Missives from the north as the world slowly returns to normal
• Spooked bond markets and Italy’s bizarre coalition in the spotlight, while India scores with IT
This week is the rentrée across Europe, when schools open and offices go back to a normal pace after the humid days of summer. In the US the summer slowdown is usually barely perceptible, but the pace of life will increase, particularly this year with tightly contested midterm elections for the US Congress. And even in Europe the ritual of the rentrée is fading, particularly in those financial services that are internationally aligned, such as asset management.
There has been a slowdown in news from the northern hemisphere but I am grateful for the missives Franklin Templeton has sent. I certainly miss its former head of emerging markets, Mark Mobius, who has undoubted style. With his bald head and white suits I thought he would make a perfect James Bond villain (or even a perfect James Bond). But Franklin Templeton certainly has a slew of other quotable sources who have kept the candle burning during the northern summer silly season.
David Zahn, head of European fixed interest, is an American who shows the same work ethic of his relative, the cable TV star Paula Zahn. He says bond markets were spooked in mid August by the Turkish lira crisis, which, he says with uncharacteristic American understatement, created some volatility in emerging-market assets. He argues that the “feverish” headlines did not reflect the true economic effects.
A few European banks are exposed to Turkish assets but they have more than enough capital to deal with it. But it did lead to something of a panic, or in today’s jargon, it triggered risk-off sentiment. It also led to that greatest cliché of today’s financial markets, a “flight to quality”. The yield on the 10-year German bund touched 0.3% a couple of weeks ago.
Zahn is quite racy for a bond manager and doesn’t believe this makes sense: eurozone inflation is in the 1%-2% range. These yields have been pushed down to artificially low levels thanks to quantitative easing (QE) — though I see this euphemism has been replaced by another one: asset-buying programme. But Zahn believes this will end by the end of 2018, after which bunds will start offering a mouthwatering 0.7%-0.8%.
Zahn says the Bank of Japan (BoJ) will soon be the last major central bank engaged in QE, although it is now reducing this in a “stealth taper”. Bond managers still talk about the 2013 taper tantrum in the same way most of us talk about the “Who shot JR?” episode of Dallas.
Bond prices tanked principally because the US Federal Reserve communicated its intentions on QE poorly.
I am sure the BoJ won’t be as ham-fisted. Its operating environment is a world away from our own. The BoJ has a target yield — if you can call it that — of 0%, but it won’t intervene in the market so long as the yield is still between 0.2% and -0.2%, doubling the range from 0.1% above or below.
There is a long tradition of astute US commentators on Europe, such as Bill Shirer and Edward R Murrow, and Zahn, though just a humble bond buyer, fits that mould. He says there is a leadership vacuum in Europe. Both President Emmanuel Macron of France and Germany’s Chancellor Angela Merkel have been weakened politically. So without clear leadership from the Big Two the markets have been watching what happens in Italy, run by a bizarre coalition of anti-establishment parties the Northern League and the Five Star Movement.
As a much larger economy than past miscreants such as Greece, Ireland and Portugal, international bond managers can’t ignore what happens in Italy. Within the next six weeks, the government will unveil its budget and it is widely expected to run deficits, which are strongly discouraged by the EU.
But Zahn says it will stop short of doing anything that could be considered reckless.
The elephant in the room remains the Brexit negotiations, and Zahn says there is a strong chance of no deal. (Just imagine how many jokes based on “Deal or no Deal?” are going around). And he says there is a recognition that no deal would affect the whole of the EU, not just the UK.
The negotiations should not focus on punishing the UK, Zahn says, and he believes a deal is still possible. There will be lastminute gamesmanship; we learnt all about that during our own constitutional negotiations.
And there will also be disagreement within the parties. Some could explode in the September and October party conference season.
I think anything that doesn’t include the UK remaining in the customs union will be a bad outcome. To replace the EU with the US and Commonwealth in trade is unrealistic.
So from Brexit, it is quite reassuring to turn to India — Sukumar Rajah, a Mobius protege in the emerging-markets team. The headwinds include the reintroduction of long-term capital gains taxes, difficulties collecting goods and services tax as well as the potential of interest rate hikes and a weaker rupee. Rajah argues that there have been capital outflows from emerging markets, which has favoured the dollar. In fact, investors would have made money going short in the Turkish lira, the Argentinian peso and the rand and long in the rupee.
A weaker rupee has been good for Indian IT exporters. Many companies have been able to pass on higher input costs in a fast-growing economy underpinned by growth in consumption and public investment.
And there is also the Made in India programme, aiming to turn the country into a manufacturing hub (where is the Made in SA programme?). Samsung opened the largest phone factory in the world near New Delhi, which produces phones at a far lower cost than its Chinese counterparts. Using indicators such as motor and cement sales, India is strong — GDP growth and per capita income are also going in the right direction.
It is a target of the US as it exports more than it imports from the US, but any tariffs would be offset by the reduction in tariffs by China.
THE BANK OF JAPAN WILL SOON BE THE LAST CENTRAL BANK ENGAGED IN QUANTITATIVE EASING