Global Soft Landing On Track?

Leading indicators signal that the global economic backdrop for asset markets remains supportive.

A host of measures argue against getting more bearish on global growth even as industrial production slows. BCA’s Global Leading Economic Indicator jumped in September, as did the global ZEW indicator and growth expectations in Merrill Lynch’s investor poll. All indicate that global economy will experience only a mid-cycle slowdown that will be followed by renewed vigour sometime next year. In short, these data underpin the case for the “goldilocks” scenario. Bottom line: Undoubtedly, bumps will appear along the road, but the message is to stay upbeat on financial markets on a 6-12 month time horizon.

Prometheus has argued before that central banks and the global financial authorities have learnt much about managing the world economy since the war. This is a major factor behind the world’s ability to avoid many pending financial calamities which in previous, less ‘sophisticated’ times might have spelt disaster. Have we now entered ......

.....A Permanently Low Volatile World?

Economic stability has improved significantly over the past 30 years, which has been positive for financial assets. The volatility of both real GDP growth and inflation in the OECD countries has dropped sharply since the 1970s, reflecting more effective monetary policy, among other things. Globalisation has also been a stabilising force, via a reduction in the sensitivity of inflation in the developed countries to changes in domestic resource utilisation. Capacity abroad increasingly acts as a “relief valve” for domestic price pressures, robbing firms of pricing power even when they are operating at a high level. In turn, a decline in the volatility of inflation has helped to moderate the volatility of short and long term interest rates.

The reduction in the volatility of inflation in the major countries has made life easier for central bankers, because inflation is less likely to surge when the economy is running hot.

There is less of a need to aggressively shift interest higher and lower through the economic cycle because the amplitude of the cycles themselves is smaller. The result has been a sharp decline in the volatility of both short-term interest rates and bond yields. Moreover, the volatility of corporate bond returns relative to government bonds has also moderated. Financial market volatility has been even lower in the past, but what is different now is that volatility has been low for a prolonged period and across different countries and asset classes. The reductions in economic and interest rate volatility have reduced risk premia across financial assets.

Lower volatility reduces the uncertainty of future cash flows, as well as the uncertainty about the proper rate used to discount those cash flows. Moreover, the more stable global economic environment is encouraging investors to arbitrage across government bond markets, which has reduced both the level and the volatility of yield spreads. Bottom line: We may have not yet seen the secular low for implied volatility and risk premia; both could move even lower once the U.S. growth slowdown ends and the global low inflation economic boom resumes.

Base Metals: Downside Risks Remain

The weak U.S. dollar and the surprisingly resilient global economy have pushed the CRB metals index to new highs. Nonetheless, select metals prices, including copper and nickel, recently have declined in response to rising inventories. This could be a sign of things to come for metals more generally. Leading economic indicators suggest that overall global commodity demand growth is poised to slow. While the supply response this cycle has been notably slow, a slowdown in demand growth should begin to ease pressures on inventories, and could lead to a re-stocking phase. Bottom line: A softening in global demand growth should soon start to weigh on spot base metals prices.  

Today’s Bank of England Inflation Report 

The initial market reaction to today’s the Bank of England Inflation Report suggests that it is being seen as quite dovish, but it does not preclude a rate hike early next year. The inflation forecast based on market rate expectations has come down compared to the August Report, with inflation returning to target in mid 2007, a year earlier than previously expected, and then staying there until the end of the forecast period. Note, however, that this forecast is based on a further rise in official rates to 5.25%. Admittedly, this does not come in full until Q3 next year and rates then fall a bit thereafter. But the message of recent months is that the MPC prefers to move sooner rather than later - the August inflation forecast did not incorporate a rise in rates until 2008, and yet the MPC hiked just three months later. As such, a February hike to 5.25% is still likely. Beyond that the MPC's activity projections may prove to be too optimistic, while inflation will drop back more sharply than it expects next year. This should prevent further policy tightening. Bottom line: We could see the Committee cutting again by end-2007. 

Japan 

Japan is now in its longest period of economic growth since World War II, and yet interest rates are still at an emergency low of just 0.25%. Recent comments from Governor Fukui suggest that the BoJ already thinks that this is unsustainable.

Stock Exchange - Snippet

It has been widely reported today that a group of seven investment banks are looking to set up a trading platform for the largest companies in Europe. This platform will pool the liquidity made available by those banks, and will be available to other users. The intention is to offer much lower trading costs than dealing on existing cash equity exchanges. There are no details yet available of the exact nature or scope of the planned platform, and so any discussion of its potential impact is heavily caveated.

The differentials in costs of trading between the different exchanges in Europe suggests that in the area of cash equity trading there is potentially bigger issue for Euronext and Deutsche Boerse than for the LSE, although this is countered at a group level by LSE's lack of exposure outside of cash equities.

To further muddy the waters today, Deutsche Boerse has withdrawn its offer for Euronext, leaving the path clear for NYSE to conclude its merger with Euronext. This leaves Deutsche Boerse out in the cold as far as its potential attempts to conclude consolidation of exchanges in Europe after almost a decade of trying. This could leave Deutsche Boerse trying to reignite talks with the LSE, perhaps with a  multi-way tie up between LSE-DB-Nasdaq to counter the formation of NYSE-Euronext. Watch this space……

And finally…….

A Yorkshire couple decided to go to the South of France to thaw out during a particularly icy winter. They planned to stay at the same hotel where they spent their honeymoon 20 years earlier. Because of hectic schedules, it was difficult to coordinate their travel schedules, so the husband left Yorkshire and flew to Nice on Thursday, with his wife flying down the following day. 

The husband checked into the hotel. There was a computer in his room, so he decided to send an email to his wife. However, he accidentally left out one letter in her email address, and without realising his error, sent the email. 

Meanwhile, somewhere in Cumbria, a widow had just returned home from her husband's funeral. He was a Vicar who was called home to glory following a heart attack. The widow decided to check her email expecting messages from relatives and friends. After reading the first message, she screamed and fainted. 

The widow's son rushed into the room, found his mother on the floor, and saw the computer screen which read:

To: My Loving Wife

Subject: I've arrived

Date: October 16, 2004

I know you're surprised to hear from me. 

They have computers here now and you are allowed to send emails to your loved ones. 

I've just arrived and have been checked in. 

I see that everything has been prepared for your arrival tomorrow.  Looking forward to seeing you then! 

Hope your journey is as uneventful as mine was. 

PS: It is bloody hot down here!

Prometheus from sources: ADM, Barclays Capital, Cazenove, Charles Stanley, HSBC, ING, SocGen, UBS.