Worries about a Greek euro exit and Spanish banks remained the focus for investors over the last week.
- However, with share markets and related risk assets having fallen sharply over the previous three weeks a lot of the bad news has already been factored in, so the past week was far less dramatic in terms of market moves.
- While news that Euro-zone countries are working on contingency plans for a Greek exit created a bit of consternation, I must admit I would be rather concerned if they weren’t! Meanwhile, both a weekend G8 leaders meeting and a meeting of Euro-zone leaders failed to come up with anything concrete to address the problems in Europe (not that anything concrete was expected), although it is clear that there is a strong desire for Greece to stay in the euro and more importantly there does appear to be a recognition of the need to focus more on generating growth, with the Euro-zone offering Greece the carrot of mobilising “funds and instruments” to put Greece on a path to growth and job creation. Unfortunately the uncertainty regarding Greece will linger at least up till its June 17 election and Spanish banks remain an ongoing problem with increasing needs forrecapitalisation and ratings downgrades with the latest coming from Standard and Poor’s.
- Our assessment is that its not a forgone conclusion that Greece will imminently exit the Euro. It would also be much cheaper for Europe to keep it in the euro (where the cost may be between €60 to €100bn in terms of further debt write downs) as opposed to having it leave (where the Euro-zone could potentially lose around €300bn directly and much more if other countries need to be defended). The key approach the Euro-zone seems to be heading towards is to: first, encourage Greeks to vote for pro-bailout parties; second, to try and
contain any fallout should Greece leave using the ECB and the bailout funds to support troubled countries, provide a possible recapitalisation of banks by the bailout fund and provide some sort of bank deposit insurance scheme (a guarantee would be better); and, finally to adopt more pro-growth policies. Euro-bonds are on the table but need to overcome strong German opposition. However, at this stage there is still much uncertainty around all of these and Europe has a bad habit of letting things go to the brink before it finally swings into action. - On a clearly positive note though, Chinese policy makers are swinging into action to stimulate their economy. Following a cut to banks’ required reserve ratios and measures to subsidize the purchase of energy saving consumer goods, Premier Wen Jiabao indicated more priority would be given to maintaining growth, which comments were subsequently backed up by the State Council. This is likely to take the form of more monetary easing and a fast tracking of infrastructure spending plans. With official 12 month lending rates at 6.56% and strong public finances, China has plenty of scope to boost growth, albeit it won’t be anywhere near as aggressive as it was the case in 2008-09.
Major global economic releases and implications
- US economic data was mixed. Manufacturing conditions indicators were soft – up in the Kansas region but down in the Richmond region and down slightly nationwide according to a new Markit PMI for the US. Also, durable goods orders were weaker than expected in April. Against this, consumer sentiment rose to its highest since 2007 and the US housing recovery is continuing with solid gains in home sales and house prices. The housing recovery is a plus for the US economy that wasn’t around a year ago when the US last had a soft patch.
- European indicators remained weak with further falls in manufacturing and services sector conditions indicators in May, possibly on the back of all the bad news regarding Greece, pointing to ongoing recession, albeit still a mild one at this stage. Surprisingly, consumer confidence rose in April. While the OECD cut its Eurozone growth forecast for 2012 to +0.1%, this is still way too optimistic – we expect a contraction of 1%.
- While the Japanese economy continues to experience deflation (the National CPI ex food and energy was down 0.3% over the year to April and down 1.3% over the year to May in Tokyo), the Bank of Japan left monetary policy unchanged following its latest meeting providing little confidence that it will achieve its 1% inflation objective. With price deflation continuing and the Yen resuming its strength since mid-March the BoJ needs to undertake much more aggressive monetary easing. Meanwhile, Japan saw another downgrade to its sovereign debt rating reflecting its huge budget deficit and debt to GDP ratio. For now Japan can get away with it as 95% of Japanese bonds are owned by the Japanese, but as its population ages and retires it risks becoming a major problem.
- Chinese economic data was mixed with a rise in a leading index of growth but a slight fall in the HSBC flash manufacturing conditions PMI for May. Interestingly the HSBC PMI is in the same range it has been in since November last year suggesting that growth has stabilised (at around 8% on the basis of historical relationships) rather than continuing to fall away, in contrast to data for April which points to a further slowing in growth to around 7%. The World Bank cut its China growth forecast for 2012 to 8.2% – our forecast remains 8%.
- Poor export related data for Taiwan and Korea, highlight that the renewed crisis in Europe is adversely affecting Asia via reduced demand for exports and possibly via reduced trade finance. This is a real concern.
Australian economic releases and implications
- It was a light week for Australian economic data, but what there was continued to point to softness with skilled vacancies falling and the Westpac leading index pointing to continuing sub trend economic growth. Housing affordability continued its rising trend in the March quarter, but it remains relatively low historically.
Major market moves
- Share market moves over the past week were generally modest but mixed with worries about Europe and China continuing to weigh, but a lot bad news already factored in. US and European shares actually had a decent bounce from oversold levels, but Asian and Australian shares were down slightly.
- Worries about global growth continued to weigh on commodity prices though and this saw the $A fall further. Its worth noting that Asian oil prices as measured by Tapis have fallen 15% from this year’s high, whereas the $A has fallen by 10%, so the impact on Australian petrol prices should have been to push them down by around 5 cents a litre.
- Sovereign bond yields were little changed in the US and Australia, but fell in Germany, Italy and France. Spanish bond yields remained under pressure on concerns regarding the need to recapitalise its banks.
What to watch over the week ahead?
- In the US expect a slight fall in the ISM manufacturing conditions index (due Friday) consistent with regional surveys but a solid 150,000 gain in May payrolls (also due Friday) and unemployment remaining at 8.1%. Expect a slight fall in consumer confidence (Tuesday), a slight gain in house prices (also Tuesday), flat pending home sales (Wednesday) and a downwards revision to March quarter GDP growth to 1.7% from 2.2%.
- Euro-zone consumer confidence and business climate indicators (Wednesday) will be watched to see if they have similar falls to the already released PMIs for May. Ireland’s referendum on the “Fiscal compact” (Thursday) will also be watched very closely given the backlash against austerity already evident across Europe.
- China’s official manufacturing conditions PMI (Friday) is expected to fall slightly but remain consistent with 8% or so growth. Japanese data for the labour market, retail trade and industrial production are likely to confirm continued modest growth.
- In Australia, a speech by RBA Governor Stevens on Monday will be watched closely for indications as to how the RBA is reading bad news out of Europe and slower growth in China and in turn what this means for Australian interest rates. On the data front, expect new home sales (Tuesday) to remain soft, retail sales (Wednesday) to fall slightly, building approvals (Thursday) to fall, credit growth (Thursday) to remain soft, business investment (Thursday) to rise 4% but investment plans to be revised down slightly. Data for construction spending, manufacturing conditions and house prices will also be released.
Outlook for markets
- Share markets could fall further over the next few months as worries about a break up in the euro and Spanish banks continue, made worse by uncertainty about China and to a lesser degree the US.
- However, shares are still likely to be higher by year end. Shares are cheaper than was the case a year ago prior to a 20% correction and we are likely to see another aggressive round of monetary easing in the US, Europe and China which will add liquidity to financial markets and boost confidence that global growth will continue. More rate cuts from the RBA are also likely to help boost the Australian share market into year end.
- Bond yields in major countries are now at or around record lows suggesting very low bond returns going forward unless Europe’s debt crisis plunges the world into renewed recession.
- The correction in the $A may see it fall to around $US0.95 in the short term, reflecting worries about the global growth outlook. However, it’s likely to receive a boost during the second half as global central banks, led by the Fed, undertake further monetary easing.
28 May 2012