Global interest rates cuts but disappointing economic data and the renewal of European concerns dominated financial markets last week.
- America’s payrolls report for June was soft with only +80,000 new jobs. This is frustratingly slow result given that US monthly jobs gains were running at +225,000 average in the opening quarter of 2012. So the American labour market has become subdued which creates concern about the durability of the US recovery. The only positives from June’s data are that the unemployment rate is stable at 8.2% and a rise in working hours.
- The European Central Bank (ECB) lowered the key policy interest rate by a 0.25% to 0.75%. This is the lowest policy interest rate setting since the ECB began operating in 1998. Comments from ECB President Mario Draghi highlighted that this interest rate cut reflected that Europe is “now seeing a weakening of growth in the whole of the Euro area” as “heightened uncertainty” is “weighing on confidence”.
- Britain’s central bank kept interest rates on hold at their historic lows of 0.5% (the lowest rate since 1694) yet decided to further expand their “Asset Purchase program” by £ 50 billion to £ 375 billion. The Bank of England conceded that “UK output has barely grown for a year and a half “ and “business indicators point to a continuation of that weakness in the near term, both at home and abroad”.
- China’s central bank cut its key lending rate by 0.31% to 6.0% while deposits rates were lowered by 0.25% to 3.0%. This is the second consecutive monthly fall in China’s official interest rates which indicates that China’s central bank has become more concerned about China economic slowdown.
- However Australia’s central bank maintained the key policy cash interest rate at 3.5%. Given the RBA Governor’s statement highlighted the “subdued international outlook” and that Australia’s inflation is “expected to be consistent with the target”, the central bank still has scope for lower interest rate settings. AMP Capital Investors forecasts that the cash rate should fall a further 0.5% to 3.0 % by the end of this year.
Major market moves
- Following the European Union summit on June 29, last week saw financial markets respond with increasing scepticism that Europe’s debt crisis has been resolved. While the political agreement to deploy the European rescue fund to directly support bank recapitalisation and buy government bonds is a positive step, there has been growing doubts that Europe is fully committed to this plan. Finland and the Netherlands have signalled their opposition to the plan to buy government bonds of the vulnerable nations. This has seen Spain’s bond yields rise sharply last week as markets again question their ability to finance their debt commitments. Spain’s 10 year Government bond yield rose by 0.6 % last week and tested the 7% level.
- Europe’s currency continues to edge lower with the latest 0.25% interest rate cut as well as European debt concerns. The Euro has fallen by -3 % this week against the American Dollar to a 2 year low. Currency markets also gained little comfort from the European Central Bank’s President Draghi pledge of liquidity support for the European banking system and that the rescue fund was sufficient to cope with Italy’s and Spain sovereign debt problems. Indeed the Euro is now at a record low against the Australian Dollar since the Euro introduction in 1999 (The Australian $ versus Euro exchange rate is now above 0.83).
- Australian shares have had a more promising opening week for this quarter. The benchmark ASX 200 was up +1.5 % for the week. By contrast, US shares were softer by falling -0.5% for the week.
Major global economic releases and implications
- American manufacturing data sharply weakened in June. The ISM manufacturing index fell to its lowest level since July 2009. The ISM noted that US manufacturers appear concerned that “demand may be softening due to uncertainties in the economies in Europe and China“. The Michigan consumer sentiment index was revised down by 0.9 points to 73.2, indicating American consumers were also becoming more cautious.
- European business surveys continue to indicate recession. The PMI manufacturing survey for June essentially suggests that European economic activity is contracting.
Australian economic releases and implications
- Australia’s central bank kept interest rates on hold at 3.5%. Yet the RBA still seems wary about global growth prospects as “recent indicators continue to suggest weakening in Europe and a slower pace of growth in China”. For Australia, the RBA views that the “recent data suggest that the economy continued to grow in the first part of 2012 at a pace somewhat stronger than had been earlier indicated”. The RBA did concede that there has “job shedding in some industries” but viewed that “the rate of unemployment remains low”.
- Australia’s retail sales appear to be slowly reviving. May’s retail sales recorded a solid increase of +0.5 % mom. This is a notable pickup on the flat April result (0.1% mom). For May there was broad based strength across the retail sectors with solid Department stores (+ 1.0% mom) and household goods (+0.8% mom) sales.
- Building approvals were up 27.3% in May. This figure is affected by a very large rise in multi-dwelling approvals and was also concentrated in just two states in New South Wales and Victoria. So this appears more a temporary rebound than the start of a strong recovery. Private sector house approvals remain around cyclical lows
What to watch over the week ahead?
- America’s Federal Reserve meeting minutes of the June meeting will be released on Wednesday. Markets will be dissecting these comments to assess how concerned the US central bank is about a slowing economy and whether the central bank is edging towards further quantitative easing (i.e. QE3). The soft US payroll data over recent months will pressure the Federal Reserve to provide additional monetary stimulus at is next meeting held on July 31 – August 1st.
- China is set to release critical economic data this week. China’s inflation data for June will be released on Monday. After May’s subdued annual inflation result of 3%, another modest CPI result will provide China’s central bank with even more scope for lower interest rates. China’s Real GDP growth for the June quarter and industrial production is due on Friday which will be vital in assessing the extent of China’s activity slowdown.
- In Australia, the labour force data and NAB business survey for June as well as the consumer confidence for July will be released. Of particular interest will be whether Australia employment data for June will maintain the continuing surprising job creation despite the recent array of job loss announcements. Our forecast is for a modest loss of -10,000 jobs in June which will strengthen the case for another RBA interest rate cut in August. The RBA Deputy Governor Philip Lowe will give two respective speeches on July 11 and July 12.
Outlook for markets in 2012
- Global shares are very cheap compared to corporate profits as well as relative to government bond yields. Yet Global shares have to battle the current prevailing headwinds of Europe’s banking and debt crisis, doubts on the US recovery as well as concerns that China’s growth is slowing sharply. While Global Shares are likely to tread water in the short term given the current “heightened uncertainty”, this year should ultimately prove a better year than 2011.
- Global Bond yields are very low in the core countries of America, Germany, Britain and Japan. This suggests low returns unless Europe’s debt crisis intensifies further and a global recession transpires. Australian government bonds are only marginally more appealing. Yet Australian corporate debt is an even better investment proposition if one needs income or is worried about shares.
- Cash & term deposits should become less attractive over the remaining months of 2012. The RBA is likely to lower Australia’s official cash rates by a further 0.50% to 3.0 % by year end.
- The Australian Dollar remains vulnerable in the short term, reflecting worries about the global growth outlook.
9 July 2012