The next six months could well be easy going for equity markets, and even the more exotic markets, like emerging market bonds, which suffered when the story first broke about ‘tapering’: a possible reduction in the US Fed’s Quantitative Easing programme. Let’s consider this and the other oft-perceived threats to the markets.
QE. Yes, QE may be tapered, but only probably, not definitely, as Bernanke was at pains to emphasise in the Q & A session following his recent speech at a National Bureau of Economic Research conference. It all depends on the data, and he assured us they are actually also worried that inflation may be too low. I think we’ve seen the bulk of the rally in US Treasury yields for now. For the next few months, I think the stock markets can live with this scenario - if data’s weak, QE will go on longer, if data's strong, then companies are going to be more profitable. Taper-shock is rapidly fading.
China. I definitely do not fall into the camp that believes China is a powder-keg waiting to explode, leading to global financial and economic Armageddon. Banking systems rely on confidence. Confidence in the unlimited supply of funding, confidence that borrowers, public and private, are solvent and able to repay, confidence that collateral values, e.g. house prices, will only ever rise.
Now, institutional over-indebtedness may well have become endemic in China, but certainly not amongst individuals, and the whole pack of cards is, as ever, dependent on the same ‘confidence trick’. Although China’s sensible determination to rebalance its economy away from investment-lead growth and towards consumption is no doubt weighing down on headline GDP, in the Chinese tradition the measures will be introduced gradually and pragmatically, as evidenced this week by senior leaders’ comments. Whilst Vice Premier Zhang Gaoli said that the government would "expand domestic demand", he also assured us they would "try every method to provide funding to support SMEs, exporters, and technology firms". Premier Li Keqiang was quoted as saying that the government would "prevent economic growth from slipping below the lower bound".
With $3.3tn in foreign exchange reserves alone, which it could quietly use to rescue the banks - I suspect we’d never even know a banking crisis had happened.
The Eurozone. Portugal, Greece, Cyprus, even France, surely we face a summer of cataclysmic popular discontent on the streets? Nope. The lesson of the Eurozone crisis is the Germans and the ECB will ride to the rescue-sure, there’ll be a to and fro over austerity measures, wrestling with the balance between creation of moral hazard in the South and ensuring the Euro’s survival, but I believe the nexus of self-interests implies we have reached a state of equilibrium. This is admittedly an inherently unstable equilibrium because of the absence of a fiscal union but, once Merkel has won her election that, and its sister, banking union, will be front and centre and suddenly on the cards. Right now she can’t say so, because of the election, but she knows the Euro won’t survive another five years without them.