The past week has seen a number of positive developments with “pro-bailout” parties forming a coalition Government in Greece, some signs that Europe is moving towards addressing its problems and the US Federal Reserve opting for more stimulus.
- The problems in Europe clearly go well beyond Greece, and Greece will continue to struggle having fallen well behind in terms of its budget commitments and with the country now clearly divided. However, the victory of New Democracy in the Greek election has substantially reduced the risk of an imminent messy Greek default and euro exit spreading contagion across Europe. Euro-zone finance ministers have now agreed to release €1bn in withheld funds to Greece, but the next steps will likely be for some extension in the amount of time Greece is given to meet its austerity targets and for some assistance in helping to boost Greek growth.
- While the G20 leaders meeting didn’t achieve anything concrete it has clearly upped the pressure on the Euro-zone to which it responded by committing to “take all necessary measures” to safeguard the Euro-zone, improve the functioning of financial markets and break the feedback loop from sovereigns and banks. Expectations for action have been fuelled by talk of using bailout funds to buy bonds in Spain and Italy, with German Chancellor Merkel indicating it was “a possibility”. The ECB also eased collateral rules making it easier for banks to borrow from it. The news on Spanish banks was less bad than feared as independent audits of Spanish banks revealed they may need up to €62bn in fresh capital, which is less than the up to €100bn that had been flagged to come from European bailout funds.
- Finally, although the US Fed didn’t rush into more quantitative easing it did recognise the threat to the growth outlook by extending Operation Twist, which involves selling short term bonds and buying long term bonds in order to keep long bond yields low, out till the end of the year and more importantly indicated that it is prepared to undertake more QE3 if the labour market does not continue to improve. So June economic data will be watched closely, with odds on that QE3 will be announced at the Fed’s late July/early August meeting.
- Despite these positives, share markets, had a volatile week, initially starting positively on the back of the Greek election but giving up gains on the back of soft economic data from the US, Europe and China and disappointment the Fed didn’t ease more aggressively. It has been a case of buy on the rumour and sell on the fact with US and European shares rallying into the Greek election and Fed meeting and then falling afterwards.
Major global economic releases and implications
- US economic data was mixed. On the housing front the news was mostly positive – while total housing starts fell on the back of a sharp fall in starts of multi-unit dwellings, single housing starts rose, permits to build homes rose strongly, the National Home Builders Conditions index rose pointing to further gains in starts ahead and house prices rose. However, existing home sales slipped and manufacturing conditions indicators fell, particularly in the Philadelphia region, and jobless claims fell less than expected.
- European data was mostly soft with PMI business conditions indicators for June continuing to point to recession (albeit they were no worse than in May), falls in French and German business surveys, a slight fall in consumer confidence and sharp falls in Italian industrial orders and in Euro-zone construction activity. In the UK the minutes from the last Bank of England meeting indicated more quantitative easing is likely to be announced at its next meeting.
- In China, HSBC’s flash business conditions PMI fell to 48.1 in June from 48.4, suggesting that growth in industrial production remains sub-par. It’s too early to expect recent easing moves to have impacted, but by the same token it is soft enough to justify further policy easing, particularly with news that house prices fell for the ninth month in a row. Expect more monetary easing and fiscal stimulus ahead.
- The Reserve Bank of India surprisingly left interest rates on hold. While high inflation, running at +10.4% over the year to May, has made rate cuts difficult, more are nevertheless expected given the softness in growth.
Australian economic releases and implications
- Australian economic data remained soft with leading economic indicators from the Conference Board and Westpac pointing to sub trend growth, skilled vacancies continuing to fall and March quarter dwelling starts plunging below the lows seen during the GFC. While dwelling approvals have fallen into the June quarter, we should be getting close to the lows in starts and lower mortgage rates should start to drive a recovery from later this year. However, further interest rate, and hence mortgage rate, cuts are likely to be needed to ensure that starts see a sustainable recovery.
- On the interest rate front, the minutes from the RBA’s last Board meeting didn’t give much away in terms of future moves and suggested a degree of reluctance if anything in actually cutting rates by 0.25% at the June meeting. However, this has generally been the case for most of this year. Our assessment remains that while the RBA is likely to sit tight for the next month or so in order to gauge the impact of recent cuts, the combination of weak confidence, rising unemployment, fiscal tightening, benign inflation and global uncertainty will ultimately see the cash rate fall to around 2.75% by year end.
Major market moves
- Share markets rallied early in the week buoyed by the Greek election result and hopes of stimulus from the Fed, but it proved to be a case of buy on the rumour and sell on the fact with markets falling towards the end of the week on the back of soft global economic data and dashed hopes for more aggressive Fed easing. As a result global shares were mixed over the week: up in Europe and Japan, down slightly in Australia, mixed in Asia and down in the US.
- Worries about global growth also weighed on commodity prices and while the $A managed to hold above parity it came off its highs.
- Bond yields in the US, Germany, the UK and Australia rose, but Spanish bond yields have fallen sharply from their highs earlier in the week (helped by news on its banks and successful bond auctions) and Portuguese bond yields fell to their lowest level in over a year on news that its fiscal adjustment program is on track.
What to watch over the week ahead?
- The big event in the week ahead will be the EU leaders meeting on Thursday and Friday which will hopefully move Europe closer to getting its debt problems under control. This is likely to involve some combination of: less austerity and measures to boost growth; support for bond markets in Spain and Italy, possibly involving the EFSF and ESM bailout funds initially but progressing towards a redemption fund; progress towards “more Europe” in terms of fiscal and banking integration; and more monetary easing from the ECB. Unfortunately, the odds are that progress in Europe will remain painfully slow as Germany remains reluctant to commit to anything which may be seen as taking too much pressure off troubled countries to reform.
- In the US, expect flat to slightly up new home sales (Monday), a slight rise in house prices (Tuesday), flat consumer confidence (Tuesday), a slight rise in durable goods orders and pending home sales (Wednesday) and modest growth in personal income and spending (Friday).
- Chinese PMI business conditions indicators will be released later in the week or on the weekend and consistent with the HSBC flash PMI are likely to remain softish, highlighting the need for more policy stimulus.
- In Australia, a speech by RBA Assistant Governor Debelle (Tuesday) will be watched for clues on interest rates and data for vacancies and new home sales (Thursday) and private credit (Friday) are expected to remain subdued.
Outlook for markets
- It’s a very difficult time for investors as on the one hand there is much uncertainty, 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 decisively with more policy stimulus and Europe shows more signs of getting its act together. As such, while the short term outlook 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 3.09% is the return an investor will get if they buy and 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.