Weekly economic and market report for week commencing 17 July 2011
Headline developments of the past week
European debt problems took centre stage yet again over the last week. Until recently it appeared that the European Union had put a firewall around Greece, Ireland and Portugal in order to protect Spain and Italy and as a result their bond yields had been contained. However, the spike higher in their bond yields in the last two weeks is worrying because together they account for 28% of Euro-zone GDP (as compared to only 7% for Greece, Portugal and Ireland) and 32% of Euro-zone public debt (compared to only 8% for the three peripherals). Italy in particular is probably just too big to rescue and what’s more German and French banks have a heavy exposure to Spain and Italy. Fortunately, Italy has moved quickly to allay market fears by adopting another round of fiscal austerity. But while bouts of short term relieve are likely, it’s clear that austerity is only making the situation worse and whether it’s Greece, Ireland, Portugal, Spain or Italy the European debt crisis is likely to remain a recurring threat and source of volatility for financial markets for some time to come.
In the US, concern that US politicians won’t agree to raise the debt ceiling by the August 2 deadline has led to increasing fears that it may have a short term default, an event Fed Chairman Bernanke said would through the US financial system into “enormous disarray”. However, there are several points worth noting on this. First, if the debt ceiling is not increased in time spending is likely to be cut ahead of not paying interest payments. More fundamentally though, just as the negotiations between Obama and the Republicans went right down to the wire regarding an agreement on the US budget a few months ago (only just averting a US Government shutdown) the same was always likely to apply in relation to the debt ceiling negotiations. Given the adverse political consequences that would follow from not raising the debt ceiling as welfare and Medicare/Medicaid payments are not made and public servants don’t get paid, the most likely outcome remains a last minute deal…but that could still mean another few weeks of intense uncertainty as the battle between Democrats and Republicans over spending cuts versus tax increases becomes increasingly acrimonious. Australian economic data remains week, with falls in both business and consumer confidence. Against this backdrop a rate hike this year is looking very unlikely.
There were some positives for markets over the last week though. Firstly, Fed Chairman Bernanke indicated that another round of quantitative easing (QE3) could be undertaken if the economy doesn’t pick up as expected. However, he also indicated the Fed wasn’t prepared to do it yet – it’s clear that the US economy will have to get worse and inflation fall before QE3 becomes likely.
Secondly, and more fundamentally, the Chinese economy is continuing to do its part in keeping the global economic recovery going with growth of 9.5% over the year to the June quarter helped along by strength in industrial production and fixed asset investment. While growth has slowed from an unsustainable pace of nearly 12% early last year there is no sign of the much feared hard landing. While headline inflation came in at a worse than expected 6.4% over the year to June this was driven largely by higher pork prices on the back of pork disease with non-food inflation starting to stall on a monthly basis. With Premier Wen Jiabao indicating that the Government should “not only stabilize inflation but also prevent major economic volatility” our assessment remains that the moderation in growth will result in a fall in inflation during the second half and that the monetary tightening cycle in China is either at or very close to an end.
The past week has seen share markets (except in China) fall sharply on the back of debt worries in Europe and the US and concerns about the growth outlook. Volatility in share markets is likely to remain high in the short term as the worry list remains significant – focussed on European debt problems, the US debt ceiling, the soft patch in the US economy and whether China will have a hard or soft landing – and the September quarter is normally the weakest time of the year for shares.
In the US in the week ahead, expect housing related data to show signs of stabilisation or improvement with a home builders survey due Monday, housing starts due Tuesday, home sales due Wednesday and house price data due on Thursday. A survey of manufacturing conditions in the Philadelphia region for July is expected to show a modest improvement after a sharp fall in June. The US June quarter earnings reporting season will start in earnest with investors expecting profit growth of around 13-15% on a year ago. In Europe the focus will likely be on business conditions readings due Friday after falls in recent months, along with ongoing debt problems.
In Australia, the minutes from the RBA’s July meeting due Tuesday are likely to confirm that there is no urgency to raise interest rates. Data for car sales and export and import prices are also due for release.