Credit Wrap: The Spectre of Mercantilism

Credit market participants are still looking for some kind of signal to what the covernments and central banks are going to do to stabelize the global economy. But this week has done noting to clarify the situation – on the contrary; more uncertainty seems to have been added. Here’s the wrap, provided by vice president Gavan Nolan at Markit Credit Research.

“The Great Depression told us that mercantilist policies can only harm fragile economic recoveries. Holders of risky assets will hope that policy makers know their economic history.”

Gavan Nolan

Investors looking for direction from this week’s major economic releases were looking in vain as markets appeared to regard the next stage of quantitative easing as a mere formality.The ISM non-manufacturing survey on Tuesday and today’s non-farm payrolls report were predicted to have a major influence on QE expectations and consequently spread direction. But it didn’t turn out that way, with spreads tightening significantly over the week despite mixed US data.

The ISM services survey, representing the bulk of the US economy, came in higher than forecast and indicated a sector that was still expanding.

The other major release, the non-farm payrolls report, was disappointing.

The headline figure of -95,000 was well below expectations and the private sector created a lacklustre 64,000 jobs.

A crumb of comfort came from the unemployment rate, which remained at a still-high 9.6%.

Given that the FED was quite clear that its decision on QE would depend on the economic data, why has QE2 before the end of the year now become the firm consensus?

Dovish investors could point towards a number of factors.

First and foremost, the current recovery is one of the weakest on record, a fact not wholly unexpected after a financial-induced recession.

Reinhart and Rogoff (2009) have shown that recessions following banking crises tend to cause unemployment to stay at high levels for longer than a “normal” recession. Unlike the Bank of England and ECB, the FED has an objective to maximise employment and the dismal state of the labour market mean it could be forced to act.

Secondly, inflation is subdued, and the Fed put extra emphasis on the threat of below-target price levels in its last statement.

But it was an unexpected event from Asia that cemented expectations of QE and caused gold to hit a record high of $1364 an ounce on Tuesday.

The Bank of Japan announced a new $60 billion programme of QE, 70% of which will be government debt and the rest a mix of corporate bonds, ETFs and REITs.

Given the size of Japan’s economy and its enormous debt levels, this expansion of the central bank balance sheet is unlikely to act as a meaningful stimulant. But it did send out a signal that the BoJ was ready to return to unconventional measures; QE was tried in 2001-2006 with mixed results.

More importantly it raised expectations that other central banks are ready to act, possibly in concert.

The IMF annual meeting is this weekend, and the markets will be watchful of comments on monetary policy from the great and the good. But another macroeconomic issue is likely to dominate the discussions.

Talk of an “international currency war” – coined by Brazil’s finance minister Guido Mantega – has ratcheted up in recent weeks.

The US and China have been at loggerheads for some time over the valuation of the renminbi, which the US says is kept artificially low by the Chinese authorities.

The rhetoric has intensified this week, and the two parties appear to be growing apart. Japan’s currency intervention last month didn’t help matters.

The depreciation of the yen helped its spreads outperform relative to Europe and the US but, like the effects of the intervention, this was short-lived (see chart above).

There are rumours that Japan will take the opportunity of a holiday-extended weekend in the US to intervene again.

The Great Depression told us that mercantilist policies can only harm fragile economic recoveries. Holders of risky assets will hope that policy makers know their economic history,” Gavan Nolan at Markit Credit Research concludes.



The Mercantilist Nation




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