World Week Ahead: Sober second-half outlook

Monday 28th June 2010

Investors are preparing for the start of the second half of 2010 with some apprehension.

There are persistent concerns about the pace of recovery in the US and the debt crisis in Europe. And the diverging views on how best to renew the global economy.

At the Group of Eight and Group of 20 meetings in Canada on the weekend, the common ground on whether to rein in spending - to bolster national economies - or to rein in deficits was skirted.

“What we share is a recognition that if the world economy is to expand at its potential, if growth is going to be sustainable in the future, then we need to act together to strengthen the recovery and finish the job of repairing the damage of the crisis,” Treasury chief Timothy Geithner told reporters in Toronto. “And we agree on the need to restore balance to a world economy that got dangerously out of whack.”

Investors weren’t taking any chances ahead of the weekend with markets in Europe ending four weeks of gains and US markets ending mixed.

On Friday the Stoxx Europe 600 Index declined 2.8% to 248.83, ending four weeks of gains.

National benchmark indexes declined in all 18 western European markets this week except Iceland. The FTSE 100 fell 3.9%, Germany’s DAX gave up 2.4% and France’s CAC 40 dropped 4.5%.

"While we are optimistic that markets will bounce back in the near term, we believe there are constraints on how far the rally can go,” Barclays said in a note to clients. “Investors will likely remain cautious and asset values are unlikely to reach anywhere near the peaks of recent business cycles."

As for Wall Street on Friday, the Dow Jones industrial average slipped 0.09%. The Standard & Poor's 500 Index gained 0.29%. The Nasdaq Composite Index advanced 0.27%.

For the week, the Dow fell 2.9%, the S&P 500 was off 3.6% and the Nasdaq Composite fell 3.7%. Hardly inspiring numbers.

“Markets are clearly not overvalued and there are some good opportunities in equities but still we're not paid to take risks. The risk reward trade-off is not great,” Eric Le Coz, investment strategist at private investment firm Carmignac Gestion in Paris, told Reuters.

What might inspire investors is the pending second-quarter earnings season, which will begin in earnest in early July.

S&P 500 firms are expected to see their quarterly earnings grow by 26.8% in the second quarter, with expansions seen in all sectors except telecoms and utilities, according to Thomson Reuters data.

A key focus will be on financials, especially in the euro zone, given the impact on banks from the region’s mini credit crunch in May.

Investors, in particular, are bracing themselves for July 1, when euro-zone banks have to pay back 442 billion euros worth of one-year loans borrowed from the European Central Bank, although they will have the option of switching to shorter-term loans.

Dollar interbank rates - the cost for banks to borrow from each other - have reached a 10-month high, while the funding cost in the commercial paper market also has risen in a move similar to the 2007-08 credit squeeze which led to the collapse of Lehman Brothers.

Added to the financial sector mix is the pending passage of regulatory reforms in the U.S., with President Obama expected to sign the new rules into law within the next two weeks after Congress reached an accord early Friday morning in Washington.

President Obama said the agreed reforms represented 90% of what his administration was seeking. Cynics are already saying that the 10% missed were the ones that mattered the most, so the victory is more for Wall Street than Main Street.

On the economy front this week, US employment, manufacturing and consumer confidence data this week will be important in reassuring investors that the U.S. recovery isn’t stalling.

Economists polled by Reuters expect employers cut 100,000 jobs in June, reflecting the end of temporary census hiring.

Ahead of the weekend, US Treasuries gained, pushing the yield on the two-year note within four basis points of its all-time low.

A government report showed the US economy grew in the first quarter less than previously calculated.

Gross domestic product in the U.S. expanded at a 2.7% annual rate instead of the 3% pace reported last month, the Commerce Department said in its final estimate on Friday.

Although the pace was below market expectations of 3% it still marked three straight quarters of expansion as the economy digs out of its worst downturn since the 1930s.

Doubts about the US economy, China's exchange rate and Europe's debt woes are likely to weigh on the euro against the US dollar this week.

Analysts expect the euro, which neared US$1.25 last week, to retreat toward US$1.20 in the coming days as central bank buying fades and worries about euro zone debt burdens linger.

On Friday, the euro rose 0.5% against the U.S. dollar to US$1.2387. Even so, the euro was still down 0.4% on the week.

The US dollar fell 0.3% against the yen to 89.24 after sliding to a one-month low at 89.21, according to electronic trading platform EBS. It was the greenback's the third straight week of declines against the yen, at 1.3 % for the week,

"We think the euro relief rally has come and gone. There's no momentum left," BNY Mellon strategist Michael Woolfolk, told Reuters. "Frankly, it demonstrates how few people want to remain long euros. It's just a question of how short one wants to be."

Investors will also keep one eye on China's yuan a week after Beijing said it would loosen the currency's peg against the dollar and allow more exchange rate flexibility.

The yuan's moves since the announcement have been minor, but Chinese authorities did set the yuan's daily reference rate - the mid-point of its daily trading range - at 6.7896 on Friday, the highest level since its July 2005 revaluation.

Analysts are split on whether the People’s Bank of China will raise interest rates this year as the economy surges back from the financial crisis, a Bloomberg News survey showed last week.

In commodities markets, oil jumped 3% to a seven-week high on Friday. U.S. crude futures for August delivery rose US$2.35, or 3.07%, to settle at US$78.86 a barrel, the highest settlement since ending at US$79.97 on May 5.

On Friday, gold rose to within US$10 of an all-time high $1,264.90 set Monday.

"Sovereign risk has attracted establishment money into gold, which tends to be long-term money. It's about adding safe-haven security to portfolios. In the next few weeks you might see profit-taking, but the trend is solidly upwards," VM Group analyst Jessica Cross told Reuters.

Spot gold was at US$1,253.85 an ounce at 3.05pm EDT (1905 GMT), up from US$1,244.05 an ounce late in New York on Thursday.

US August futures settled up US$10.30 at US$1,256.20 an ounce.

Businesswire.co.nz

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