GLOOMY JUNE DATA NOT ALL DUE TO JAPAN
WELL, that was a poor start to the new month. Last week saw the release of a stack of economic numbers from around the globe, the majority of which were significantly weaker than expected. The US data were particularly disappointing as the Chicago PMI, consumer confidence, S&P/Case Shiller house price index, vehicle sales, ADP employment, manufacturing PMI and factory orders all undershot analysts’ estimates. Friday’s non-manufacturing PMI bucked the negative trend, but this slight uptick in services did little to assuage concerns. Investors were too busy reeling from the disastrous non-farm payroll number which was released earlier in the day.
The disruption to global supply chains caused by the Japanese earthquake and tsunami is taking much of the blame for the weaker data, especially anything related to manufacturing. But while the effects of the disaster were devastating on so many levels (and let’s not forget that the Fukushima nuclear facility is still unsecured), there was already plenty of evidence to indicate that the pace of global growth was slowing. China’s efforts to curb inflation and dampen speculation through monetary tightening have led to concerns that demand from the Asian Pacific region could fall sharply as the pace of growth moderates. Meanwhile, Europe’s debt crisis is in a more critical state than ever, with its political leaders apparently crippled by indecision. On top of this, the US Federal Reserve’s current asset purchase programme (QE2) concludes this month, which will remove a huge slug of liquidity from financial markets.
One feature of QE has been how bond yields (interest rates) have risen when QE is implemented, yet fall when QE is absent, or about to be withdrawn. This happened last year, and is occurring again right now. As we approach the conclusion of QE2, the yields on 10-year US Treasuries have fallen sharply, trading below 3% last week. As the Fed will no longer be a buyer of Treasuries, this seems counterintuitive. Perhaps bond investors are quite reasonably predicting that without QE the economy will weaken and so require lower rates. But a flattening yield curve hurts the financial sector and banking stocks have pulled back sharply ever since yields began falling three months ago. Unfortunately, it now looks as if the broader equity market is following them down.