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May 30, 2014
U.S. and developed-market international stocks continue
to flirt with all-time highs, even as rallying U.S. Treasuries
appear to send a less enthusiastic message. As I wrote
last week, a flattening yield curve cannot be ignored, since
it often portends slower growth ahead. In today’s case,
however, past may not be prologue. Simultaneous rallies
in equity and bond markets may be unusual, considering
that if the economy is getting stronger, Treasuries might
be expected to weaken. But, as OppenheimerFunds’ Chief
Investment Officer points out in a forthcoming blog what
happens elsewhere in the world matters for interest rates,
too.
What we’re seeing out there is the potential for deflation in
the Eurozone, a slowing China and a still-struggling
Japan. Against that backdrop, it’s not entirely surprising
that global fixed income investors would seek refuge in
U.S. Treasuries. Throw in geopolitical risks like Ukraine, a
relative lack of supply of Treasury bonds, and a Fed that’s
likely to remain on hold for a long time, and the dual rally
doesn’t seem so implausible. That having been said, the
rally in Treasuries may be somewhat overdone, so a
modest backup in interest rates would not be unexpected.
Last week’s poor first-quarter GDP results, as you’ve no
doubt already read elsewhere, almost certainly do not
reflect the underlying current strength of the U.S.
economy. Weather and a soft inventory build detracted
from growth in the beginning of the year, but the incoming
data suggest a decent, if not overpowering, rebound in the
second quarter and beyond.
ECB easing anticipated amid rising
Euroscepticism
Of more immediate concern for the global economy is
what the European Central Bank decides to do at its policy
meeting this week. Bank President Mario Draghi has
telegraphed that easing measures are on the way,
although it’s impossible to say with any certainty exactly
what they might be. A cut in the ECB’s current 0.25%
benchmark rate is possible, as is reducing (into negative
territory) the rate the ECB offers banks for parking their
funds there overnight. The idea behind a negative deposit
rate would be to provide an incentive to banks to make
loans rather than holding onto their capital, but such a
policy could also have deleterious effects on banks’ capital
ratios—something they don’t need right now. Another
possibility, which would particularly target the problem of
poor credit access in the European periphery, is for the
ECB to purchase packages of loans (asset backed
securities) from banks, freeing them to make more loans.
Such a scheme could, however, prove technically difficult
to implement. An alternative would be to introduce some
form of long-term funding scheme for banks that would be
contingent upon their increasing lending to credit-starved
firms.
on putting a floor under economic growth rates, as
Premier Li has repeatedly implied.
Also important, in my view, is that China isn’t going back
to its old ways—trying to goose growth by building reams
of steel mills or encouraging massive new property
development. As I’ve said in the past, whether China gets
its transition to a consumption-led growth model right is
one of the most important questions the global economy
faces over the next decade. Targeted easing programs
such as these, with their focus on consumption rather than
old-style borrow-and-invest binges, are a step in the right
direction.
The recent elections in Europe could throw a wrinkle into
the bank’s plans. After all, across the European Union,
“Eurosceptic” parties (including some quite radical parties
on both the right and left) had a strong showing, winning
140 of the 751 seats in the European Parliament. To be
sure, antipathy toward immigration and, in some cases,
outright bigotry, played a role in some of the election
upsets. But economic stagnation and European officials’
response to it have also inflamed broad anti-EU passions,
raising the question of whether the ECB might feel any
pressure to back off from aggressive policy responses. To
the contrary, I believe the election results, and the falling
confidence in the EU that they represent, make a
muscular ECB policy response more likely, not less so. To
paraphrase a former U.S. president’s advisor, “It’s the
economy, stupid!”
ECB decisiveness arguably halted the European debt
crisis in its tracks. Likewise, a strong commitment to
forestalling the threat of deflation today could do much to
help reinvigorate the Eurozone’s economy and potentially
those of its neighbors, too. A stronger Europe could help
stimulate global growth and provide a lift not only to
European equity markets, but to companies that sell their
products and services into European markets.
China introduces new easing measures
Meanwhile, as China reorients its economy toward a
consumption-driven model, the government continues to
try to mitigate the short- to medium-term impact to growth
such a transformation entails. In April, China announced a
fiscal mini-stimulus that cut taxes for small and midsized
businesses; provided more spending on housing for the
poor; and increased financing for railroad expansion into
less developed interior regions. Last week, the
government followed up with another round of targeted
easing measures aimed at facilitating lending to rural
regions and small businesses. Such measures should
increase confidence that the government is indeed intent
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