Friday, 9 September 2011

Word on the Economy from the Fund Managers

Today, I met several investment fund managers at a work conference, and was given a useful opportunity to quiz them on several issues regarding the economy. They gave some quite interesting answers.

Q: How do you view the UK economy compared to the rest of the world?
A: There's no doubt that the spending cuts and tax rises have slowed growth in the economy; however, given the circumstances the public finances were in, this is an unavoidable consequence. On the up-side, UK gilt yields are very low, some index-linked gilts are now being issued with negative yields. The markets feel confident that the UK's spending cuts are a necessary retrenchment, and are happy that they are progressing. Any change of course would likely be severely punished, with gilt yields rising, making borrowing considerably more expensive for the Government.

The UK is ahead of the curve with regard to its deficit reduction programme, and as such, is regarded in better light than some of its Western counterparts who have only just started fiscal retrenchment. There is no real doubt that remaining outside the Euro has given the UK considerable flexibility in its recovery, by being able to devalue its currency and allow exports to become competitive. Exports of manufactured goods are leading the UK economic recovery.

Q: What about America and their recent downgrade by Standard & Poors?
A: Standard & Poors, quite frankly, made a mistake. Since the downgrade, US treasury yields have fallen, and prices have risen, indicating strengthening, not weakening, confidence. The markets were concerned when the Democrats and Republicans were playing 'political chicken' with regard to raising the debt ceiling, but now that an agreement is in place, the US public finances are regarded as improving. The Fitch ratings agency has re-affirmed its own rating of US sovereign debt, as have the Chinese ratings agencies, which is significant as China owns roughly 40% of US treasuries. A climbdown by Standard & Poors in the not-too-distant future wouldn't come as a surprise.

Q: How do you view the situation in Europe?
A: There are three potential outcomes:
  1. Break-up of the Eurozone, and all the member states reverting to their own currencies. This would probably be the least desirable option, certainly in the short term, as the disruption it would cause to global markets would be highly significant;
  2. Establishing a Euro bond market. This would entail the EU taking responsibility for issuing debt instead of member nations. The borrowing costs for peripheral economies would drop, but would likely increase for France and Germany, as they would effectively be agreeing to subsidise other economies on a permanent basis. On a markets basis, this would probably be the preferred outcome, as it offers the lowest level of disruption, but it is unclear whether there is the political will to see such a unification through;
  3. Partial break-up of the Eurozone. This would result in Germany (and possibly France) effectively leaving the Eurozone and forming a separate currency, or the deliberate expulsion of some peripheral economies such as Greece, Ireland and Portugal. Although not ideal, this is the solution the markets regard as most likely - effectively a compromise between options 1 and 2.
Whichever option finally comes to fruition, it is clear that the current dogma of bail-outs is not working, and as long as it continues, the markets will be uncertain about Europe.

So, the conclusions:
  1. The spending cuts are affecting economic growth, contrary to the Tory position on this. However, the consequences of not undergoing this fiscal retrenchment would be significantly worse, and increased borrowing would not be viewed favourably by the markets. Indeed, the UK is seen to be poised for a faster recovery than other Western nations, because of the quick and decisive action the Government has taken, and because of its decision to stay out of the Euro;
  2. The stimulus approach taken by the US is credible, when taken into account with the spending cuts secured by the Republicans. The downgrading by Standard & Poors is widely regarded as premature, with confidence in the US economy improving gradually;
  3. The situation in Europe is problematic. It is not yet regarded as verging on another credit crunch, but it does offer cause for concern, which needs resolving before it gets any worse. The best solution for the markets would be fiscal union, but it is not clear whether there is the political will to bring it about. Failing that, an ordered, partial break-up of the Eurozone, with a partition between the core and periphery economies, is probably the next best, and most likely, option.

Rather refreshing to get a real idea on the economic direction without petty party-political point-scoring or media scare-mongering getting in the way. Of course, they're only fund managers. What do they know?