Brevan Howard is one of the largest hedge funds in the world. Based out of the UK, the firm manages several different hedge funds. Last year, the flagship fund, Brevan Howard Master Fund returned over 12%, as we reported recently.
The flagship fund was up 0.20% YTD (as of February 29th). The fund manager, Alan Howard, detailed his views on the economic conditions in five different ‘countries’; the US, Eurozone,
Howard seemed to be confident about the US recovery but noted that rising taxes, and risks from European contagion remain.
In regards to Europe, Howard noted that the economy was stabilizing but was specifically concerned that youth unemployment over 21%.
The UK remains at risk to Europe contagion and the recovery is weak due to de-leveraging on the consumer level.
Howard notes that Japan appears to be unable to get out of its 20 year cycle of deflation.
On China, Howard is among those who believe that China will have a soft landing, and slowing inflation is helping policy makers.
Below is the full commentary:
USA
The outlook for US growth faces cross-currents, with the labour market improving at a steady pace while aggregate demand slows. Job gains have averaged 200,000 per month over the last six months, the unemployment rate has dropped by 0.8 percentage points over the same period and initial claims for unemployment insurance have recently fallen to approximately 350,000 per week. These factors, combined with increases in private sector wages and salaries (rising at an annualised rate of 5%), should provide support for expansion in the coming quarters.
In contrast, indicators of household consumption and business investment have failed to impress, leading us to mark down real GDP growth to approximately 2% for the first quarter of 2012. Although spending on motor vehicles has soared, overall real personal consumption has been flat over the last three months, in part due to higher prices for gasoline and depressed spending on utilities because of the unusually warm winter weather. Key indicators of business capex – orders and shipments of non-defence capital goods – declined in January and, apart from uneven investment in power transmission equipment, were approximately flat over the last three months. Nevertheless, given a generally favourable macro backdrop, we expect consumption and investment to return to moderate growth rates in the coming months.
Looking forward, we believe that the US economy faces three uncertainties and one certainty. In terms of the uncertainties, the unemployment rate has dropped rapidly despite growth being around trend, calling into question the sustainability of this drop. Second, the European financial crisis has eased somewhat but the respite may again prove to be temporary. Third, geopolitical tensions in the Middle East could push up gasoline prices by enough to derail the expansion. One certainty in our view is that the US faces an enormous fiscal drag in 2013. Personal taxes on income, dividends, and capital gains are scheduled to rise sharply; across-the-board cuts to discretionary and defence spending will automatically kick in; and the payroll tax holiday and extended unemployment insurance are due to expire. This combination is likely to subtract more than 3 percentage points from real GDP growth.
The question is whether the President and the new Congress will postpone some of these measures, however even if the fiscal drag is cut by half, it would still have a noticeable impact on growth.
Europe
The second Greek bailout package was eventually agreed upon in a lengthy session of the Eurogroup in late February. The deal includes a financial support package to Greece of EUR 130bn, as well as extended private sector involvement in the form of an average 53.5% haircut on the nominal value of outstanding Greek government bonds. The eurosystem agreed to forego all profits from its investments in Greek bonds in exchange for being excluded from the haircuts. The deal was underpinned by a revised debt sustainability analysis by the Troika, which under the refinancing agreement sees the Greek government debt fall to approximately 120% of GDP by 2020. The analysis quoted substantial downside risks to the adjustment, coming from weak implementation and the possibility that an economic recovery will not materialise as predicted.
The Greek authorities subsequently launched the debt exchange process which was successfully completed by mid-March, with a 95.7% participation rate after collective action clauses in Greek-law bonds were invoked, while the exchange offer for holders of foreign-law bonds only expired later in the month. The activation of collective action clauses triggered CDS contracts on Greek government bonds. After the agreement of the Greek bailout package, the Eurogroup discussion turned to the need to enhance the financial firewalls that would mitigate financial contagion to other peripheral economies in the event that the Greek programme goes off-track. At German insistence, the discussion was postponed until after implementation of the Greek debt exchange. Final agreement on the issue is expected some time during March.
Meanwhile during February, the Irish government announced its intention to hold a referendum on the Fiscal Compact. A rejection from Ireland would not affect the implementation of the deal in the euro area as only 12 countries are required to sign the treaty to make it legally binding. However, a no-vote would effectively bar Ireland from accessing the European Stability Mechanism funds. Posing a direct challenge to the Fiscal Compact, the Spanish government announced its budget deficit target for this year as 5.8% of GDP, approximately EUR 15bn above the 4.4% limit agreed by the previous government. This was despite the European Commission having insisted that Spain must adhere to the agreed targets to restore fiscal stability.
The second ECB three-year long-term re-financing operation (“LTRO”) saw a gross allotment of EUR 529.5bn. The total roll of maturing operations is approximately EUR 220bn, meaning that the net new liquidity added to the system amounted to approximately EUR 310bn. Following the allotment, the Italian bond market rallied strongly, suggesting that some of the funds were invested by banks in Italian government paper. After the two LTROs, the eurosystem’s balance sheet now exceeds the EUR 3 trillion mark, almost a three-fold increase since the crisis started.
Nearly a third of the refinancing extended by the ECB is now in 3-year maturity, while the maturity of the regular re-financing operations, which normally constitute the bulk of ECB lending to banks, is one week. Concerned about the growing risks to the eurosystem’s balance sheet, the Bundesbank President wrote a letter to the ECB President. He highlighted the risk exposure faced by those national central banks in the eurosystem which are on the creditor side of the large imbalances accumulated in the euro area payment system (TARGET2), given the fact that the eurosystem is substituting for the private cross-border interbank market in the euro area.
In its regular monthly policy meeting a week after the LTRO, the ECB Governing Council decided to leave interest rates unchanged. The ECB staff projections for real GDP were revised slightly downwards, while projections for inflation were revised upwards.
Incoming macroeconomic data has confirmed the broad economic stabilisation of the euro area after the 2011 fourth quarter GDP growth rate was confirmed to have contracted by 0.3% quarter-on-quarter. The latest headline composite PMI fell slightly, largely reflecting the adverse weather conditions in February. On the financial side, monthly growth in money and credit aggregates also showed some stabilisation although the data still highlight risks of a credit crunch in the near-term. The most worrying piece of data this month was the eurozone unemployment rate, which climbed to 10.7% in January and to 21.6% among those aged under 25.
UK
The increase in momentum evident in UK data over recent months has been
maintained, but did not increase further in February. The recent improvement in the housing market is likely to have been largely due to accelerated activity ahead of the expiry of the stamp duty holiday in March. GDP should rebound in the first quarter, so the economy is likely to avoid two consecutive negative growth quarters. The drag on real income growth caused by high inflation that prevailed in 2011 is subsiding. Inflation has already come down to halfway between its peak and the 2% Bank of England target, and we expect a further moderation over the course of this year. With nominal wage growth at approximately 2-2.5%, real wage growth is likely to be around zero in 2012, a marked improvement relative to the sharp real wage contraction in 2011.
The bigger picture in the UK is still one of a below-trend recovery, as fiscal austerity and household and bank deleveraging present substantial headwinds to growth.
Current spending by the UK government is now contracting outright, its weakest growth rate since the 1950s. Money growth has started to pick up slightly, although it remains subdued. The risk of an externally-driven further downturn driven by the euro area crisis has eased, largely due to the ECB liquidity action and the Greek debt restructuring. However, the deeper balance of payments problems in the euro area remain unresolved, and cannot be resolved by liquidity assistance alone. The UK remains highly exposed to this situation. Against this backdrop of marginally improved short-term news, but a still subdued medium-term outlook, the Bank of England added a further GBP 50bn of quantitative easing in February, taking the total target up to GBP 325bn. This represents a fifth of GDP or a third of the stock of gilts outstanding. Additional easing is not ruled out, but would require a renewed deterioration in growth prospects or a sharper-thanexpected fall in inflation.
Japan
Japan is going through a phase of moderate cyclical upswing led by domestic
demand, as foreign demand dynamics remain subdued. The renewed easing by the Bank of Japan and the consequent weakening of the Yen are also contributing to the boost in sentiment. Indeed, in February, the composite PMI orders index increased by a full point, to 50.8, on the back of a 1.3 point acceleration in the services component of the survey, and a more subdued 0.2 point rise in manufacturing. This reflects a significant acceleration in domestic orders, which was partially offset by a remarkable deceleration of exports, from 50.2 to 47.1, a three month low. Other surveys geared on domestic demand also increased, such as the Economic Watchers Survey. One should also note that 2011 fourth quarter GDP was revised up significantly, from -2.3% to -0.7% quarter-on-quarter. On the inflation front, there are only glimmers of easing deflation, as the core (excluding food and energy) national CPI year-on-year growth rate increased in January from -1.1% to -0.9%, defying expectations that it would remain unchanged.
China
The Chinese economy appears to be on a gently moderating path. While the HSBC composite orders PMI indicator remained unchanged at a relatively low 50.9 level in February, actual data – which had somewhat overshot surveys in recent months – showed a moderate slowing down. Nevertheless, a hard-landing of the economy is highly unlikely, particularly in a year of political changeover. Chinese authorities set a 7.5% year-on-year GDP growth target for 2012, communicating to the market their objective of lower, but sustainable, expansion.
Importantly, inflationary pressures appear to be easing, which may leave room for some policy-easing in due course. In February, consumer price inflation fell significantly from the higher-than-expected reading in January – which was largely due to the impact of the Chinese New Year on food prices. The CPI year-on-year growth rate fell from 4.5% to 3.2%, undershooting consensus expectations. PPI inflation also declined, from 4.5% to 3.2%. China set a 4% target for CPI inflation in 2012, taking into account imported inflation, increases in the prices of production factors (labour, land, etc) and utility price increases. Policy-wise, the PBOC cut the Reserve Requirement Ratio by 50bps, effective on 24 February, with the aim of easing the interbank liquidity crunch. Both M2 and credit are on a smoothly downward path; at 13.2%, the M2 year-on-year growth rate is lower than the 14% target set for 2012, reflecting a still prudent stance on monetary policy. In 2011, M2 expanded by 13.6%, below the 16% objective.
