The Kingdom remains United for the time being as the referendum for Scotland to separate from the UK was defeated. The issue brought the voters to the booths with a reported participation rate greater than 90% in some areas. Clearly there is passion on both sides of the topic and reforms may have been a long-time coming, but economic rationality prevailed in our view. Still, the idea of self-determination is strong throughout Europe given the fragmented cultural identities created over centuries even within “national borders.” So called separatist movements appear throughout Europe where provinces or regions seek separation from the likes of Spain, Italy, Belgium, France, Denmark and so on. That again is what makes pan-European policy making so challenging. The challenge for the European Central Bank’s (ECB’s) recently announced goal to reverse the shrinking of their balance sheet and to grow it back to 2012 levels faced another hurdle this week as the first of two Targeted Long Term Refinancing Operations (TLTROs) had much less uptake than expected (€80bln as opposed to €100bln – €300bln estimates). Banks seem less than willing to take on funding from the central bank of their own volition. Thus, it will come down to the resolve of ECB President Draghi to take the political onus on himself to rise above and take action. We shall see when we get our next direct guidance on future programs on October 2nd.
Looking to the Middle Kingdom, media reports trumpeted that China had joined in on the stimulus front by injecting the equivalent of around $81bln of liquidity into five large banks. That being said, the injection is for a 3 month period and we must also recognize that there is a holiday coming where banks will need more cash on hand to meet withdrawals. As we have said in the past, Chinese leaders face a delicate challenge of encouraging and stimulating growth in some parts of their economy while keeping tight reins on others. This was reinforced by the thoughts of the Matthews Asia investment team during conversations with one of our research colleagues that visited their office last week. Packages of mini-stimulus are likely to continue along with progress on reforms which they felt investors had spent too little time appreciating the long-term upside. The crackdown on corruption is increasing credibility of the Party and removing constraints from private enterprise, but the media has tended to focus on the impact on high-end luxury good consumption used as bribes and entertainment. More reforms are expected from the next plenary session including plans to address leverage at the state and local level which will trade off transparency of finances versus the flexibility on the forms of taxation and capital raising. Like we have said on Europe though, don’t expect too much too fast. China has been deliberate and controlled in the progress they have made since the first raft of major economic reforms last year, but they have followed through.
Turning our eyes back to the United States, the Fed meeting this week kept expectations of QE ending in October on track. That was no great surprise, but what the talking heads where chattering away about was whether the they would keep the phrase “for a considerable period of time” in regards to how long rates are likely to remain low. That reflects a serious desire to read tea leaves when it comes to what is next for Fed policy and when. Alas, the phrase was kept. Included in the remarks was updated guidance on the order by which the next policy moves will be made as tapering comes to a close. Fed Chairwoman Janet Yellen stated that a move up in the Fed Funds rate (managed by use of the Interest on Excess Reserves, or IOER, and reverse repos) would be the next step followed by no longer re-investing proceeds from bond interest and maturities on their balance sheet. Outright sales were guided against but, of course, they reserve the right to change their mind. Again, no real surprise there. The real question then is, when? Below is the forecast of the Federal Open Market Committee voting members of where the Fed Funds rate is likely to be at each year end. You can see that dispersion of the forecasts grows in 2015 into 2016 before once gain narrowing in 2017 and then the “longer run” whereby normalization is assumed. Action in 2015 is clearly consensus with the magnitude in question. However, with inflation in the US running around 2%, all but one of the forecasters are still calling for negative real rates from the Fed. This means support, while lessening, is sticking around for a bit longer.
Source: Federal Reserve