UNCERTAINTY STILL REIGNS IN MARKETS
THERE is considerable confusion in the markets over the fundamental question of whether the global economy has bottomed out. This has resulted in wide swings in sentiment. At the time of writing, the S&P 500 had gained 5.8 per cent in the month to date, largely a result of relief over news coming out of the banking sector. Weighed against this, bad housing market and retail sales data from the US have both significantly disappointed the market.
This lack of coherence between the economy and the equity market rally means some are wondering if equities may have come too fast, too soon. Equity markets appear to be pricing in a sharp, V-shaped recovery both in earnings and, by implication, in the economy. Few economists are so confident.
BUMPING ALONG
The present recession is so deep that it is possible that the global economy will bump along the bottom before a recovery is firmly established. In many counties it will probably be some time before growth rates strengthen back to their old levels, meaning that that the equity rally could well stall over the summer months. If this happens, foreign exchange investors will plunge straight back into safe havens: both the yen and the US dollar could yet see stronger levels before economic recovery is firmly established.
If we see continued uncertainty over the relative strength of the global economy and sentiment carries on swinging between optimism and pessimism, there is a significant chance that many forex pairs will see choppy ranges through the summer months.
If range trading does prove to be a theme, then sterling may prove to be an exception. Cable (pound-dollar) is clearly in an upward trend. The euro-pound again this week tested its recent lows. For some months sterling has been sensitive to good news, suggesting that the market was very short of the pound. When the queues first started to appear outside branches of the Northern Rock in September 2007, sterling began to wilt under a deluge of negative news. For many months the financial crisis seemed to be focused on UK and US banks and as the economic downturn played itself out, sterling suffered heavily on the very sharp deterioration in the national accounts. But, by the end of the first quarter it began to seem likely that all of the bad news was already in the price.
As for the Eurozone, last week’s release of Germany’s first quarter GDP data at -6.9 per cent year-on-year made people realise that the Eurozone economy had suffered more in the first three month of this year than had previously been realised. It also raised the risk that economic recovery in the Eurozone could be more of a struggle than previously expected. The IMF estimate that non-UK European banks may still be facing $87bn of bad debts.
The years ahead will also be a real test of the Eurozone’s structural reform. Despite the progress that has been made, it is likely that many parts of the Eurozone will suffer lingering high unemployment levels well after the recovery has begun. Surveys are suggesting that in the longer term, the euro-pound will trend lower. It is possible that this has already begun.