City Insider: The prognosis for travel after quantitative easing

City Insider: The prognosis for travel after quantitative easing

City Insider - FT journalist David Stevenson on the travel industry

This Wednesday (June 22) could be the most important day of the year. Wednesday may be the beginning of the end – or at least the end of the putative global economic recovery and the beginning of the next bout of nastiness.

Alternatively Wednesday June 22 could also be just one day like any other. Or at least like any other follow up day to the monthly Federal Open Market Committee meeting in the US.

To understand the importance of this meeting of central bankers to everyone else on the planet (especially in the travel trade) we first need to first understand the totemic importance on the Federal Reserve Bank of the US and the current bout of Quantitative Easing, nicknamed QEII in its current incarnation.

Hard as it is to believe, but business in the travel sector could have been be a whole lot worse if it wasn’t for Quantitative Easing. The US central bank’s decision to step in and buy up financial assets such as bonds, loans, treasury bills and troubled bank assets provided the liquidity the financial markets desperately needed to kick start again.

The Great Recession of 2007 and 2008 nearly turned into another Great Depression because confidence collapsed and liquidity in the financial system vanished into a black hole. The QE experiments represented a brave attempt to pump prime the markets and encourage corporations to start spending again. In that worthy objective, QE has succeeded.

Corporate profits around the world have increased and (outside of the Anglo Saxon world) consumer confidence is robust. Sadly consumer confidence here in the UK hasn’t rebounded, if only because our government has decided to accompany its own bout of QE with a much heralded fiscal tightening.

The US government, by contrast, has been much less ambivalent and has kept spending even as the Federal Reserve has flooded the financial markets with money.
Sadly for many in the markets, the next FOMC meeting is widely expected to signal the end of QE2.

Fed boss Ben Bernanke has said repeatedly that he does not intend to initiate another bout of easing, and the investment community has started working itself up into a blind panic.

To understand this fear of the unknown, consider the beastly stockmarkets. The all important US S&P 500 for instance has slumped to its sixth consecutive weekly low and investor’s are now bracing themselves for even bigger losses over the next week as all that Fed-supplied monetary support is slowly withdrawn.

More to the point, investors worry that the Fed will not only stop buying bonds and equities, but start selling the vast portfolio of assets it’s acquired over the last few years. If it does start selling like maniacs that’ll mean falling stock prices, falling bond prices, and rising bond yields which will in turn push up natural interest rates throughout the world.

Suddenly that massive race to refinance corporate balance sheets will stop dead in its track and the end will be nigh…

A big game of chicken

Sitting in slightly distant sectors such as travel, one could be persuaded of an alternative reality that isn’t quite so depressing – the markets are currently engaged in a massive game of chicken.

Bernanke has quite rightly said that ‘monetary policy cannot be a panacea’ and he may even be right that the ‘the end of the program is unlikely to have a significant effect on the financial markets’.

Investors have talked themselves into believing that without massive monetary intervention we’ll automatically lapse back into a double dip recession. This isn’t an entirely unwarranted fear, especially with talk of Greek defaults and poor US employment growth data. But two trends might become obvious as 2011 draws to an end.

The first is that the global business cycle is still trending upwards and although that rebound may have slowed in pace, the most obvious explanation is that it’s simply taking a breather before picking up speed again in the Autumn.

This is exactly what has happened time and time again in previous cycles and has to be the most likely scenario for the next six to 12 months. More to the point, stock markets and bond investors will have to start investing again not because they think the US Federal Reserve will buy their paper, but because growth is robust and profits are moving forward.

The second obvious fact is that QEI and II in the US and the UK haven’t succeeded in boosting consumer confidence appreciably. Here in the UK consumer confidence started collapsing at the end of 2010 as government spending cuts became increasingly obvious.

Over in the US the still fragile housing market has dented consumer confidence with an immediate effect on new job creation. The US Federal Reserve will almost certainly now consider more radical solutions – as might the Bank of England.

My biggest bet would be on some form of intervention in the US housing market by buying mortgage securities and encouraging lending to cash starved house buyers.  The aim here will be not to subsidise bank balance sheets or to encourage big corporates to hoard yet more cash but instead to get us all to collectively spend a bit more.

If I’m right, (and it is the consensus among most economists) both these developments – intervention to encourage consumers and a resumption of growth in the economy – will reignite investor enthusiasm at some point in the Autumn, pushing the equity markets forward again for at least another six months (quite what happens after then is anyone’s guess.)

A slightly more hopeful Q2 for travel?

And the effect of this rebound in the global economy on the embattled UK travel sector? I’d hazard a guess and suggest that three trends might begin emerge.

The first and most obvious is that pressure will grow on the UK government and the Bank of England to ‘do something’ to restore consumer confidence. That might consist – as Labour suggests – of targeted tax cuts or alternatively intervention in the mortgage and lending markets. But the pressure to do something will be huge.

The next obvious effect will be that investors will rekindle their obsession with commodities and most especially oil. Petrol pump and aviation fuel prices have slipped back in recent months as fear of a double dip recession have grown but if the markets do turn more optimistic I’d expect prices to start pushing back towards $120 and maybe even $130.

The last effect to watch out for will be in the currency markets. As confidence does begin to return in dribs and drabs, the real economic strategy will become apparent – both the US and UK government need to quietly engineer an even greater decline in their respective currencies via the FX markets.

The net effect on the ‘cable rate’ – the $/£ rate – may not be great but I’d suspect there’s a good chance that sterling may push past $1.65. We might even see the sterling rate against the euro push below 1.10 again, possibly even creeping towards 1.05 as the Greek debt crisis temporarily dips from view.

This dollar weakness should be good news for some parts of the travel trade selling into the US – although it’s probably bad news for holidaymakers planning a trip to Spain. Overall, though, I’d expect short term inflationary price pressures to increase and margins to come under yet more stress, even if the top line does start to grow again.

More to the point we should expect a number of bitter price battles in the sector towards the end of year as the bigger players attempt to grab even more market share.


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