It is one of those times in the markets when it is hard to know what to write. Nothing seems to be happening. There is a lot of news flow, but it all seems to fall within expectations, and news that is expected is not really news. At times like these I think it is useful to do a brief survey of what is going on.

What is going on? Europe is heading for a recession as the logic of balance-of-payments adjustment inside the Eurozone pushed the periphery towards deflation. At the same time, China and EM are generally slowing as a result of domestic monetary tightening and the effect of the European situation. US data have surprised on the upside in recent months even as leading indicators have suggested a slowdown because consumers have financed new purchases with debt even as real income growth has stagnated. Thus the global economic picture is one of slowdown or recession, with the US lagging behind because of the perennial robustness of its consumption habit. Monetary policy remains relatively tight around the world. In EM and the Antipodes, there has been a monetary tightening cycle in the past two years. The ECB has raised rates twice, to levels that proved too high for the European economy. With expectations central to monetary policy in the present environment, the most important effect of these hikes may have been in signalling a demented commitment to “price stability”. The Fed has ended its QE programme and also signalled an excessive concern about inflation with its weak “Operation Twist” decision. A combination of generally weakening economic growth, recession fears and relatively tight monetary policy has been bad for risk assets and good for safe havens. 

Nothing has happened in recent times to change this picture. There is talk of more monetary easing but it has not happened yet (except in the UK, which doesn’t make a lot of difference). US data flow has been stronger than expected but is not inconsistent with an underlying weakening trend in the economy. That means that the poor environment for risk assets is likely to persist.

What will change the picture? The European recession or Chinese slowdown could be worse than expected, and the European situation could get a lot worse before it gets better (which I think it will, eventually, with the euro intact). Any of these would accelerate the declines in risk assets. On the other had, the most likely short-term reason for an improving picture would seem to be a further improvement in the US data, such that a self-sustaining acceleration of growth starts to look possible once again. This might be combined with another round of QE from the Fed. Also, Chinese growth might prove more robust than commentators appear to expect, or government action to keep the show on the road might happen sooner rather than later; either case would be supportive of commodity prices and thus of risk assets in general. It ought to take a solution to the European problem to create a bull market is risk assets, but QE and a strong economy in the US could be good for domestic equities. The shape of a European solution must include higher German inflation, fiscal transfers and further bond purchases by the ECB; I think the market now understands this, but it has a poor memory and it is possible that another sticking-plaster solution could give a few months’ respite in which a general rally could take place. 

What do I expect to happen? The European recession and Chinese slowdown appear to be baked in. The US economy should slow in response. Profit margins should fall from cyclical highs in Europe and the US. Risk assets should be generally weak.

Changing the subject slightly, The Economist suggests this week that a euro breakup could happen within weeks. I think that the commentariat is becoming slightly hysterical. High sovereign borrowing costs, nasty recessions and even sovereign default do not in themselves imply euro breakup. There is no market mechanism to allow it to happen. The breakup of the euro must be a political decision, and at present I cannot see any government that is likely to go for it in the next few weeks.

Data:

Eurozone M3 2.6% YOY vs. 3.4% e.
Eurozone private loans 2.7% YOY b.e. but still terribly weak.

This week:

Mon: UK inflation report hearings; US new home sales.
Tue: UK nationwide HPI; US CB consumer confidence.
Wed: French consumer spending and German retail sales; Eurozone unemployment and flash CPI; US ADP employment change, Chicago PMI, pending home sales and beige book.
Thu: Global PMI’s; US initial claims.
Fri: US non-farm payrolls.
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