It’s been another volatile week in investment markets.
Asian markets started the week on a strong note following better than feared Chinese data and news that Spanish banks will receive up to a €100bn bailout from the European bailout fund. However, worries quickly returned, before hopes for policy stimulus finally pushed markets higher towards the end of the week.
The positives from the bailout of Spanish banks are that it is pre-emptive, big, doesn’t involve new austerity and is at affordable interest rates for Spain. However, its negatives are that it will add to Spain’s public debt, likely subordinates other lenders to Spain and helps shift the focus to Italy and it is these that investors started to worry about after of a brief positive reaction. More ratings downgrades for Spain and its banks and more poor economic data in Europe and soft US data added to nervousness, particularly with the Greek election looming and with it fears that it may set Greece on a path to a disruptive default and exit from the euro.
The next two weeks are shaping up as potentially very volatile starting with the Greek and French elections, the G20 leaders meeting on Monday and Tuesday, the US Fed meeting on Wednesday, Eurozone
finance ministers meeting on Thursday and Friday and then EU leaders meeting on June 28-29. Significant uncertainty surrounds each of these events and taken together the next two weeks have the potential
to determine the direction for the global economy and hence share markets over the next year. As such, the next two weeks could prove to be a watershed. The dilemma for investors is that uncertainty is high, but risk assets like shares are quite cheap and there is significant potential for policy action to provide a boost to markets. The latter is particularly so with talk that central banks are likely to inject liquidity into global markets if needed after Greece’s election and signs that Europe is heading towards “more Europe” with German Chancellor possibly relaxing her opposition to a redemption fund that would be used to buy Euro-zone country debt above 60% of GDP in return for fiscal and banking union.
Major global economic releases and implications
- US economic data was soft, with retail sales disappointing, weekly unemployment claims rising, poor readings for manufacturing and a fall in consumer sentiment. Against this, small business confidence was little changed in May and weekly mortgage applications rose strongly, probably reflecting the record lows in US mortgage rates. US growth is on track for 2% this year, which is probably not enough for the Fed, particularly with inflation falling.
- European data was weak with industrial production falling in April, albeit by less than expected, employment falling, Spanish house prices hitting a new low and a Manpower hiring index indicating a slowing German jobs market. Our forecast for Euro-zone GDP growth this year remains -1%. The Bank of England announced new efforts to boost bank lending with Governor King referring to a growing case for more monetary easing.
- Japanese data was mixed with a fall in a tertiary activity index but gains in machine orders and consumer confidence. Japan is expected to grow 1% this year. Disappointingly the BoJ left monetary policy on hold.
- Chinese data for bank lending came in better than expected which combined with signs economic activity indicators for May were stabilising after a loss of momentum into April added to confidence that China will avoid the much feared hard landing. We see Chinese economic growth bottoming out around 7.5% this quarter.
- Clouds continue to darken over the Indian economy with industrial production coming in below expectations at just +0.1% year on year in April, inflation rising more than expected in May and Standard and Poor’s warning India may loose its investment grade credit rating due to slowing growth and poor economic policy making.
Australian economic releases and implications
- In Australia, the run of stronger than expected data came to an end with poor readings for business conditions and consumer confidence, despite more interest rate cuts. The NAB Business Survey for May
showed business conditions fell to its lowest level since May 2009. Despite another rate cut and good news on growth and employment consumer confidence only rose 0.3% in June leaving it below long term average levels. Normally at this point in the rate cutting cycle consumer confidence has had a decent bounce, but not so this time supporting the view that interest rates still need to fall further. Apart from bad international news flow, one factor continuing to weigh on household confidence is rising electricity costs. On one estimate, an 18% rise in average electricity prices in NSW from July 1 will cost the average household an extra $360 or so per annum.
- There was some good news though for first home buyers of new homes in NSW who will see an increase in concessions. This combined with falling mortgage rates should help drive an upswing in housing construction and prices (mainly for new homes though as grants for buyers of existing homes will be scrapped).
Major market moves
- Share markets had a volatile week being buffeted by bad economic news and worries about Greece, Spain and Italy, but receiving support from talk of global policy stimulus which saw most markets end higher.
- The $A benefitted from more talk of reserve currency buying and increasing expectations for more US monetary easing pushing it back above parity against the $US.
- While Spanish and Italian bond yields rose, making a general bailout for Spain look inevitable unless yields fall soon, bond yields elsewhere were mixed – down slightly in Australia, down in the US, but up in Germany as investors realised (again) that German bonds are not without risk given German support for the rest of Europe.
What to watch over the week ahead?
- The week ahead will be a big one. First up will be investor reaction to the Greek elections on Sunday. The most recent polls gave New Democracy a slight lead over stridently anti-bailout Syriza, but it’s too close to call and the polls are more than two weeks old. If Syriza wins such that it can form Government markets may react negatively on fears of a messy default and euro exit, whereas if New Democracy can form government markets may breathe a sigh of relief. Of course, it’s not that simple as there could be another stalemate in which case uncertainty will continue, whatever the outcome Greece will continue to struggle to get its budget under control and periodic flare-ups involving Greece will continue and any outbreak of market turmoil is likely to be met with European, and possibly global, stimulus measures. The results from French national assembly elections will also be watched closely because if extreme left parties do well then it raises the risk President Hollande will appoint a more leftist Prime Minister.
- In the US, its likely that the Fed will announce further monetary stimulus on Wednesday. Recent speeches by five FOMC members suggest support for such a move given recent softer data. This could take the form of an extension of Operation Twist (ie, the Fed selling short term securities and buying long term), the economic effect may be benefits of which are questionable though given how low long term bond yields are. But it would suggest the Fed is conscious of the risks and that more quantitative easing may be the next step. Meanwhile, a survey of home builders (Monday), housing starts (Tuesday) and existing home sales along with house prices (Thursday) will be watched for signs of improvement in the housing sector. A survey of manufacturing conditions in the Philadelphia region (Thursday) is likely to soften.
- The G20 leaders meeting on Monday and Tuesday is likely to do no more than indicate the possibility of coordinated policy stimulus, but the Euro-zone finance ministers meeting on Thursday and Friday will be watched for signs Europe is heading towards a more lasting solution to its problems.
- HSBC’s flash China PMI for June (Friday) will be watched for any sign of improvement after recent softness.
- In Australia, the minutes from the last RBA Board meeting aren’t likely to give much away in terms of the direction of future rate moves, just like the Statement that followed the meeting. Given the softness in business and consumer confidence along with global uncertainties we continue to see the cash rate falling further into year end, to a low of 2.75%.
Outlook for markets
- It’s a very difficult time for investors as on the one hand there is much uncertainty surrounding the events of the next two weeks and what this will mean for a global economy that is already slowing, but against this shares and growth assets generally have already factored in a lot of bad news and would benefit if policy makers move in with more policy stimulus and Europe shows more signs of getting its act together. As such, while the short term is uncertain we remain of the view that share markets will be higher by year end.
- While sovereign bonds in safe countries are a good diversifier, bond yields in major countries around record lows suggest very low medium term bond returns. The Australian ten year bond yield of 3% is the return an investor will get if they hold such a bond to maturity.
- The correction in the Australian dollar may still see it fall to around $US0.95 in the short term, reflecting worries about the global growth outlook. However, it is likely to receive a boost during the second half of the year as global central banks, led by the Fed, undertake further monetary easing.
18 June 2012