Friday, 7 September 2012

Week in Review: The rise of the technocrats...

Spanish pesetas. Source: Wiki
In a week which was always slated to be busy, and marked the start of a month which promises yet more drama, the highlight was the European Central Bank's (ECB) press conference following the non-event of its interest rate decision. In the full glare of the world’s financial media ECB president, Mario Draghi, outlined the various measures the central bank would undertake to eliminate the risk of ‘convertibility’. Convertibility is financial speak for the risk that an investment which you thought was in one currency might convert into another currency; like drachmas, lira or pesetas.

We won’t describe the details again here as the provisions outlined were similar to those we had been hoping for (although the yield targets I had described as optimal didn’t make it to the final release). I likened the resulting program to methadone for an addict when I described it earlier: by keeping borrowers hooked, it gives the central bank tremendous control over them and allows it to manipulate them into doing things they might not feel comfortable with.

All, of course, for the greater good and markets cheered the decision. The S&P 500 rose 2% over the week while the FTSE 100 rose by about 1.4%. But the real moves were in those peripheral European markets which had performed so poorly for most of the year. Greek shares rose over 7%. Italy, Spain and Portugal were not far behind.

Why such euphoria? Because as Mike described, “the risk to the stability of the financial system should diminish, and with this the risk to the stability of the global economy.”

Peripheral bond markets rallied sharply. Italian five year borrowing costs fell from nearly five percent to under four. Credit Default Swaps however rallied even harder, reflecting the fact that no eurozone sovereign now need default unless they almost actively choose to do so.

The lone dissenter on the ECB’s governing council was the Bundesbank who, despite ample reassurances from peers, remarked that “Such a policy is for me close to state financing via the printing press”. Jens Weidmann, the bank's president, is concerned that the euro will be debased by such reckless action but so far the news has strengthened the currency which would not bear out his fears.

The good news from Europe almost overshadowed announcements from China of an increase in intrastructure spending which included the building of 1200km of new roads. That saw Asian shares perform (as well as UK mining stocks) and is to be welcomed as indications remain of relatively turgid economic growth in China (relative to its historic growth rate, that is).

So all was well going into the weekend, when the much-watched US non-farm payroll numbers were released. While these were actually disappointing (as Mike noted), undershooting economists' forecasts in the current month and being revised down in previous months. The market was broadly indifferent. As we have remarked many times this year “bad is the new good” when it comes to US data as it enables the Fed to retain the option of further stimulus. That case is made stronger by an absence of wage inflation reported at the same time.

No doubt we will pay great attention to the upcoming US election but this week it has been the central bankers’ influence over global affairs that has been growing...

Guy Foster
Head of Portfolio Strategy

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