Markets update: Euroland, US & China

Today’s Eurogroup summit could yield some additional details on the implementation of the Spanish bailout, but it very much looks as if full clarity on the specifics won’t be available for several months, or at least until the ESM treaty is ratified by 12 out of 17 states. Accordingly we do not expect any new policy decisions but we will look to see if there are any signs of concessions being made to Germany. Apparently French Finance Minister Pierre Moscovici has said that Spanish banks need to be re-capitalized quickly and that he expects the Eurogroup of finance ministers to meet again on July 20^th but whilst there may be a head of steam building, one potential hurdle for the ESM will be the German Constitutional Court decision on both the ESM and fiscal compact legislation on Tuesday.

We rather anticipate that the court will decide that the treaty is not unconstitutional, which would pave the way for its implementation and given that this is broadly what the market expects, we do not see much upside from a positive outcome in terms of market reaction. However we would view a negative decision as a catalyst for a large risk sell-off. An unconstitutional assessment of the ESM would, in fact, call into question the entire rescue framework approved at the June EU leader summit. Thankfully this outcome looks very unlikely, but cannot be discounted and will keep markets jittery. Meanwhile, on the data front, we expect Euroland industrial production to be reported as roughly flat month on month on Thursday.

In contrast to the held breath on Euroland, this is quite a light week in prospect for US news flow and numbers. Dealing first with the numbers, the July preliminary reading of the University of Michigan Consumer Confidence index is due out on Friday and will likely be the main focus for investors. The survey is likely to come in at about 73.0 after last month’s sharp decline to 73.2. With not much in the way of data, it is the FOMC minutes on Wednesday which are likely to capture most attention, and may well reveal a division of opinion between those who think that the Fed has done quite enough, and those who want further new asset purchases – a further round of quantitative easing.  The real economy data do suggest on balance that there will likely be additional asset purchases at some point, so it may also be a question as to when as well as if, and the trigger for a decision to act may come from the jobs market numbers, with last Friday’s release being badly received by bullish commentators and market participants.

Looking further afield, there is a regular meeting of the Bank of Japan, and it presently looks as if policy may be left unchanged, with last week’s Tankan survey coming in slightly better than had been expected. That said, there is plenty of potential for additional easing this year and with central banks introducing additional accommodation in the US, Europe, and in the UK over the past couple of weeks, the yen may strengthen which would in itself represent a tightening of conditions, and thereby support calls for easing.

The other economic elephant is of course China, and it will release its key economic numbers for June, including its advanced Q2 GDP estimate on Friday, and it will also release data on new Yuan loans on Wednesday. There is a risk that the Q2 GDP growth figures surprise the market significantly on the downside, with some analysts expecting a cycle low of around 7.2% year on year, as against the 7.7% year on year consensus. Meanwhile Xinhua News has reported that China’s Premier Wen Jiabao said over the weekend that downward pressure on the economy is still “relatively large” and the government will intensify fine-tuning of policies even as measures taken since April are helping stabilize a slowdown. The June CPI came in as 2.2%yoy, below the consensus forecast for a 2.3%yoy rise and down from 3%yoy in May. On a month-on-month basis, the CPI fell 0.6%, dragged down by a fall in food prices. The downward trend in growth and inflation should create more room for interest rate cuts and economists who are cautious on growth expect one more 25bp lending rate cut this year, along with further reserve ratio reductions. The very cautious see risks for additional cuts should inflation continue to surprise to the downside.

Against this backcloth, an optimistic view would be that global Industrial Production momentum troughed in June. If that’s right, global risk appetite can drift higher and European risky assets can outperform if a rebound in risk appetite is sustained. For this to happen we would need the global economy to show ongoing signs of stabilization on a new, albeit lower, growth track. There remain material uncertainties – darkly but realistically, the EFSF/ESM secondary market interventions are unlikely to work. Primary market interventions for Spain could have the potential to allow easier market conditions to continue but perhaps only for a few months. It may well be that Spain will soon need a full sovereign bailout – and that risk will keep markets jittery and fully justify a cautious approach to investment selection, even if apparent opportunities are missed.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla

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The Local Authority Treasurers’ Investment Forum September 25th, 2012, London Stock Exchange
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