Yesterday saw England rudderless and confused with a poor performance from Sterling. But enough about the football although let me congratulate Iceland and wish them good luck in the next round. As we have a spell of market calm this morning with the FTSE 100 up 2% at 6100 as I type this and even the poor battered UK Pound £ rising above US $1.33 there are opportunities to take stock. An early lesson is a type of shock effect both emotionally and in the way that financial markets can move far far faster than the economy can respond. Whilst it has many flaws in other areas rational expectations economics has some success here although of course the obvious rejoinder is what do we rationally expect now?
Ratings Agency Downgrades of the UK
Once upon a time these bodies bestrode the world and economic agents were afraid of them . If they sliced a notch off a credit rating then the “bond vigilantes” would ride into town driving sovereign bond yields higher and making it more expensive for that country to borrow. The credit crunch hurt them in two ways starting with the way that debt they rated as “AAA” turned out to be a lot further down the alphabet in reality. Also as events like the Euro crisis hit they ended up chasing events rather than leading. They have survived because the need for measurement and analysis has risen in the credit crunch era and that has offset to some extent the plummet in their credibility.
So let us get to what they told the UK yesterday. From Standard and Poors
Ratings On The United Kingdom Lowered To ‘AA’ On Brexit Vote; Outlook Remains Negative On Continued Uncertainty.
This had particular emphasis for headline writers as it was the last of the ratings agencies to have the UK as AAA. Around 5 years ago I pointed out that we did not really deserve such a rating as whilst we have our own currency and could always print as much as we wanted that would likely be accompanied by a lower value of the UK Pound £. Also Fitch wanted a slice of the action as Reuters reported.
Fitch Ratings cut Britain’s credit rating on Monday and warned more downgrades could follow, joining Standard & Poor’s in judging that last week’s vote to leave the European Union will hurt the economy.
Fitch downgraded the United Kingdom’s sovereign rating to “AA” from “AA+” and said the outlook was negative – meaning that it could further cut its judgment of the country’s creditworthiness.
Some kept a sense of humour about it all.
#FITCHSLAPPED Fitch downgrades UK to AA/neg now (@NicTrades )
A Wider Perspective
These days the story does not end there as you see there are much wider trends and themes at play. Overnight we have seen yet another example of the move lower in sovereign bond yields.
#Japan | *JAPAN’S GOVERNMENT BONDS ALL YIELD LESS THAN 0.1% FOR 1ST TIME
Apologies for the capitals used. If we move beyond that there is plenty of scope for reflection that the highest sovereign yield in Japan is not even 0.1%! Each time we see such a move I point out that business models which depend on yield such as pensions and annuities cannot work anymore. The ten-year yield is now -0.22% which fits poorly with all the proclamations of economic recovery. Overall we see this.
Japan’s long yields on the road to zero. 40-year falls to record 0.08%, some 80% of JGB market is now sub-zero ( @HaidiLun )
Back in the UK
The story of the bond vigilantes riding into town has quite a reverse here. It was only yesterday that I pointed out that our benchmark 10 year Gilt had seen its yield fall below 1%. So yields are surging today in response to the downgrade? Er well no, as it is at 0.97% as I type this so on the edge of all-time lows ( since 18th century according to Ed Conway of Sky). This is a little higher than the lowest of yesterday but not much and this of course is a response to the higher level of the stock market. The thirty year Gilt yield is at 1.83% which in terms of my time following it is simply incredible.
So those looking for a response to the ratings downgrade only have inverse responses with Gilt yields extraordinarily low and the stock market and UK Pound £ rallying.
The impact of the lower UK Pound £
There have been a lot of headlines about the UK Pound £ saying it is a 31 year low or was yesterday. Many have forgotten to point out this is against the US Dollar which of course has been in a strong phase and overall we have seen falls but mostly smaller ones elsewhere such as to 1.20 versus the Euro.
As we have reached a calmer phase I can complete some calculations as the Bank of England only compiles its trade weighted index daily and is based on yesterday’s close. Thus we came into 2016 at just over 90 and are now at approximately 80. So using the old Bank of England rule of thumb we have seen a move equivalent to a Bank Rate reduction of 2.5% so far in 2016. Compared to this time last year it is more like 3.25%.
We can expect an inflationary push as well especially as the fall has been loaded towards the US Dollar. Many basic commodities will be seeing a push higher from this as it added to a falling trend anyway although there will be some offsetting from the falls in the oil price over the past few days. Over the past year the oil price (Brent crude oil -24%) has fallen more than the UK Pound £ (-15%) but over the last week it has fallen by less. So upwards but not by as much as those who have missed the oil price fall have suggested.
There continues to be much to consider as a multitude of economic events occur together. What it shows us is how tightly the world financial and economic system is tied together. Some of this is good as in manufacturing efficiency but some of it is not so good as complacency and bluster about the banks turns to near panic in an instant. On that subject whilst he is not always right this poses a question. From De Welt.
George Soros is betting 100 million Euros against Deutsche Bank
Meanwhile we have received an increase in uncertainty followed by an inflationary economic boost provided by the fall in the UK Pound £. Just what some at the Bank of England have called for over the years so it is no surprise to see former Governor Baron King reappearing in the news. In fact quite a few economists have called for that although it is nice to see the Resolution Foundation backing up one of my themes.
Housing wiped out 2/3 of post-2002 income gain. RF report on underplayed role of housing in living standards squeeze.
If you need some light relief at a difficult time you should watch this rather spectacular effort.