Italy

I am finding it rather difficult to know what to make of the recent Italian bond volatility except that it is a bit of a storm in a political tea-cup. The decline of established political parties and the corresponding rise of so-called ‘populist’ parties needs to be put into context. Whatever the rhetoric about leaving the euro-zone, the euro itself remains more popular amongst Europeans than the EU. There is little desire to return to national currencies and if Greece can remain within the euro (at considerable cost to the Greeks), why should not Italy? It is hard to see what about the Five Star Movement and the Northern League would gain from actually giving up the euro, particularly the Northern League whose strength is derived from a region that has done tolerably well out of the EU. Joining the Eurozone was probably not the wisest decision the Italians have ever made but leaving would be equally unwise. All that said should not disguise the serious issues outstanding to help monetary union work better, primarily some form of banking union, greater risk sharing between countries and a more expansive fiscal policy by Germany. Italy itself needs to address its banking sector and the bad loans therein. I see little reason but to expect more of the same, Italy to remain within the Eurozone but with a struggling economy and with bond yields at a substantial premium to those of Germany.

Global growth

Global growth. The IMF has recently released its world growth projections alongside its April world economic outlook. It paints a tolerably optimistic outlook with expected growth of just under 4%pa for the period 2017/19. This compares favourably with 3.4%pa for the previous 5 years 2012/16. The driver behind this improvement has been the OECD countries where growth is forecast to rise from 1.7% to 2.3%pa whereas developing countries’ growth will remain at around 4.8%pa over the whole 2012/19 period. The IMF gives two reasons for the improvement; the first is a rise in investment spending and the second is an increase in trade volumes. It is worth putting this in context. Global growth has averaged 3.7% since 1970, (implying a doubling every 19 years), so what the world is currently experiencing is in line with the long run trend. This might come as a surprise to some who think of current growth rates as being poor. What has happened is two-fold. The first is the rebalancing of growth away from the rich countries of the OECD to Asia and China in particular. The second is that we have been conditioned by the GFC of 2007/08 and the relatively weak recovery afterwards to think that the current situation is dire. In fact, global growth was weaker in the 1980s and 1990s than it has been since the millennium. Things however are changing. The emergence of China as an economic super-power has helped sustain global growth since 2000. But growth rates of over 10% are unsustainable and Chinese growth is likely to settle down at around 5% or less with consumption rather than investment and exports as the driving force. This means that China will be source of demand rather than supply. The second factor is that the recovery in OECD countries since the GFR was driven by an ultra-loose monetary policy in preference to using fiscal policy. This is ending, most notably in the United States. Here, the Federal Reserve has raised rates and is reducing the size of its balance sheet. The Administration under Trump has significantly loosened fiscal policy by disguising it as tax reform. This leads to a third factor. The US Administration wants to reduce the American trade deficit using a combination of threats and tariffs but its monetary and fiscal policies will have the opposite effect. This wrong mix of policy will lead to a higher deficit which could lead to more tariffs and so to a break-up of the old liberal world trade order. In the short run, the gradual tightening of monetary conditions could cause some turbulence. American policy should lead to a stronger dollar, which is always bad news for emerging markets. We have already seen this in Argentina and Turkey. Corporate spreads are widening a bit which could put pressure on high yield investments. There is still quite a lot of bad debt hidden away on bank balance sheets most notably in Italy. The travails of Deutsche Bank demonstrate just how much bank restructuring in Europe has lagged the US. The good news is that inflation remains on the low side albeit rising commodity prices and a stronger dollar will have an impact. As always, we live in interesting times; matters are never quite as bad as they seem but Donald Trump will do his best to make them so, and whatever you do, don’t share his self-serving optimism.