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Market action overnight was mixed but the announcements which could determine the direction of equity markets for the remainder of this year were anything but. What was highly significant in my view was the co-ordinated action by the central banks in the UK, Europe and China with another round of international stimulus gathering pace. This also gives more credence to what I have talked about over the past week about an increasing sense that governments and central banks are lining up on the same page when it comes to addressing the challenges facing global economic growth.
I remarked yesterday that here was a good chance the ECB will cut rates by 25 basis points and BoE will launch a third round of QE. I also talked about the prospect of action by the Chinese central bank at some point, and so it has played out. In fact it was almost a race to stimulate, with the three key banks acting within 45 minutes of each other.
The co-ordinated global central bank action which is now underway will go some way to reducing investor angst, and restore faith that the headwinds facing the global economy can be navigated.While there will be a wall of worry to climb, I remain of the view that markets will climb higher. Particularly given bonds are paying the lowest returns in history, and the likely inflow of the substantial liquidity from the side-lines as investors who are underweight equities rush to ‘up weight’ their equity portfolio settings.
As I suggested in the daily on Monday and yesterday, the ECB easing set the tone overnight. We have talked about how the decisions made at the EU Summit threw the gauntlet down to the ECB to follow suit, and they have been most respectful here. The ECB cut rates by 25 basis points to a record low of 0.75%. While ECB President Mario Draghi played down the impact, I think the move is not only highly symbolic, but will have a real impact, as will the decision to lower the overnight deposit rate to zero making it easier for the regions’ banks to borrow and lend, and generally boost confidence.
Adding to investor ease will also be the decisive action taken by the Bank of England, which announced that it would keep rates steady at 0.50%, while expanding its quantitative easing program by a further £50 billion. This was highly significant, with the BoE recommending a stimulus push, and buying bonds again only two months after stopping. With the tepid state of the UK economy at the moment this it is certainly the right call to put the punch bowl back in the room.
In yesterday’s daily I also talked about the likelihood of further easing by the Bank of China, particularly given that inflation is subdued. ‘The prospects for further fiscal and monetary stimulus are high, and to date, the amount of stimulus thrown at the economy remains significantly below the 2008 GFC with US$3 trillion plus in reserve’.
And so it was that overnight there was a surprise announcement from China of a cut in its benchmark deposit rate by 25 basis points, and lending rate by 31 basis points. To foster credit, the central bank is also enabling banks greater leeway in setting lending rates at a discount (up to 30% now) to the benchmark.
I believe the latest move is highly positive. There may now be an expectation that second quarter economic data coming out from China will be weak, but the central bank has clearly displayed that it is committed to being proactive when it comes to ensuring a ‘soft landing’. I remain of the belief that the Shanghai Composite Index has a good chance of reasserting itself to the upside once the latest stimulus measures take effect and also as uncertainty around Europe and the US recedes. I see a meaningful reversal to the upside in Chinese equities sometime this year or in 2013.
So it certainly seems that central banks are getting on the same page. It becomes even more apparent if you step back and look at the periphery. Overnight, Kenya cut rates for the first time in 18 months and Denmark lowered its benchmark to record lows. As we know, Australia recently cut rates but what you might not know is so too did Israel, Vietnam, and the Czech Republic. And the UK is not the only one buying currency – the Swiss National Bank has been stocking up on Euros to defend the Swiss franc.
So that then leaves…
Attention will now focus on what the next move by the Fed is, whose stance will be viewed as more reserved now when compared to some peers.
I expect the Fed will need to provide a bias towards loosening. Bernanke has talked of taking ‘more measures if needed’ so there will certainly be a lot of interest in Friday’s employment statistics. A minor increase in jobs will boost the prospects for action on the QE front, and the FOMC meeting in late July will increasingly be the focus point for markets over the next few weeks.
Tomorrow’s non-farm payrolls and unemployment reports should be significant. The consensus is a gain of 90,000 jobs in June following May’s tepid 69,000, with overall unemployment rate static at 8.2%. Interestingly, Goldmans have just announced an upgrade of their forecast for tomorrow’s nonfarm payrolls to 125,000 from 75,000 previously, citing five better-than-expected employment-related facts as the reason:
1. relatively robust employment component in the ISM manufacturing survey;
2. substantial month-over-month increase in online job ads;
3. today’s much better than expected ADP number;
4. slightly lower new jobless claims;
5. improved ISM non-manufacturing employment index.
It should be pointed out that – as recent experience has shown – the correlation between the ADP data and non-farm payrolls is tenuous. Tomorrow could nevertheless prove to be a catalyst where a strong jobs number as foreshadowed by Goldman of more than 100,000; or conversely, another shocker could produce a similar outcome – a move higher.
The former scenario could induce an “all is well” relief rally, while the latter should mean the “Bernanke Put” will be deployed sooner rather than later – or speculation to that effect.
In any event, the overnight jobs data released actually pre-open augured well. Private employers added 176,000 new jobs last month according to the ADP National Employment Report – a big improvement on May’s adjusted 136,000 and well above the 105,000 consensus. Additionally, weekly jobless claims fell 14,000 to 374,000 versus the 385,000 forecast. However, a weaker-than-expected ISM non-manufacturing report underpinned the challenges faced. US services expanded to 52.1 last month compared with 53.7 in May and the 53.0 forecast. (The reading nevertheless remains in growth territory.)
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