The man who knows too much
Alan Greenspan continues his journey to the status of immortality. He can do no wrong. The (very) surprising half-point rate cut at the start of the year is not to be viewed as an error, which it might well have been had it been announced by either the beleaguered Bank of Japan or the hapless European Central Bank. There seem to be two schools of thought developing in the aftermath of the action: either the US is heading into recession, at speed; or the slightly more cynical view that Greenspan’s decisions are more influenced by Wall Street than he would be willing to admit.
ABN Amro has no plans to mark down any of its economic forecasts and do not think the US economy is on the brink of a recession. Alan Higgins explains: “We still believe that the economy will see a decent rebound in the second half of this year, and have no forecast for any quarters of negative growth in the first half. It seems that they the Federal_Reserve are putting a lot of weight on survey data such as the NAPM, consumer confidence and jobless claims. In fact, I think that the very poor outlook for the equity market at the start of the year may have been preying on Greenspan’s mind, and in reality it is Wall Street which is a lot less resilient than Main Street and which needs more ‘attention’.”
For other managers however, the cut in rates is viewed in a far darker light. For Hugo Doyle at Banca Comerciale, the move creates more uncertainty. “Why did he Greenspan cut by so much? The hard data do not appear to be pointing to big trouble ahead for the economy. So what does he know that we don’t?” He speculates that perhaps the Californian utilities’ problems influenced the Fed chairman, adding: “We know that Governor of_California Davis met with Greenspan in December of last year and was possibly more worried about it as a result.” Doyle is referring to the recent disclosures that one of the Californian utilities, Pacific Gas & Electric (PG&E) was in dire financial trouble and had less than $500m of cash left to pay for more than $2.2bn of upcoming payments due for electric and gas costs in February and March.
“It is very rare for the Fed to cut rates between its regular meetings,” agrees CCF’s Jean-Pierre Grimaud. “It just makes me think that there is something strange going on. And so it is hardly surprising that as we speak there are rumours swirling round the market that the Fed is poised to announce another rate cut. Maybe one could argue that this was a cut delayed by the prolonged election ‘problems’. Whatever Greenspan’s specific reasons, we say that activity in the US is slowing very sharply, and we do not have a problem with the market discounting a further 100–150 basis points of cuts.”
Grimaud admits to feeling uncomfortable about the rapidity of change in the US economy, especially considering that only eight or nine months ago, in the second quarter of 2000, GDP was estimated to be expanding at an annualised rate of 6%, compared to the current 2%. “Why should the economy be slowing so rapidly? There is no problem with inflation, which did not even react to a large rise in the oil price, and so with a falling oil price the outlook for inflation improves considerably.” Grimaud suggests that the sharp decline in liquidity within the financial markets, as most graphically illustrated by the huge widening of credit spreads, may have influenced the Federal Reserve’s judgement.
CCF is not alone in worrying about the US economy, Stephen Roach, chief economist at Morgan Stanley Dean Witter, has stated that he believes the US is in the process of entering a ‘true’ recession – that is, where the economy experiences two consecutive quarters of negative growth. Because of their downgrading of US economic prospects, Roach and his team are cutting their global growth forecasts for 2001 to 2.9% from 3.5%. They too express surprise at the rapidity of change in the pace of global activity adding, “This paints a picture of a $32trn global economy that has essentially turned on dime.”
Philip Mann, fixed income fund manager at Julius Baer Asset Management, is still to be convinced by the doom and gloom rhetoric. He says: “At the moment we have no big ‘bets’ on. We are slightly long in duration terms in the US and slightly shorter within Europe, but that is about it. I cannot deny that we were surprised by the Fed’s bold move, but we are sticking to our belief that the US economy will experience a soft landing, and we do not buy into these recession stories.”
Other managers tend to disagree with extending portfolio durations at this time and tend to think that the short end of the curve holds more attractions. ABN Amro’s Higgins explains: “The front end, which has already reacted well to the cut while the long end is pretty much unchanged, has much better risk/reward characteristics just now. We do no think the long end has much to offer.” CCF’s Grimaud agrees, adding: “The rally in the 10-year has stopped and we think there is not too much to go for from here. Although yields might fall, 5% represents fair value. Over the next three to four months we reckon that the very short end – that is, one to two years – will perform best.”
Although not particularly enthusiastic about government bonds anywhere, Grimaud is hugely bullish on credit right now. “We are really positive, especially in the high yield market which is anticipating huge default rates. If the US or global economy is just slowing down, and not heading into a deep recession, then credit spreads are going to come in a lot.”
Grimaud is positive for credit markets on both sides of the Atlantic. He points out that the current spread of 10 percentage points between ‘junk’ and government debt implies a default rate of 16%. “Neither the US nor Europe – where we are facing a small slowdown at worst – is about to be plunged into a deep recession, which is what these huge implied default rates are indicating. We moved overweight in high yield, going underweight AAA in the process, in December. Although the move has cost us so far, we are more than happy to stick with it for a while.”
ABN Amro is similarly bullish on European credit markets, although it stresses that its portfolios are only overweight in maturities below five years. Julius Baer’s Mann is rather more cautious: “Yes, we are enthusiastic, but not wildly so. So many credit markets took a real hammering last year, especially the sub-investment grade. We would advocate caution, and be especially careful about sector selection in Europe.”