China provides no help either and the Shanghai Composite, which has been a lead indicator for equity markets elsewhere, remains fragile. The Japanese yen has been the main currency “beneficiary” of this fresh increase in risk aversion and the yen trade-weighted index is now at its highest level since mid-July. Further strength can only ring the alarm bells at the BoJ/MoF especially in front of G20/G8 meetings this month and into October.

Today, the main data release will be the ADP employment index which will give us clues as regards Friday’s key US jobs report. The picture in recent months has been one of some deceleration in job losses with the unemployment rate suggesting that it might be stabilising at (relatively high) levels of close to 10%. A “bad” number clearly won’t help the equity markets regain their poise. On the other hand, a “good” number might not do much either which leaves the equity markets with the worst of all worlds. So caution is required. My view of the economic outlook is that we need to monitor what is happening to consumer spending rather than extrapolate from inventory data and manufacturing PMI’s that suggest a “rip-roaring” recovery.

 In the context of the aftermath of a severe financial and economic crisis such an outcome was always looking optimistic. Finally, on that note, I suggest you read “Reflections on the Causes and Consequences of the Debt Crisis of 2008” by Menzie Chinn and Jeffrey Frieden. It’s a good account of the causes of the crisis and contains some salient points as to what the economic outlook might look like (click here).

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Stockmarket historians know that September is the worst month of the year losing about 1.0% on average. In the FX market, we recall that sterling exited the Gold Standard on 21st September 1931 resulting in a sterling devaluation of 28%. It was 16th September 1992 that sterling left the ERM after double-digit interest rates and a double-digit unemployment rate highlighted the unsustainability of the UK Government's exchange rate policy. And for those interested in military history, today is the 70th anniversary of the German invasion of Poland which started WW2 (click here). Last September saw the worst of the financial crisis with Fannie Mae and Freddie Mac taken under conservatorship (7th September), BoA acquiring Merrill Lynch (14 September), Lehman filing for Chapter 11 (15 September) and a collapse in AIG's share price (16 September).

Now as we start the new month this year, stockmarkets look jittery. The Shanghai Composite is down for its fourth successive week and August is the first month this year that the index has closed lower with the index losing 22% in the month. The Shanghai Composite might resemble a racetrack but many think that China is experiencing a credit bubble that is about to burst. Investors are clearly nervous and it is worth noting that emerging stockmarkets have underperformed developed markets for the fourth consecutive week.

Indeed, the stockmarkets seem to be turning a blind-eye to all the "good" economic data that has been coming out of the major economies in recent weeks. I have commented before on the apparent "disconnect" between the stockmarket and the bond market as regards expectations for the economic outlook. The bond market is telling us that it is priced for much more subdued rates of economic growth than the stockmarket. For sure, there has been an impressive rebound in manufacturing activity in the major economies which I think is largely due to a turnaround in the inventory cycle. In addition there has been a substantial fiscal stimulus in the US (which is now fading) as well as a massive injection of liquidity (which in the main is not being recycled into fresh lending but simply being parked by the commercial banks at the central banks). This will generate very good headline rates of GDP growth for Q2 and Q3 but thereafter I think GDP returns to fairly soft rates of growth. The consumer is key especially the American consumer who accounts for 20% of the global economy.

Readers of my blog will know that I have been wary of stockmarkets in recent weeks and after an amazing rally from the March lows, it is no surprise to see at least a pause for breath. And, yes, I think there is a growing risk of a sharp correction but I am not looking for a crash or a retest of previous lows.

The debate about the prospects for the global economy is very interesting. Jim O'Neill at Goldman Sachs was one of the first economists earlier in the year to highlight the prospect of an economic recovery and he is still bullish and you can read his latest thoughts in the Times "Now its looking like V for Victory over recession". Where I disagree with Jim is that I am mindful that the consequences of the financial crisis especially for the US and UK make for a painful adjustment and the latest research on this matter by the IMF which I have referenced in previous blogs cannot be ignored. Private sector deleveraging is being offset by government laxity in monetary and fiscal policy. In addition, over-investment and speculative activity in the Chinese property market worries me and I am not persuaded that the Chinese economy can sustain strong economic growth going forward. Already, the Chinese government is taking action to slow lending and curb investment excesses.

There are other commentators who have a different and less optimistic view than Jim. For example, Hugh Hendry has a more bearish assessment and is worried about debt-deflation (click here). Ambrose Evans-Pritchard thinks that "our quarter century penance is just starting (click here). Liam Halligan is particularly bearish on the UK and notes that the UK GDP data last week was our worst peacetime performance. He also notes that business capital spending is falling at its fastest rate in more than 50 years and that net lending to non-financial companies recorded its steepest decline in July since the credit crunch began. He also notes that that UK households are more indebted and have greater reliance on the financial services industry than any other economy. (click here).

It all makes for an interesting September. The G-20 meet this week and there has been a lot of talk about a Tobin tax being imposed on FX transactions (click here and here). Many in the currency market would argue that such a tax is misguided and wont help solve the deeper-rooted problems that have more to do with imbalances created by government economic policy. However, I wouldn't rule out such a tax being imposed. The public and political attitude to financial markets is changing to more regulation and intervention. Not a surprise after the events of the last 12 months.

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