Liquidity pressures have forced the ECB to step into the market again; the bank announcing new six-month measures to try and ease money market tensions at this afternoon’s rate setting meeting (rates were held at 1.50%) in addition to the no doubt more distasteful step of returning to support peripheral bond markets – Portgual and Ireland benefitting in the first instance. Trichet claimed the bank had not previously ceased its purchase programme – stating he had never personally said it was dormant, but this just look like semantics to us. The bank has never been comfortable with this course of action and the fact that the ECB is back in the market (and not with unanimous support from the council) speaks volumes about the scale of the crisis enveloping the region and the steps needed to provide even a small perception of control.
The timing of today’s meeting is a little unfortunate given the moves from the Swiss National Bank, Bank of Japan and Central Bank of Turkey this week. While action during the first financial crisis was very much a global affair, what stands out now is the unilateral nature of these steps; the Turks noting the action was designed to protect against the risk from peripheral Europe and a US slowdown despite currently solid local macro fundamentals and already competitive exchange rate (earlier monetary policy moves having weighed heavily on the TRY). This is not that surprising; sovereign balance sheets have been trashed over the past three years, significantly weakening the hands of governments desperate to stimulate growth. Deleveraging, which was the only real solution, will never fit into the electoral cycle. The imbalances that contributed to the crisis are also still very much present, indeed in many instances exaggerated. One just has to look at Germany and the level of Asia FX reserves to see how the much criticised export driven model has survived.
There is a real risk now that these unilateral steps are repeated elsewhere as authorities look to build protection against the feared slowdown in global growth. Many indicators are already alluding to this; for example JP Morgan’s global PMI index (above) is now only marginally above the 50.0 level and Citi’s global economic surprises index (below) has been printing negative surprises ever since the Japanese earthquake, a sign the market is behind the curve. If one throws the probability of the odd sovereign default into the mix (peripheral Europe), the probability of a US downgrade and prospects for further tightening in China the temptation to try and get that first mover advantage can only increase.
It’s difficult to envisage a scenario where there is a clean resolution to current problems. If the Fed embarks on new policy stimulus it will likely be dollar negative, exaggerating tensions between the free floaters and the pegged currencies. Hopes of faster Chinese appreciation which might allow more flexibility across Asia doesn’t fit well with slowing global growth either. A round of competitive devaluations and a plethora of new tensions (i.e more obvious protectionism) looks like a logical next step, a multilateral solution will be near impossible to forge if this begins, if it’s not already. One only has to look at the European situation to understand how difficult it is to find a consensus and the debt ceiling clash in the US is even more glaring.
We’ll dare to name a few potential - if not that radical - flash points: Japan/Korea, BRL heading an EM block vs. the dollar and the classic CNY vs. USD, something US politicians might actually be able to unite on.
From an investment perspective the implications look dangerous both in a shorter-term context and longer-term. Equities should remain volatile, the stock markets of the exporter nations set to be most sensitive to a slowdown in global growth. High cash weightings look sensible in this context.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.