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Tom Meade, Investment Director at RLCM, shares his monthly investment views.
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September 2011:
The main theme of the moment continues to be the Eurozone debt crisis. Our view is that it is difficult to see markets allowing the current uncertainty to drag on too much longer and so the situation is becoming increasingly binary. The crisis will therefore either be resolved and the Eurozone will remain intact or the Eurozone will disintegrate in an uncontrolled manner.
Recent market volatility has helped to focus the attention of European politicians and another round may galvanise politicians and the ECB to take the necessary action. Despite the inevitable disagreements between countries we do appear to be moving painfully slowly towards some sort of understanding. There would also now appear to be substantial pressure on the German political elite from the US and probably China, two of their largest trading partners, to reach a solution, which would have to encompass most of the following;
- The writing off of a huge chunk of Greek debt.
- Recapitalisation of the banks hit by this write off, making the whole banking system “bomb proof”, so that monetary policy can begin to work again.
- A larger European Financial Stability Facility (EFSF) capable of either buying Government debt or perhaps guaranteeing a certain percentage of losses on sovereign bonds.
- The speeding up of the creation of the European Stability Mechanism (ESM), which is the permanent rescue fund agreed as part of the latest Greek bail out and is designed to replace the temporary EFSF. The ESM was originally scheduled to be implemented in 2013 and will require significant strengthening of the European Monetary Union.
- A much more active ECB preventing liquidity issues becoming solvency ones.
- Global support for any package from sources such as the emerging markets and a sense that G20 economies would be prepared to aid Global rebalancing.
The alternative is to argue that there is no solution to this crisis because the Euro project is just too fundamentally flawed and the politics are too complicated because there will be massive popular resistance to anything that smacks of fiscal union, bank bailouts etc. Furthermore, even if a plan would work, it won’t be agreed soon enough given the byzantine nature of European politics.
Obviously under the first scenario the current economic situation will improve whilst under the second it will get much worse. Given the seriousness of the situation further brinksmanship is likely but ultimately hopefully all of the key players will agree that a solution is better than another currency revolution.
Across the Atlantic the US Federal Reserve announced details this month of it’s latest attempt to stimulate the US Economy by using ‘operation twist’ to reduce longer term US bond yields. The theory behind this is that US consumer borrowing rates are tied to these longer bond rates and so if they fall then so will interest servicing costs for US consumers. In turn it is hoped that the improvement in household finances will result in increased US domestic economic activity.
Closer to home forecasts for UK GDP growth are being scaled back and fears are even growing that the UK may enter another recession. One monetary forecasting model, which has been developed to try and forecast the probability of UK recessions using current and lagged values for a range of monetary and financial indicators, has unsurprisingly suggested that the chances of another recession have recently increased. However the figure this model currently ascribes to the likelihood of this happening is 27%, well below the 50% trigger point reached using this methodology before the last 4 recessions of 1974-75, 1979-81, 1990-91 and 2008-2009.
Whilst the UK GDP figure is still expected to remain positive, and so the economic fundamentals are significantly better than in 2009 when QE was first used in the UK, the current deterioration in outlook has been judged sufficiently serious by the MPC to restart QE. At the October meeting it was agreed to increase the QE budget by £75bn to £275bn and for the bonds to be purchased over the next four months.
Our central view on the UK remains that we will escape another recession but that economic growth will remain subdued into 2012 meaning that UK interest rates will remain on hold.