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Global Markets Weekly - 20 July 2009

• Risk appetite rose, as Chinese growth picked up and the Fed upgraded its economic forecast.
  Riskier assets – such as equities – have been making progress whenever evidence emerges of economic recovery. And last week was no different, with signs that China is rebounding from the global downturn as the country grew 7.9% for the second quarter (up from 6.1% in the first), thanks to a massive stimulus package that has encouraged domestic demand. In the US, the Federal Reserve (Fed) noted in its minutes that the recession was ending and upgraded its forecast for the economy. However, the Fed forecast that ‘output would expand sluggishly over the remainder of the year’, which accords with our own view.
• Inflation is still declining but remains in positive territory in the UK.
  Consumer price inflation (CPI) data for June came out in the US, the UK and Europe. Inflation has slowed dramatically since last autumn in all three regions, as it has globally. Although the UK’s inflation rate of 1.8% is well below September’s peak of 5.2%, it remains in positive territory, unlike inflation in the US (-1.4%), Europe (-0.1%) and Japan (-1.1%). This is in part due to the differing constituents of the indices each country uses. But it is also a reflection of inflation pressures from higher import costs after sterling’s 20% fall over the past two and a half years. As a result, inflation is increasing for 22 of the 36 components in the CPI basket. This is most noticeable in big-ticket imported goods, such as cars and audio-visual equipment.
• The US corporate earnings season kicked off with some upbeat news...
  Apart from the economic data, investors are also gathering information on the current business environment direct from companies. The two-week peak of the US second-quarter earnings season – when almost half of the S&P 500 stocks will report – is only just starting, but there have already been some significant announcements, which were welcomed by analysts. The financial sector is showing signs of revival, with Goldman Sachs and JP Morgan posting better-than-expected profits. That was echoed in other industries, such as technology, where blue-chips such as Intel and IBM also reported good numbers. That was enough to overcome a potential significant negative for the market as CIT group, the US bank which lends to small and mid-cap companies, faces bankruptcy after bail-out talks with government stalled.
• ...which helped to drive equities and cyclical commodities higher, while bonds sold off.
  After taking a well-deserved pause over the past six weeks, investors needed no further incentive to buy riskier assets. Equity markets posted a strong weekly performance, with the S&P 500 up 7.0% and the FTSE 100 up 6.3%. Cyclical commodities also rose, led by industrial metals such as nickel, copper and aluminium. Although the benchmark oil price briefly fell below $60 a barrel, it rallied thereafter, as better economic news bolstered demand from investors. Certainly, oil below $70 a barrel looks attractive, although markets remain oversupplied in the short term. Meanwhile, government bond markets declined, with US 10-year yields rising 35 basis points as real yields remained flat but inflation breakevens rose.
• Increased risk appetite has also weakened defensive currencies.
  Currencies with defensive characteristics – the Swiss franc, the US dollar and the yen – gave up the previous week’s gains. The beneficiaries were commodity currencies, such as the Australian dollar, which should benefit from the improved prospects for global trade. Sterling also rallied, despite the IMF’s warning on its expanding budgetary deficits, as better global growth prospects would help to bail it out. This rally has left sterling looking vulnerable, and we expect it to weaken against the dollar. We also forecast further pressure on the euro, which appears historically expensive and faces many of the same fiscal and monetary challenges as the dollar.

Indices, Interest rates and Inflation

 

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