Double-dip?

Equity markets are stronger again today, which prompts to pose the question ‘ ‘double-dip recession, what recession’? It is quite possible that equities have lost touch with reality but more likely equities are responding to the promise of more liquidity. This will explain why the gold price is so strong.

The other argument is that the recovery from the 2008 recession is still very much in place, despite the recent softening (unless there is a full-scale crisis PIIGS inspired crisis in the euro-zone. The OECD lead indicator and the JP Morgan Global PMI both suggest that the world economy is still slowing, resulting in cries for the Federal Reserve ‘to do something’! But some of the more immediate indicators are suggesting that the slowdown is past it worst as companies have readjusted their inventories downwards to match slightly slower than expected sales. Growth momentum in the developing world still seems to be intact despite tightening in China and India. Growth in the 4th quarter of 2010 should exceed our somewhat dismal expectations.

Ireland

Ireland is under the spotlight again with her 10 year bond premium to German bunds reaching 355 basis points (at the beginning of 2010, the premium was ‘only’ 145bps. The reason is that her banks need further capital to offset their huge losses in the housing sector. There is nothing very surprising about this; what is surprising is that we are not seeing similar moves in other EU countries where losses must be almost as bad. Or perhaps it is just the Irish being a little more honest about their problems.

Economists that know say there is a shortage of safe assets, hence the rush into Treasuries, Bunds, Gilts etc. This is not just a case of bonds versus equities as there are plenty of bond markets which are not safe, e.g. Greece, Ireland and Portugal. The premium of these markets to G3 bonds continues to widen. I think there is another banking crisis underlying the edginess of today’s markets.

The yen

Recent weakness in equity markets has been due to some poor domestic data from the US. Quite why this should be such bad news is something of a puzzle as we are not looking to domestic demand for growth in the US. Eventually, strong growth in Asia and other emerging economies should be reflected in the US external sector sooner or perhaps later. But no matter, investors want 'safe assets' such as bonds. They are also buying the yen, the logic of which escapes me. It is possible that what we are seeing is the unwinding of ‘carry trades’, which creates an artificial and temporary demand for yen.

In response, the Bank of Japan did take some small steps to increase monetary stimulus – by extending the time horizon of their monetary operations, allowing commercial banks to borrow funds for a duration of six months at very low interest rates. Such is the nervousness of financial markets that it had minimal impact and the yen has continued to appreciate.

With a bit of luck, or false optimism, the continuing strength of the yen might force the BoJ to do something a bit more drastic, which would help not just the Japanese but the rest of us. More likely, the defeatist attitude that there is nothing they can do will prevail.

GDP growth April to June

It is worth trawling the details of some of the 2/Q GDP reports to get some idea what might be behind the economic slow-down that started in April. In the case of the US, strong growth in investment and exports has been met from imports. The UK saw good growth in the second quarter boosted by stock building rather than final demand. Japan, as always, has to rely on growth in net exports with very little in the way of domestic demand whereas Germany has the benefit of very strong investment demand as well as net exports. In summary, aggregating the four economies, it does not seem that it is domestic demand that is the problem. This grew by an annualised 2.6% in the first half of 2010. For some unexplained reason, this was reduced to 1.7% by a drag from net trade but on top of that, there was a build up in inventories which resulted in overall GDP growth of 3.0% in the first half of 2010. It may be that the surge in imports has led to some involuntary stock building, the run down of which might explain the recent weakness in production.

Watch this space for additional comments as more countries release data.