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The economic threat facing the world is bigger than Brexit

November 30,-0001 00:00

The week will be dominated by politics, not economics, which will make it harder to hear the messages coming through about the future of our economy, and indeed that of the wider world. But if you are looking into the UK from the outside, there is one ...


The week will be dominated by politics, not economics, which will make it harder to hear the messages coming through about the future of our economy, and indeed that of the wider world. But if you are looking into the UK from the outside, there is one particularly troubling thing to look for. That is what is happening to long-term interest rates.
To single this out might appear nerdy, for bond yields do not catch the headlines in the same way as the FTSE100 index, for example. But something remarkable, and disturbing, has happened in recent days that carries a worrying message about the future of the world economy: the plunge in yields. They are lower now than they have ever been before – yes, ever – and they keep on falling. And the message they carry is that there will be a world-wide recession.
Thus German 10-year bonds yield minus 0.13 per cent, Japanese, minus 0.26 per cent, Swiss, minus 0.58 per cent. These are extreme examples of the so-called flight to quality – “safe” investments that, though you know you will lose money on them, you won’t lose too much. The entire stock of Swiss government debt is now negative, as the world pays money to lend to Switzerland.
There is an impact on the US and UK too. US 10-year treasuries are down to 1.45 per cent, and UK gilts to 0.86 per cent, both the lowest ever. They may go lower yet.
From a narrow British point of view it might seem a relief that, despite all the commotion of the past 10 days, that the government can still borrow at such low rates. It makes the slow-down in the correction of the deficit cheaper than it otherwise would have been. But a world where investors are prepared to accept lower returns on their funds than at any previous period of human history says something terrible about their outlook for the world economy. The only way such an investment makes sense would be if they expected the obvious alternatives, investments in stock market equities and in property, to plunge.
This is because both equities and property are supported by revenue flows: dividends in the former, rents in the latter. If you can get close to a 4 per cent dividend yield from FTSE100 companies, why on earth invest in gilts?
That is the average yield on the "Footsie". The return from some of its largest members is higher – more than 8 per cent on HSBC, nearly 7 per cent from Shell and BP, 5 per cent from GlaxoSmithKlein and Vodafone. So the message from the markets is: expect big trouble.
Shares
Of the other things to look for, the next obvious indicator will be the FTSE100. The majority of companies on it are global and have non-sterling revenue streams. The index is not really about British companies. It is sterling-denominated bet on the world economy. That explains the strength of the index last week. Will it continue? In particular, will it continue even if the pound starts to bounce back? If it does, that says something more positive about the outlook next year. Maybe the developed world will avoid recession after all.
Sterling
Number three will be the pound. The headlines have been stolen by its plunge against the dollar and understandably so. But it has been less weak against the euro, for the euro has fallen against the dollar too. I do not expect much to happen until we get a new government, but once that is in place (conceivably this week) see how far the pound recovers.
House prices
Crucial to maintaining consumer demand in the coming weeks will be what happens to house prices. If they plunge, consumption will slump, but they will not respond immediately. The best early warning signal will come from the level of transactions, for a sharp drop there would signal further weakness ahead. So what transactions, not prices.
Economic commentary
One of the unsurprising aspects of the past 10 days has been the relentless flow of negative comment, tempered slightly by surprise about bond and equity prices. This is similar to the flow during 2012-13 when many commentators feared, wrongly, that the UK would enter another recession. At some stage this flow will ease, and the question is when. Probably not this week, for it is too early for that. But any sign of a more balanced approach would signal that normality is returning.

More about:

Economics
Brexit
Bonds
British economy
global economy

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