No saviour in sight as world credit cycle rolls over

Any country that has failed to lock in a self-sustaining recovery by now must expect to pay the price for the failings of its policy establishment. There is building evidence of a cyclical downturn and experts are finding it highly troubling that the eurozone is still marred in a recession.

By Ambrose Evans-Pritchard
8:14PM BST 29 May 2013
The Telegraph

Any country that has failed to lock in a self-sustaining recovery by now must expect to pay the price for the failings of its policy establishment, and some risk a slide into outright deflation.

“We see building evidence of a cyclical downturn,” said Fredrik Nerbrand, HSBC’s global asset guru. “We find it highly troubling that the eurozone is still marred in a recession at the same time as our cyclical indicators appear to have peaked.”

The bank said there is a market “disconnect” between the world’s gloomy outlook and talk of tapering by the US Federal Reserve, the supposed moment when it starts to wind down its $85bn of monthly bond purchases.

It is surprising to me that HSBC’s leading indicator has taken so long to buckle, since commodities topped in September and the Dutch CPB index of world trade contracted over the February-March period. Rarely has there ever been such an equity boom on such quicksand.

Mr Nerbrand said slowing momentum “should send shivers down the spine of any investors that are long risk”. Yet markets are betting that central banks will come to the rescue yet again if need be. This may be so, but only after they have first struck a blow against moral hazard and demonstrated their distaste for asset bubbles. The central banks take their time. Mr Nerbrand says they will not act until the markets have already priced in a “sub-optimal outcome”, Canary Wharf dialect for a nasty sell-off.

HSBC said it is cutting its holdings of high yield credit, emerging market debt, gold and real estate REITs. It is plumping instead for US Treasuries, the “least rotten apple in the barrow”. An astonishing 42pc of its tactical portfolio is now in US Treasuries.

We have been through these episodes of putative Fed tightening twice since the Lehman crisis. Markets tanked in 2010 and again in 2012 after the Fed turned off the spigot.

It took a while for the Fed to recoil on both occasions, and it may take even longer this time. Key insiders are fretting that the longer QE goes on, the harder it will be to unwind. The global consensus for QE is, in any case, crumbling. The Bank for International Settlements has more or less said that emergency stimulus is becoming a dangerous addiction.

Much of this critique is, in my view, misguided, and risks a repeat of the Fed’s great policy error of 1937, when it killed recovery stone dead. Yet QE critics clearly have a point. As Pimco’s Bill Gross puts it, there are “bubbles everywhere”. The Credit Suisse index of Global Risk Appetite has been flirting with the “euphoria” line, not far short of levels seen in 1987, 2000 and 2007.

The share of leveraged “cove-lite” loans issued this year without covenant safeguards has been twice as high as in 2007, the last peak just before Armaggedon. Companies are borrowing cheap to buy back their own stock at nosebleed prices, and doing so en masse with the carefree abandon of those pre-Lehman days. By some estimates this has driven half the US equity gains this year. No wonder Fed hawks such as Richard Fisher are watching this with horror.

Should there be another round of QE/helicopters, we must surely find a better way to inject the money. Today’s method is enriching the uber-elites, with a painfully slow trickledown. The Gini co-efficient of wealth inequality is soaring. The better alternative is to stick the needle straight into the veins of the economy - building roads, railways or nuclear power stations; but that is a subject for another column.

If HSBC is right about the turning cycle, we are in for choppy seas. Interest rates are already near zero across the developed world, public debts are much higher than in 2007, unemployment is already at a post-EMU high in Europe and 27pc in Spain.

The last time, the BRICS were in the mid stages of a roaring boom, strong enough to weather the Lehman shock. China responded with what is probably the greatest loan spree in history - $14 trillion of extra credit in four years. None of this can be done again. The BRICS are now nursing post-bubble hangovers as well, and China’s Politburo has no intention of repeating what it deems to have been a serious error.

Contrary to widespread belief, Europe is not retreating from austerity or taking serious steps to reverse its contractionary policy mix. On Wednesday the European Commission gave France, Spain and Holland more time to meet their deficit targets of 3pc of GDP, but that merely frees them from the need to slash and burn yet further, pro-cyclically, to cover a shortfall caused by recession itself. It is allowing the fiscal stabilisers to work. That is all.

Net tightening by the eurozone this year will still be 1pc of GDP, even though the OECD says the region is in a “dire situation”, facing contraction of 0.6pc this year, with falls of 1.8pc in Italy and 1.7pc in Spain.

Nor is the European Central Bank switching gear. Monetary policy remains tight, and has tightened further this year, despite the token rate cut last month. Private credit contracted €34bn in April. The M3 money supply has been flat over the past three months. Eurozone core inflation has fallen to an all-time low of 0.4pc - stripping out tax rises - just one shock away from a deflation trap. Die Welt reports that the two German members of the ECB’s council are balking at further efforts by ECB president Mario Draghi to break the logjam. Nein to negative overnight rates, nein to asset-backed securites and absolutely nein to any form of QE.

On a trip to Frankfurt two weeks ago, St Louis Fed chief James Bullard politely advised them to launch full-blown QE before it is too late. “Doing nothing risks the mildly deflationary situation experienced by Japan in recent years,” he said. Nothing is what they will do.

The US may yet shake off its fiscal tightening this year, the most in half a century, but as David Rosenberg, from Gluskin Sheff, points out, real personal income fell at a 5.8pc rate in the first quarter. It is hard to spend your way through that sort of drop.

After almost five years we are still in a contained global depression, struggling with a world record saving rate of 25pc, and a chronic shortage of demand. The US has kept the world afloat by running down its own saving rate to 2.7pc this year. This is not a remotely tenable equilibrium. Hang on to your seats when that snaps back.

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