Equities, commodities fall as market decoupling continues; gold plummets
22/Apr/2013 • Currency Updates•
The decoupling in financial markets that we had been pointing to continued last week. Different asset markets are starting to move idiosyncratically, and last week most of the action took place away from major FX markets. Last week saw fairly dramatic price moves in some markets, yet Euro, Sterling and the dollar barely moved against one another. The real fireworks came from the gold market, which experienced its sharpest fall in thirty years, dropping over 9% on Monday alone, to become the worst-performing asset class year-to-date. This was just the latest and most spectacular price action in the commodity rout, which are down 7% on average for the month. Equities also pulled back from recent records. Among major currency markets, Yen once again provided most of the excitement, dropping sharply and nearing the 100 Yen per USD floor that we expect it to breach quite soon.
The Monetary Policy Committee of the Bank of England has made it clear that upside surprises in inflation are constraining its willingness to further expand QE and support the flat lining economy. Therefore, CPI releases in the UK have regained the importance they used to have. Last week, inflation numbers brought mixed news. A drop in food inflation compensated for an uptick in core inflation to leave the headline rate unchanged at 2.8% yoy. However, there were signs that further easing is gaining votes within the MPC, as Martin Weale suggested last week that the Committee is comforted by the generalized fall in commodity prices and may therefore be more willing to further ease monetary policy. Last week confirmed that such easing is badly needed. The puzzling divergence between the stagnating economy and the (until now) relatively buoyant labour market is disappearing, and not in a positive way. Job growth in the three months to February ground to a halt, and increases in the labour force pushed unemployment up to 7.9%. Most critically for the MPC, pay growth slowed sharply from 1.2% to 0.8% yoy, and it is actually down over the past 6 months. The complete absence of upwards wage pressure should force the MPC’s hand, and we expect the Bank of England to announce a further 25 billion GBP expansion of its balance sheet at the May meeting, subject to the critical GDP release next week.
Additional to monetary policy decisions, late on Friday, Fitch Ratings became the second of the major international credit rating agencies to strip the UK of its AAA rating, downgrading it to AA+. It cited weaker economic and fiscal outlooks as the reasoning for its downgrade, but outlined that further near-term downgrades are unlikely claiming that the economy’s outlook was stable.
A spate of second-tier reports provided further evidence that the eurozone economy remains stuck in recession. Car registrations for the fist quarter fell an additional 12% in annualized term from already depressed levels, and construction output fell again in February by 0.8% mom after a 2.1% drop in January. All eyes now turn to next week’s PMI sentiment indices for April. These will be the first surveys conducted since the Cyprus crisis, and we expect them to show another drop to new cycle lows.
In a related development, misguided austerity policies are under attack; not only from economic reality, but from an academic standpoint as well. A well known Rogoff-Reinhardt NBER paper, which purported to show dire economic consequences once the level of public debt rose above 90%, was shown by a 28-year-old graduate student to be riddled with gross errors of data, coding and statistical procedure. It was only a few weeks ago this now-discredited work was cited by European Commissioner as a critical intellectual support for austerity policies. The IMF appears to be breaking ranks with Eurocrat consensus, becoming increasingly critical of austerity policies. We do not expect European authorities to bow to academic discredit any more than they do to actual reality just yet, but the pressure is piling on. We now expect the ECB to cut rates at the May meeting; such a move should provide the downward impetus needed for the euro to make a clean break below the 1.30 level.
Economic releases out of the US is telling a story of mild slowdown. Industrial production declined slightly (0.1%) in March, as manufacturing appears to be slowing down from the 5% or so rate in the first quarter of 2013 to a 2% pace. On the positive side, the housing sector is still powering ahead. Housing starts are once again above 1 million at an annualized rate. We are pleased to see our 2012 forecast realized, and expect the 1% or so boost to growth from housing to continue into this and next year. The complete absence of inflationary pressures was brought into sharp relief by the CPI numbers, as headline inflation dropped from 2% to 1.5% on the back of falling commodity prices. Clearly, inflation will not be a constraint on the Federal Reserve quantitative easing policies for the foreseeable future.