Inflation Back as Market Mover After Crisis: Cutting Research
Inflation is reemerging as a key driver of financial markets across the industrial world, according to Nomura Holdings Inc. and Wells Capital Management.
The responsiveness of currency traders to inflation data that misses expectations started to increase in the past 12 months in a trend set to continue this year as economic recoveries gain ground, said Jens Nordvig, Jordan Rochester and Yujiro Goto of Nomura.
Meantime, Jim Paulsen, Minneapolis-based chief investment strategist at Wells Capital Management, says stocks are moving inversely from bond yields for the first time since 2007 in a sign of brewing inflation concerns.
“The implication is that forecasting inflation momentum will be crucially important for forming FX views in coming quarters,” the Nomura strategists, led by New York-based Nordvig, wrote in a March 10 report.
Comparing last year’s behavior of currency markets to that of the past seven years, Nomura found that six of 10 exchange rates were more sensitive to consumer-price announcements. The reaction was bigger than average in the currencies of New Zealand, Sweden and Norway. Those of Switzerland, the euro area, the U.S. and Japan were less affected.
The sensitivity to inflation statistics is a change from recent years, when the financial crisis meant news on growth and employment were seen as more important gauges of an economy’s health. The relationship may strengthen as central banks such as the Federal Reserve and the BOE revise their forward-guidance policies, which had put more weight on labor-market data.
One way to gauge inflation expectations is to look at correlations between daily movements in stocks and bonds, Paulsen said in a March 11 report. A negative correlation, when rising bond yields are associated with falling stock prices, occurs when inflation is the major fear.
Between 1968 and 1996, when inflation concerns dominated, a 1 percent increase in yields on 10-year Treasury securities resulted in about a 3.5 percent drop in stock prices, Paulsen calculated. A similar relationship began to reappear at the end of last year, for the first time since 2007, suggesting “the dominant cultural concern was shifting toward inflation.”
“While an imminent correction is not necessarily suggested, the recent change in investor focus from deflation to inflation concerns does increase the risk for stocks,” he said.
* * *
The governments of Australia, Switzerland and Sweden have more capacity to open their economies to market forces than the other 35 developed and emerging countries on a list devised by Credit Agricole Private Banking.
The “reform capacity” indicator is based on the approval rating of the head of government divided by the number of reforms recommended for that country by the Organization for Economic Cooperation and Development, according to Chief Economist Marie Owens Thomsen.
Australia tops the table with 20.5 points, followed by Switzerland with 16.3 points, while France is ranked last with 1.2 points. She focused on such OECD-endorsed reforms as reducing cost and legal barriers to entry and improving the transparency of regulation.
“Our key macro call for 2014 and beyond: Buy structural reform!” Owens Thomsen said in the written presentation she gave in Dubai on March 12.
* * *
The European Central Bank is failing to recognize that undershooting its inflation target may leave a permanent loss of output.
Extending a 2013 study of Sweden by former Riksbank (SWRRATEI) Deputy Governor Lars Svensson to the euro area, David Mackie of JPMorgan Chase & Co. said the ECB should be “very concerned” that inflation of 0.8 percent is lagging behind its goal of just below 2 percent.
The reason is that investors and policy makers alike are assuming the ECB will meet its target in the medium term, said Mackie, JPMorgan Chase’s chief western European economist and a former Bank of England economist. So long as inflation expectations fail to budge even amid a sluggish economy, policy makers can’t allow the economy to overheat later to make up for the loss of output suffered in the slump, Mackie said.
If the output gap between the economy’s actual and potential growth rates is 6 percent of GDP, about what JPMorgan Chase assumes, then inflation could settle at the current 0.8 percent and there could be an annual output loss of 572 billion euros ($797 billion).
“Recognition of this would make a quick return of inflation to the target even more imperative,” Mackie wrote, adding that more aggressive monetary stimulus probably would be required.
In a study released March 4, International Monetary Fund economists Reza Moghadam, Ranjit Teja, and Pelin Berkmen also warned that what they called “lowflation” could damage the euro area by leading to higher debt, unemployment and inflation-adjusted interest rates.
* * *
Animal spirits are back in the world’s major industrial economies.
Capital spending in the Group of Seven economies will grow an average 5.25 percent this year, up from 2 percent last year, according to new estimates released this month by UBS AG.
That leaves the team, including Larry Hatheway and Maury Harris, more optimistic than most economists about the outlook for the U.S. They predict growth of 3 percent this year, versus the 2.7 percent median in a Bloomberg News survey.
UBS expects U.S. business-equipment spending to grow 7.5 percent this year, faster than the 3 percent pace of last year and almost 2.5 percentage points above consensus.
The prediction is based on a new forecasting model that includes an index for gauging business confidence, or what economist John Maynard Keynes labeled animal spirits.
The model, which is rising toward levels last seen before the 2008 financial crisis, is based on sentiment indexes released by the Conference Board and National Federation of Independent Business.
The optimism is shared by strategists at Bank of America Merrill Lynch. They said in a March 11 report that there are “increasingly compelling” reasons to expect growth in U.S. private non-residential fixed investment to accelerate to 4.7 percent this year and 5.7 percent in 2015, from 2.6 percent in 2013.
Among the reasons: accelerating global expansion and manufacturing, tight capacity utilization, aging equipment and easier lending standards. Investors are also agitating for money to be spent on growth rather than buying back shares. The IMF projects investment will reach 26.6 percent of GDP in 2018, the most since at least 1980.
Echoing UBS’s call that a sustained rise in capital expenditure probably will boost equities, BofA Merrill Lynch said winners should include technological, industrial and energy companies, which have gained in past periods of greater business spending.
* * *
From 1986 to 2008, the gap in wages between college and high-school graduates shrank in Japan while increasing in the U.S., said economists Daiji Kawaguchi and Yuko Mori of Hitotsubashi University.
The faster rise in the number of Japanese college graduates versus the U.S. explains about a third of the contrasting trend, they said in the March 7 report. A greater supply of graduates means they can be paid less.
“The difference in post-war fertility trends largely explains the difference in the supply increase of college graduates between the two countries,” Kawaguchi and Mori said.
* * *
Government investment isn’t the route to stronger economic growth, according to a study by the London-based Centre for Policy Studies, which was co-founded by Margaret Thatcher prior to becoming U.K. prime minister.
Tests of the relationship between average real growth rates and average government spending by function across 19 countries from 1996 to 2011 were carried out by Brian Sturgess, an economic consultant to the centre.
He found spending on education as a share of GDP had “no discernible impact” on growth, while the correlation between expansion and spending on health and social protection was negative.
Outlays on health, education and social protection accounted for an average of 65 percent of total public expenditure across 19 OECD countries, Sturgess said in the report, published today.
* * *
The Fed’s three rounds of quantitative easing encouraged emerging-markets companies to issue twice the amount of debt they would have done otherwise.
That’s the estimate of a working paper published this week by the ECB. The Fed’s buying of assets, launched in 2008 and continuing to the tune of $65 billion a month today, eased global financing conditions and risk aversion among investors, making it easier for companies to raise funds.
The increase in issuance was similar across 38 countries studied, suggesting international factors were in play, the paper said. In advanced nations, the impact of the Fed’s asset purchases was less strong, said the report by ECB economists Marco Lo Duca, Giulio Nicoletti and Ariadna Vidal Martinez.
To contact the editors responsible for this story: Craig Stirling at email@example.com Anne Swardson, Fergal O’Brien