THE BLOG

Bye Bye Taper?

05/08/2013 18:07 BST | Updated 02/10/2013 10:12 BST

Wow. The July US employment report was downright lousy. The headline non-farm payrolls number was disappointing, at 162,000 vs expected 185,000, (with 26,000 downward revisions to June and May), and a large part of the fall in the unemployment rate 7.4% can be explained by a resumption of the fall in those actually trying to find work. Those working part-time for 'economic reasons' numbered 8.245m-excatly the same as it was a year ago. Average earnings, which were expected to have risen 0.2%, fell 0.1%, (is dis-inflation really transitory, Mr Bernanke?). The workweek fell to 34.4hours, from 34.5 hours, and personal income grew 0.3%, against 0.4% expected.

I have been relatively bullish for the first half of this year, but a glaring economic anomaly is really starting to worry me.

We have talked about the current global macro situation as resembling an economic Bermuda Triangle, (EBT). The Bermuda Triangle in real life runs from Bermuda to Pueto Rico to Miami. The economic one runs from high stock market valuations to high unemployment to low growth/productivity. How can these apparently contradictory metrics be sustainable in a consumer/services-lead society like the US?

The EBT is getting harder and harder to sustain - if for nothing else because the constant reminders of the enduring effects of the crisis keep us all defensive, with short investment horizons; we all naively think we can exit the 'risk-on' trade before everyone else.

The Federal Reserve hoped to create a positive wealth effect via QE, which ultimately leads to better sentiment and investment. The barometer of success is the stock market, but does the stock market really correlate to general "wealth"? Clearly the stock market has been on a tear, but is everyone, the average Joe benefitting? Ownership of stocks resides with the top 10 percent of the population. Social divide is much higher today than before the crisis. Furthermore, 85% of jobs and growth come from SME's - meaning the 15% of the stocks, the listed ones, which are flying, are benefitting, but SME's are not. We have a market for the 15% biggest in the corporate world and the top 10% of the private sphere, so I guess when Fed and BOJ talk about wealth effect, they are really talking about ELITE effect?

The middle class-which accounts for the bulk of consumer spending-is being squeezed and can't be relied upon to save us now. The latest lack-lustre US Retail Sales figures, for June, tell the story vividly.

Maybe waning emerging market growth is beginning to morph into a more general global slow-down. So, I'm beginning to think we haven't achieved self-sustaining escape velocity and, over the summer, the Federal Reserve, the Bank of England, Bank of Japan, International Monetary Fund, European Central Bank will all go back to the drawing board and.... do more of the same.

Can tapering really happen in the context of news such as July's employment report? The next month or so could be extremely volatile, as the market anticipates and then digests first the release of the latest FOMC minutes on 21st August, and then the next employment report on 6th September.

What about Europe? At the ECB press conference, S.Draghi seemed to be straining every sinew to give the impression that the market simply was not understanding the full significance of his message the members of the Governing Council "expect key interest rates to remain at present or lower levels for an extended period of time", he just couldn't quite get the market to play ball.

He could hardly have dropped more hints that we should be expecting rates to stay were they are, or move lower, for many, many quarters. He stressed, (twice), that the ECB's Deposit Rate, could go lower, even though it is currently zero. He stressed that liquidity would remain ample, and if it didn't, he'd see to it, (presumably with another Long Term Refinancing Operation, LTRO)

He even borrowed the Bank of England's assertion that "the current market pricing of rate hikes is unwarranted". Getting a little desperate, maybe, he emphasized the pathetic growth in money supply, and that lending by banks in the periphery was still very weak.

Despite all his efforts, futures markets remained steadfastly rooted to the spot by the time he finished, stubbornly refusing to extend their timescale for rate hikes, however he may insist they should. The euro weakened a little initially, but then recouped some of its losses-which may have been caused by a strong dollar anyway.

Perhaps the problem is markets know he has perhaps the most unenviable role in major central bank leadership-he needs to be an Olympic Cat herder. Everything is compromise, mixed with liberal amounts of bowing and scraping to the Bundesbank. Therefore the markets are screaming 'show us the money!'-until he actually cuts rates, or adds another LTRO, or firms up his forward guidance with depressingly distant economic thresholds, investors remain very sceptical of the current, 'words are easy' form of forward guidance.

ECB meeting minutes? They couldn't even reach a decision on this-Mr Draghi announced an intention to publish more specific information on decisions taken by the GC, but, the discussion is at an "early stage". The ECB board is to make proposal in the Autumn. Yawn.

Look for some, (but surely not all!), of these actions next month or in October, and before year-end the ECB will be close, very close to doing something which will smell and feel like QE-but not before Merkel gets re-elected.

The bottom line? 2013 may still be an excellent year for the stock market, as monetary policy will remain in a 'sweet spot' for equities, but we will reach a cyclical peak in Q4 - with a growing realisation that the EBT may swallow us all whole.