Financial and Natural Hurricanes

Haiyan is the name of the biggest hurricane ever that has reached the Philippines this week. According to experts, there is almost no structure built on the Philippines that can withstand winds like that. We know natural disasters very well, but aren’t we in for some which are caused by man? Very probably yes. Monetary policies are the best example of potential catastrophes for mankind these days. They are direct proof that nothing has changed since 2008. Otherwise, we would have higher rates. As we wrote last week, ECB finally cut the basic rates by 25 bps to historic lows and will keep them unchanged for a longer period of time. According to President Draghi, the reasons behind such a step were low inflation expectations, risk of growth remaining downside, as well as the unemployment rate. The ECB expects that Euro area will face a prolonged period of low inflation, if not deflation. The Bank of England has not changed its policy, but surprisingly our brothers, Czechs, entered currency wars. Although CNB decided to keep interest rates unchanged, it has decided on interventions on the foreign exchange market that weaken the koruna, so the exchange rate of the koruna against the euro is held close to CZK 27.

“Today there is only one country and the only one in command: Germany” Romano Prodi said last week. In his opinion, what Europe needs is that ECB should fulfill its inflation targets of 2 %. Prodi said that Italy is in trouble because of low inflation, and that it is trapped in a deflationary spiral. Italy has primary budget surplus, but its debt to GDP ratio is still climbing due to the unsatisfactory nominal GDP growth. Prodi also urged for the creation of “Latin front” against Germany. He claims that Germany is obsessed by low inflation like teenagers are obsessed by sex. It is not strange that some Italians opt for the purchasing power of Euro to be lowered. They did it with their currency before Euro all the time. But as we have emphasized many times, these opinions are still stronger and I think that higher inflation times are slowly coming to Europe; hopefully, they will not end with the word “hyper”.

We have had another general 24-hour strike in Greece. Protests were taking place as Greece holds talks with its ‘troika’ of creditors. Labor unions feared that politicians would impose further wage and pension cuts to meet the terms of the bailout, and that they would introduce more job cuts in the public sector, as well as privatization. But we are accustomed to such news and we will see more strikes in the near future. That is for sure.

China´s Prime Minister, Li Keqiang, declared last week that China needs to grow at least 7.2 percent annually to create 10 million jobs a year, which is necessary for employment as one of the country´s priorities. His remarks were made at a union meeting two weeks ago, but have only been published in full this week, just days before a pivotal Communist Party plenum to set policy open. He also warned about easy credit supply, which is about 100 trillion yuan ($16.4 trillion), which means that it is already twice the size of China´s GDP. And new credit could cause inflation which is a dangerous game for Chinese leaders’ in this one-billion-man country. Growth at the peace of 7.2 percent is quite an ambitious plan, because – as we have written many times – China is suspicious of adjusting official economic data. From time to time, news which supports this theory appears. For example, last week there was news that  Chinese leaders called for stopping the expansion of such industries as steel and cement, in which supply outstrips demand, to cut overcapacity of these industries. And as data shows, cement manufacturers use only 71.9 percent of their capacity from 2012 and the steel industry uses only 72 percent. So, as you can see, the situation around the growth of GDP is at least cloudy. On the other hand, everybody expects that some reforms concerning industry deregulation, financial liberalization, and reforms of land titles, state-owned enterprises and social security will be introduced at their Third Plenum meeting. We will see what this meeting brings to the globe.

The most important data this week from the US was non-farm payrolls. October nonfarm payrolls soared to 204,000. It was a nearly double of the expectations of 120,000. The unemployment rate in the US is at 7.3%, a little bit up from 7.2% in September. Does it mean that the Fed will change its policy in the near future? It is difficult to tell. But as the UBS warns, the Fed is trapped. According to the UBS, the Fed is facing two major risks. The first is that premature tapering could disrupt markets and trigger global turmoil across all asset classes with consequence of weakening the already weak economy. The second is that if the Fed delays tapering of its policy of 85 billion purchase program, it will fuel the creation of asset price bubbles, which could burst eventually and do major damage as well. So, you can choose, as usual, what will really happen. Maybe we will witness no tapering at all, but an increase in QE. Who knows …

Matus Posvanc