From John Stepek, just across the river from the City.
It’s nice to go away on holiday, but it’s also nice to come back to the familiar sights and sounds of home. And even after two weeks away, it seems to be business as usual in the world of finance and economics.
Oil prices keep rising, stock markets keep setting new records, and British consumers just can’t stop spending.
It’s all that ‘liquidity’ washing around the world, say the papers – there’s so much money out there that it seems almost unbelievable that the current happy state of affairs of ever-increasing asset prices could ever end.
But cheap money is a poor foundation on which to build an economic golden age. And cracks are now appearing in the façade that threaten to let all that liquidity drain away…
One of the most obvious warning signs of trouble ahead for the global economy has appeared in the bond market.
As John Authers put it in the weekend edition of the Financial Times, “bond prices have just gone down, a lot.”
The yield on a 10-year gilt (UK government bond) last week hit a seven-year peak of 5.48%. The value of the gilt market has dropped by 4.5% since January, says Henderson Global Investors quoted in the FT. As the paper points out, that‘s “a significant correction for these normally stable investments.”
It’s a similar story in the US, where 10-year Treasury (US government bonds) yields have also been heading higher as US commentators start to come round to the idea that US interest rates aren’t going to be cut any time soon.
Why does this matter? Well, as Roger Bootle says in this morning’s Telegraph: “It may seem esoteric to you, but the yield on government bonds is the foundation on which all asset values rest.”
Basically, if you can get a yield of say 5.5% by putting your money into a UK or US government bond (generally regarded as risk-free, although obviously the market has seen some comparatively hefty ups and downs this year), then anything riskier (which is just about anything) needs to offer a better return than that.
So yields on everything from commercial property to emerging market debt need to rise. And for yields to rise, prices have to fall.
As Bootle puts it, “I suspect the era of very low real rates is coming to an end… we may be about to enter a period of high real rates… this would have profound consequences for asset valuations everywhere.”
Bootle’s far from being the only worried voice. Dan Roberts, business editor of the Sunday Telegraph, reckons “the writing is on the wall” and that the era of low interest rates and cheap money is finally at an end. “The most extreme manifestations of cheap money are already showing the effects,” he says, pointing to the stumbling commercial property market as an example.
But it’s not just the commercial property market that’s facing problems. The residential housing industry is also living in terror of rising interest rates. Robert Bryan-Pearson of independent property valuer Allied Surveyors, tells the Sunday Telegraph that “a quarter-point rise is as much as the market can take. Anything more will precipitate a serious crash.”
Given that more and more economists now reckon that the UK base rate will be at least 6% by the end of the year, that’s a pretty unnerving statement. On top of this, about a million borrowers who took out two-year fixes at the end of 2005 (when the base rate was well below 5%) are about to see their fixed rates end, meaning a painful rise in mortgage payments as the impact of all those extra interest rate hikes between then and now takes effect.
And yet, consumers still aren’t getting the message that the world is changing. The UK savings rate has been negative for the past four years. In other words, the average person is spending more than they earn, and eating into savings (or more likely, slapping it on credit) to maintain their standard of living. And there’s no sign of them stopping – the savings rate is now at its worst since 1987, when records began, according to the Bank of England.
That means that when times turn and things get tougher, consumers will be more exposed than ever before – which could make previous recessions look positively tame by comparison.
Expert investor Paul Hill explains why he reckons stock markets, which also look rather vulnerable, are heading for a crash in the very near future – and explains what you should do about it – in the current issue of MoneyWeek.
If you’re not yet a subscriber, you can get access to Paul’s story plus all the other content on the MoneyWeek website and sign up for a three-week free trial of the magazine, just by clicking here: Sign up for a three-week free trial of MoneyWeek
Turning to the stock markets…
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In London, the FTSE 100 was 82.5 points higher on Friday at 6,649 as Wall Street rose on an easing in core inflation data and UK miners responded to higher base metal prices. Lonmin was the stand out performer, up 192 at 4,169, after a report from Morgan Stanley rated the African miner as its top pick in the sector.. For a full market report, see: London market close (/file/30910/london-close-top-stocks-close-at-7-year-highs.html)
On the Continent, the Paris CAC-40 was up 58 points to end the day at 6,105. And the Frankfurt DAX-30 ended 181 points higher, at 8,030.
Across the Atlantic, stocks rallied on the benign inflation data, easing fears that a rate rise could be on the way. The Dow Jones added 108 points to close at 13,662. The tech-heavy Nasdaq rose 25 points to 2,625. And the S&P 500 gained 12 points to end the day at 1,535.
In Asia, the Nikkei responded to optimism on Wall Street by pushing 178 points higher to close at 18,149, a four-month high. In Hong Kong, the Hang Seng rose 149.79 points to a record close of 21,017.05.
Crude oil for July delivery was at $68 a barrel in New York on Friday, after fears over supplies for the peak summer season pushed it to a nine-month high.
Spot gold rose to $655.90/657.40 an ounce from $654.50/656.00 late in New York on Friday on a weak US dollar.
And in London this morning, UK paint and chemicals giant ICI has rebuffed a £7.2 billion bid from Dutch rival Akzo Nobel. The 600 pence a share offer saw its share price rise 15% this morning to 633p. Akzo says it is leaving open the option of increasing its bid.
And our two recommended articles for today…
How Peak Oil went mainstream
– June 14th could go down in history as the day Peak Oil theory entered the public consciousness. And it’s all down to the power of the internet. For Dave Gonigam of Whiskey and Gunpowder’s thoughts on what the repercussions could be, read: How Peak Oil went mainstream
How to protect the money you’ve made
– As anyone who’s read this week’s MoneyWeek cover story will know, there are plenty of reasons to feel nervous about recent stock market exuberance, which is why we’re recommending our readers take steps now to protect themselves against a crash. One way to do so is to create a balanced portfolio – and in this previous MoneyWeek cover story, just available to non-subscribers, Tim Price explains how to do just that: How to protect the money you’ve made