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

The most recent post appears at the top – scroll down for older entries.

I have never seen markets so correlated, with all other assets seemingly taking their cue from the S&P index. I can also barely remember a time when the financial community had so little conviction about anything – confidence levels are very low. This is making for a very skittish market, but behind it all the global sovereign debt crisis gathers momentum.

The G7 Finance Ministers and central bank Governors met in Iqaluit (escaping the snow storms that struck the Eastern coast of the USA). Nothing they said is inspiring me with much confidence. The FT write up of the G7 meeting is worth reading (click here). The plan is to manage a delicate balancing act, supporting growth now and simultaneously maintaining the credibility of deficit-reduction plans. The Europeans, meanwhile, provided assurances that the Greek fiscal crisis would be resolved. It all smacks a bit of desperation. There are no new policy initiatives, just a hope that the global economy is getting better (slowly) and a promise that fiscal problems will be resolved. To be fair to the G7, savage fiscal restraint would not be the right policy and there is a case for just biding time now and seeing how things play out. However, markets do not like a lack of action and do not like the sense that policy-makers are increasingly impotent.

The risk this week is that after an initial attempt at a bounce in equity indices, fear about sovereign default returns. And that is where the market’s lack of conviction comes into play. The right policy may be to do nothing and wait for the slow grind of better economic data to calm nerves. But psychologically-important chart levels have been broken in almost every asset class and if we do see prices of equities drift lower again, the move is in danger of gathering momentum like a snowball. A break of 1,050 in the S&P index would signal a move to test 5,000 in the FTSE, and I still fear a breakdown towards $1.30 for the euro. That could see GBPUSD get close to 1.50.

Where does this end up? Ultimately, it heads to even lower rates for even longer and renewed ‘debasement policies’. That could see the US step up their quantitative easing in due course or it could involve more open dollar-devaluation talk. In the US it may involve a further attempt at fiscal largesse, though everywhere else the scope for such action has pretty much run out. All of these policies are bad for the dollar and, in particular, good for commodities and for gold perhaps most of all. However, we must not get ahead of ourselves. For now, fear lurks inches below the surface and I really wouldn’t rule out another sharp fall in equity prices, another move wider in credit spreads and a spike lower in EURUSD this week.

Other news over the weekend started with the US payroll report. Benchmark revisions increased the number of jobs lost in the recession by almost a million but the highlight of the report was a fall in the unemployment rate in January to 9.7%. Monthly payrolls fell but that was partly due to a weather-related fall in construction employment and with hours worked heading higher (including overtime), the overall picture was OK. Politicians are unable to cheer because the unemployment rate is still too high, but Q1 is lining up for reasonable growth. Financial markets, however, just don’t care.

In the UK, the news highlight is the suggestion in the Sunday press that the government could call a general election in April as opinion polls continue to point towards a growing possibility of a hung parliament. My emotional reaction is ‘good’, insofar as the sooner the election is out of the way the better. Markets, however, still fear political paralysis above anything else and will not be very enthusiastic about the UK with this threat hanging over it. Not to mention the ever-so-easy conclusion that the UK is next in the spotlight when the markets stop worrying about European sovereign debt.

.

Sovereign creditworthiness shifted to the forefront of financial markets’ awareness yesterday with a vengeance. Fear that governments had taken on too much debt bailing out broken banks and propping up their economies was a localised problem until now – it brought down Iceland and it sent sterling into a tailspin in 2008. It has been a worry for Greece for weeks but it is now spreading like wildfire, driving equity markets lower, causing further concerns both about medium-term growth prospects and in currency markets. Old correlations are back to the fore with the US dollar and the Japanese yen thriving, as ‘riskier’ currencies like the Australian dollar and sterling fall. The euro, meanwhile, remains extremely unpopular.

The cost of 5-year credit default protection on Spain has increased from 80bp in early December to 168bp now, higher than it was at the peak of market illiquidity and fear in February 2009. That matters in part because it raises the cost to Spain of borrowing money, but even more because Spain is a much bigger economy than Greece. As I wrote yesterday, Greece represents under 3% of eurozone GDP. Spain counts for nearly 12%. And of course, as is the way with contagion, now that this is no longer a Greek problem but a broader one, the focus is on the lack of room for fiscal manoeuvre everywhere.

The end result of this new fear will be to keep monetary policy at the forefront of efforts to revive growth. That doesn’t necessarily mean more asset purchases by central banks – at least not yet – since government bond yields are low and extending quantitative easing would be like pushing on a string. But it does mean interest rates stay even lower for even longer. And it also means we should expect very dovish talk from central bankers. This will, in due course and once the current risk aversion fades a little, put gold back in the spotlight. I am not infatuated with gold the way some people are but I can’t think of any central bank at the moment that wants either to increase rates or to see their currency appreciate. Gold is ‘anti-currency’ and shines by default when the need for easier monetary policy is a global theme.

We will have to see how deep current market hysteria proves to be. I am nervous. Today’s US employment report now feels like a side-show, except that the market will probably react more to a weak figure than a strong one. The consensus looks for a small increase in employment of about 15,000. A further fall in employment will increase fear about the lack of job creation and the implications for budget deficits and for demand. A strong figure might be ignored since this latest bout of market hysteria comes within a week of the US Q4 GDP data that showed a 5.7% real GDP growth rate.

Going into the weekend: lower rates for longer; wider credit spreads; softer equity markets; and a stronger dollar and yen seem to be the key themes. The pound is not at the forefront of markets’ attention and is trading with the euro. At some point, EURGBP is likely to move lower as Europe’s problems are increasingly seen to be as big as the UK’s.

.

The cost of 5-year credit default protection on Greece has widened again this morning to 410bp – and 5-year government bond yields have edged back above 6.5% in the process. The European Commission yesterday issued its verdict on the Greek deficit reduction plan (click here) and while markets initially reacted positively, the conclusion was soon reached that this was a pretty lukewarm ‘blessing’ from the Commission. The FT reaction is worth reading, and is typical enough (click here). The euro has consequently fallen back overnight.

This crisis isn’t really about Greece however. Any more than the global credit crisis was about Lehman, or the dotcom boom was about WorldCom. Solving Greece’s problems is not all that expensive (Greece accounts for less than 3% of eurozone GDP, after all). But bailing out Greece too easily, and without tough conditions, would send a poor message to the Greek government and a worse one to others with fiscal problems. But even this concern – a major one for the EU leadership – is small, relative to the reality that government debt has ballooned everywhere and markets are going to be increasingly nervous of those lacking the political will to tackle their problems. Strains on sovereign creditworthiness will remain, public sector spending will have to fall across the industrialised world and central banks will respond by keeping interest rates exceptionally low. In Europe, where history suggests that restraining the size of the welfare state is difficult to achieve and where markets had been betting on ECB hawkishness sending the euro higher, we have a recipe for heightened concerns and a weaker currency. The current move has further to run. The ECB will almost certainly leave rates on hold today and Mr Trichet will be asked plenty of questions about Greece in the Q&A at 13:30 GMT.

In the UK, the focus is on the MPC and the probability that they will announce that they are not (for the timebeing) extending asset purchases (QE) beyond the current GBP200bn limit. The Telegraph highlights the  similarities between Greece and the UK (click here) and the Times shadows the MPC’s view (i.e., don’t extend) (click here). I’ve written a fair bit about quantitative easing, but the bottom line is that it has worked insofar as it has sent Gilt yields down, tightened credit spreads, allowed companies to refinance their debts in the bond market and sent equity and house prices higher, slowing the rise in the savings rate that was threatening to turn a recession into a depression. To do more now would be a bit like pushing on a string: yields would not fall further and equity and house prices probably would not get much help either. From here on, the main focus will likely be to keep rates at current levels for the remainder of the year and see how much Gilt yields rise (I am guessing that 10-year yields head to 4.5% in the coming months, from 3.9% now). Sterling should get some help from a QE pause – though today the reaction would be bigger and negative if the MPC were to extend QE further.

It’s US jobs day tomorrow and that is a report which will drive markets in days to come. We have had poor employment data in New Zealand and soft retail sales data in Australia overnight, so equity indices are soft and the US dollar is strong. New trends start tomorrow afternoon. I will write a preview before then.

.

So far, economic data for the start of 2010 has suggested that the recovery which got underway in 2009 is continuing to beat economists’ expectations. Overnight we have had releases showing a further rise in business confidence in India and Hong Kong and, while these pale into insignificance compared to the strong US ISM data at the start of the week, they are worth a mention. The global economy continues to prove doubters wrong.

The strong data has not, however, had any impact yet on Bond yields. At 0.86%, the US 2-year Treasury yield is slightly below its average level of the last six months, despite the strength of Q4 GDP and signs that Q1 will be strong as well. There are three reasons for this. Firstly, inflation expectations are incredibly well anchored in this cycle – something which allows a lot of leeway to policymakers. Secondly, without inflationary worries and in the face of uncertainty about the durability of recovery, central banks can keep rates at current levels for a long time. In the US, the FOMC is unlikely to hike rates in 2010 – and perhaps not in 2011 either. And finally, quantitative easing has resulted in fewer government bonds being available for sale to the private sector, at a time when banks are being encouraged to buy more ‘safe’ government debt to improve the quality of their balance sheets. The upshot – and it’s relevant today because it is the driving theme for markets once again – is that we have low yields and strong growth, which is the perfect combination for ‘risky’ assets. This week has seen the price of gold shoot up, the S&P index in the US move back above 1,100 (for now, anyway) and higher-yielding currencies are recovering. That has brought the dollar’s revival to an end too.

The issue going forward is whether this combination of strong growth and low yields can remain in place. The main events of this week lie ahead, culminating in the US employment report on Friday. My suspicion at this stage is that as the US moves from fewer job losses to actual job creation, the interest rate market will react. This may be a ‘jobless recovery’, but we can still see some strong employment data as the firms which are now increasing output to help rebuild stocks start hiring people. If that happens, the equity market – flavour of the month again this week – may just grind sideways as the good earnings news is diluted by higher rates. The ‘risk’ trade could progress, but more slowly, and we should see the US dollar move higher again.

That is all ahead of us. Today, we have started with a soft services survey from the CIPS. The index of 700 services companies’ confidence fell back to 54.5 from 56.8 last month, in contrast to the strength of the manufacturing survey and suggesting that what the pound did for the latter was not repeated in the services sector. We are waiting for the European Commission to publish its report on Greece’s fiscal plan, but this is likely to provide a qualified endorsement. Anything else would cause chaos in markets and be totally counter-productive. Nouriel Roubini captures the general mood – that Greece will not be allowed to default – in a piece in the FT today (click here). This afternoon we get the US ADP survey of private sector employment which will provide some clues as to Friday’s official data. This survey understates employment growth overall and is expected to come in at around -30,000. We also get the US ISM index for non-manufacturing companies, expected at 51 vs. 50.1.

.

The surveys of purchasing managers (ISM index in the US, CIPS index in the UK) are the first major data releases of each month. They are 'only' surveys, and of the 'old economy' manufacturing sector at that. However, they tend to lead the official data and are a better indicator of where it is heading than you might expect. The US index was much stronger than expected yesterday, rising to 58.4 (a reading above 50 implies the economy is growing). That is consistent with an annual growth rate of 4% and has not been seen since 2004. It smacks much more of a V-shaped than a U-shaped economic recovery. There are caveats galore, in that this is driven by the revival in global trade and by the need to rebuild inventory levels, and doubts about the outlook for employment growth and for consumer spending will remain intact. However, the news is undoubtedly positive, gloomy views are being challenged and if the Federal Reserve does wind down its asset purchases as planned, somewhat higher Treasury yields and a stronger US dollar seem likely through the next month or two (click here for the Wall Street Journal's take on ISM).

The UK equivalent, the CIPS survey, rose to a 15-year high, in a sign that the weaker pound is helping exporters. My first reaction was to think this would be good news if the UK had any manufacturing industry left, but that's a bit unfair – manufacturing output is still around 14% of the economy in line with other developed economies. The FT comment is worth reading (click here).

The UK markets were less interested in the CIPS data than in the Bank of England's 'Trends in Lending' report (click here). This week's discussion point will be the possibility of a pause in the Bank of England's asset purchase programme. The weakness of mortgage lending is a reminder that any thoughts of higher rates should be put firmly on the back-burner. That isn't 'news', however, and it doesn't mean that quantitative easing needs to continue.

With European PMIs revised up, the overall story is one of positive growth trends persisting into 2010. Add to that the prospect of monetary policy remaining accommodative and you have a recipe for the current pause in equity prices, commodity prices and asset prices generally to be only temporary.
.

Nouriel Roubini, feted at Davos again, was one of those who predicted the financial crisis and has taken on the mantle of arch-bear on the global economy. So, predictably, when told that the US saw 5.7% real GDP growth in Q4 last year, he retorted that the outlook remains very dismal with most of the growth coming from inventory accumulation. He expects a growth rate of 1.5% in the second half of 2010.

It is the nature of journalism that Professor Roubini gets so much attention – bad news sells and last year’s winners get more attention than those who got it wrong. But you wouldn’t want to manage money on the basis of paying more attention to the most recent performance. That the size of the debts faced by governments and households alike will act as a brake on growth is a given. But even the non-inventory aspects of the US GDP data were a little stronger than expected, with final sales growing at a 2.2% rate. And perhaps the brightest part of the Q4 report overall was a 4% annualised growth rate in real personal incomes. Income and employment growth are the recipe for a sustainable demand recovery in a world where we cannot borrow our way to wealth any more. We’ve seen good news on the former and the focus now switches to the latter with the release of the January employment report on Friday. Last month’s data were a little disappointing though as I wrote ahead of the figures, a ‘miss’ of 100,000 is not statistically significant. The market is looking for the improving trend to continue, creating a gain in jobs of some 13,000. Only when monthly increases are above 100,000 can we really talk about employment creation, but the trend is still positive. I expect the Q1 GDP increase to be impressive, albeit perhaps not quite as good as Q4, and as that becomes more apparent we will probably see talk of Fed tightening re-surface. And at a more mundane level, if this week’s data (starting with the purchasing managers’ survey today) are robust, the dollar’s revival can continue and the S&P’s correction may be nearing its end.

If the outlook is bright for the dollar, the euro remains in all sorts of trouble. The conversations I have had about the problems faced by Greece and Spain all centre on their failure to get public sector spending under control during the good times. Spain has suggested a budget to reduce debt levels but there will be concern about whether it is achievable. This is not about what is in the plan but about whether limiting the size of the social safety net that differentiates much of Europe from the US – and to a lesser extent the UK – is politically possible. The Irish, to some degree, have shown us what can be achieved if the government is willing to take really unpleasant decisions. In the UK it has been done before. But in Europe there is a different (not necessarily worse, but that’s another story) political philosophy which makes tackling this budget problem in these economic conditions really hard. It seems likely that things have to get worse for Greece and Spain (and Portugal) before they can really get better. And in the meantime, the euro will remain the most vulnerable of the major currencies and the ECB will have no option but to remain accommodative if Council members want to urge fiscal austerity.

The nature of the UK’s finances was shown up starkly on the front page of the business section of the Sunday Times, with two stories that caught the eye (click here and here). The first is a report of a potential bid for Northumbrian Water. The UK is selling its houses, its football clubs, its chocolate and its water. It isn’t dong so on purpose, but in a world where financial conditions are almost perfect for large-cap companies to go on acquisition sprees, the UK is one of the countries that puts few obstacles in the way of foreign investors. And this is one reason why sterling has stopped falling. The second story is more mundane in that it highlights how close Thursday’s vote at the MPC will be, on whether or not to extend the Bank of England’s asset purchases. I think they will pause, because quantitative easing has served its purpose. And when they do, Gilt yields will rise and, in due course, support the pound. But between now and Thursday, expect the markets to get very nervous about the possibility of quantitative easing being extended.

.