Just a few quick points today. Terribly slow in the head in this heat.

The big question of the moment is whether markets are reverting to the kind of behaviour that existed before that financial crisis. What I mean is: whether US equities are breaking their relationship with real interest rates because the economy is now able to function without extraordinary monetary stimulus. That is what the FOMC appears to believe, and its belief is presently reflected in the markets in the combination of a strong S&P 500, a steep yield curve and rising real interest rates.

Ever since the GFC, it has been a good bet that the economy will be weaker than forecasters expect. This has been the result of a structural problem with the nature of economic forecasts: they assume that the economy will return to a trend, but we have not been in a trend-resuming kind of situation. What if the trend is now resuming?

The complicating factor is that this all started with Japan. The move in USD/JPY coincided with the departure of the S&P 500 from its relationship with real rates, and this suggests to me that the move was important. Perhaps some kind of capital flow from Japan was impacting US equities, I hypothesised. But when I look in the Japanese and US flow of funds data, and current-account data for both countries, I cannot find any strong evidence that such a flow has occurred. Could there be some other kind of connection? Could it be that purchases of foreign securities by some Japanese actors — the banks, for example, in Q1 — could have set off a reflexive upward move in US equities? Could it be that some other kind of “liquidity” effect has occurred (I am never quite sure what “liquidity” means).

If the S&P 500 has actually been strong because it has been behaving like a pre-crisis market, then there is the potential for a trade if one thinks it is being overly optimistic. The same trade could be executed by shorting US long-term rates. If the S&P 500 has been strong because of Japan, and economic prospects are actually rather dimmer than one might infer from the market’s behaviour, then the Japan effect could continue and there is no reason to trade the market; but the same anti-strength trade should still work in US Treasuries. In other words, rates may have got rather too high, and if they have, then that is the thing to trade. There is no need to worry about what is affecting the US equity market.

One thing that is clear is that UK and European equities have been dragged upwards by the strength of the US. The UK market is so unlike the UK economy that that might be reasonable, but European markets are rather more tied to the European economy. Their strength therefore does not make a great amount of sense. Perhaps long US Treasuries, short European equities would be a good way of expressing a (single) directional trade.

India has been seeing stonking outflows. I am a bit behind the curve on this. The current account deficit has absolutely ballooned. Foreign institutional investors pulled a record amount out of the country in June, according to Barclays research.

Picking up on my point about liquidity, does anybody know what it is? It’s conceived as some kind of flow of money. So, is it an increase in the money supply? Not necessarily — M2 increased sharply in the financial crisis, for example, but people probably wouldn’t say that “liquidity” was strong. Is it nothing more than the overall availability of credit? But it is supposed to affect equity markets too, so perhaps we should say the availability of financing. That is the best definition I have been able to come up with.


  • UK CPI 2.9% b.e. Jun. Core 2.3%. Rise in motor fuel, as in US. Also clothing — summer fall in prices not as large as usual.
  • German ZEW 36.3 d.e. but remained fairly high.
  • Eurozone CPI rose again to 1.6% Jun. Core 1.2%. Over 4% in Estonia and Romania; sub 1% in Greece, Latvia, Poland, Sweden, Denmark, Malta, Ireland and Cyprus. Energy and food were leaders, as in UK.
  • US CPI 1.8% b.e. Jun. Core 1.6%. Gasoline and food, as in UK and Europe.
  • Capacity utilisation flat at 77.8%, a.e. Jun. Down from 2012 and 2013 highs.
  • Industrial production 0.3% b.e. Jun. 0.6% Q2 annualised. 2% YOY. Mining and then construction were the leaders, utilities and nonindustrial supplies the laggards.
  • UK unemployment flat at 7.8% a.e. May. Employment up, not-in-labour-force up, unemployed down, over 3 months compared to previous 3 months.