Risky assets—stocks, high-yield bonds, emerging market bonds and carry-trade currencies have performed rather well in the last two weeks, despite one day of wobble caused by Standard and Poor’s threatened downgrade of US sovereign credit rating by 2012, if no political will is found to reduce the US government budget deficit sustainably. In fact, one could say that there has been a melt-up in risky assets.
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Short but eventful week
This is a holiday-truncated week in continental Europe and so is the next week. But, it is not likely to be short on action and events. In Asia, we have three countries releasing consumer prices for March. One is Singapore. Then, there is Australia that releases the first quarter consumer price inflation and the third is Japan that releases its data on Friday. In Singapore and Australia, data would be watched closely for inflation surprises. We should not be surprised if the actual inflation turns out to be higher than consensus expectation.
Further, in Japan, this week we do get release of the Small Business Confidence Indicator. Small businesses were beginning to feel confident before the earthquake-tsunami struck in March. This might be the most important release from a business perspective in Japan. Last week, we noted that consumer confidence in Japan fell in March. Contrary to expectations, Japanese stocks have not really surged since the natural disasters as many of us had anticipated based on the hope that the Bank of Japan (BoJ) would crank up the money supply. In fact, BoJ’s current balances have been slowly reverting to pre-March levels after the initial big surge in liquidity in the early days after the disasters. That is why $-yen has not strengthened and the Japanese stock market has not taken wings.
There is the potential for Japan to use the natural disaster as a defining moment. But, for potential to turn into performance, there have to be decisions and initiatives. So far, they have remained elusive. But, we remain hopeful that it is a matter of time simply because Japan has no other alternative.
US first quarter GDP
All attention would be on the US first quarter gross domestic product growth estimate due to be released on the 28th. Consensus estimates (from Bloomberg) are for a growth rate of 1.9% (annualized). Right now, most economists have downgraded their estimate of growth in the first quarter to below 2% (annualized quarter on quarter). Therefore, the surprise will only have to be on the upside. Far more important is the outlook for the remainder of the year. Last year, those who expected the soft patch of the Spring-Summer period to turn into a recession were proven wrong. They might be wrong again or might not be. The interesting implication is that —whatever the outcome on growth— higher inflation appears to be a certain visitor globally if not in the US.
If the US economic softness continues into the second quarter, then speculation about the end of quantitative easing in June would shift towards speculation of the manner and method of its extension rather than its termination. If the economy rebounds, then there would be speculation on when the Federal Reserve would begin to tighten monetary policy.
Outlook for US monetary policy
Now, it is not clear if the Fed would tighten policy soon, even if the economy rebounds. Recent official communication retains the language of exceptionally low rates for an extended period. Second, even if they begin to tighten, their recent history of tightening suggests that they would do so only gradually such that real rates of interest would remain low or even negative. Therefore, speculation in risky assets and commodities would be favoured by the Federal Reserve policy, regardless of whether the economy hits air pockets or not.
In this regard, the communication from the Federal Reserve on the 28th morning (Asian time) and Ben Bernanke’s press conference—a new initiative of the Federal Reserve Board—would be more interesting than the first quarter economic growth numbers. Market watchers would be parsing his body language, his verbal intonations and choice of words to divine the course of US monetary policy in the near future.
The last words
Jim Reid of Deutsche Bank reminded his readers of the following:
We are probably in-between crises with the strong global recovery offering hope to those of a more optimistic persuasion. For us we are a recession away from another financial crisis and remember from our Golden Age document that the US has been in recession for around 30% of the time since 1854 and we have had 33 of them over the same period. Recessions are not as rare as most people imagine. (‘Early Morning Reid’, 21 April, 2011)
To some of us, it appears to be the last hurrah of risky assets, considering that global economic and political risks are mounting. But, risky assets can defy Cassandra at least for a while. That is what they did in 2007. They might yet do so for some more months. Of course, that would only make them more vulnerable for a crash and not less.
V. Anantha Nageswaran is chief investment officer for an internationalwealth manager. These are his personal views.
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