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World week ahead: Central banks rule

Monday 20th September 2010

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While some investors may think otherwise, intervention isn’t a four-letter word. It is – however temporary - a powerful act.  

Last week’s move by the Bank of Japan to depress the value of the yen against the US dollar was a reminder of the ‘degree of power’ a central bank wields. As impressive as the decision to act, the timing was more so as it has put many investors on the back foot. 

And the BOJ, which spent about US$20 billion to ease pressure on the yen, has left open the door to acting again - a very effective management approach. 

Whether that money will prove over time to have been well spent is debatable; history is inconclusive. In many ways though, it’s not particularly relevant and was a distraction from the global economic outlook, which really underpins how investors bet. 

In general, there are increasing signs that the two economic powerhouses - the US and China - are finding paths forward to the chagrin of the bears. And investor optimism is steadying, if not rising. 

The Standard & Poor’s 500 last week found its way back to even for the year; it had been down as much as 8.3% in early July. And despite the sovereign debt crisis, with Irish speculation the latest in the queue, the Stoxx Europe 600 has surged 13% from its year low in May. 

As for the outlook, US stocks are expected to make strong gains before the end of 2010 as worries about a second recession subside, according to a recent Reuters poll of investors and strategists who scaled back forecasts slightly from a June survey.

Median forecasts from 46 respondents surveyed showed the Standard & Poor's 500 index closing the year at 1,195, about 6% higher than its Friday close of 1.125.59.

Billionaire Warren Buffett is one investor who sees better days ahead, and while not every bet he makes has proved profitable, or well timed, he’s hard to dismiss. Last week he declared, yet again, that he was a huge “bull” on the US economy.

Ah ... the sound of money. 

This week, the spotlight shifts to the US Federal Reserve, not so much in terms of what it will do but in terms of its perception of what’s happening in the US economy. And specifically how it words its perception.

The Fed’s analysis will come in a statement released in Washington on Tuesday (Wednesday New Zealand time). 

While there has been chatter that the Fed may soon move to buy more assets, there’s less certainty about when, even if, it will be necessary. That uncertainty bolsters Fed Chairman Ben Bernanke’s power. 

Fifty-four of 63 economists say the Fed will leave unchanged a sentence saying high unemployment and low inflation warrant “exceptionally low” rates for an “extended period”, according to Bloomberg News. Perhaps a switch in language now would be wise. 

The Bloomberg survey also showed that economists were divided about the need for more stimulus through asset purchases with some saying a far greater deterioration in the economy was required. 

As dismal as has been the US economy’s performance at points through this year, there’s no sign of a double-dip recession. In fact, growth appears to be moderating at a slower forward rate, which is good. At this moment in time, the economic data continues to be mixed; one day positive for bulls, one day positive for bears. 

There’s no doubt that significant hurdles still exist for the global economy because of the wariness of consumers. It’s hard to know how positive or negative to be. On Friday, a report showed that US consumer confidence slumped this month because of concerns about rising personal income taxes, in particular for those households pulling in more than US$75,000 a year. A reflection of the rhetoric leading to the US November elections. 

If US consumers really have lost confidence in the future, then the outlook will indeed turn grim. That gave both gold and oil reasons for their respective moves on Friday. Gold surged to a record high; oil fell for a fourth day.

"Gold continues to reflect the overall level of concern. The weak consumer confidence data was certainly supportive to the rally in gold," said Frank McGhee, head of precious metals trading at Integrated Brokerage Services in Chicago. 

As we know from every other asset class, gold isn’t going to move in one direction for long. 

This week the main US economic data is housing. On Monday, the National Association of Home Builders releases housing market index for September. 

On Tuesday the Commerce Department will release housing starts for August. On Thursday, the National Association of Realtors releases existing home sales for August and on Friday, there’s a government report on new home sales for August. 

And let’s not forget, the Bank of Japan could buy even more US dollars next week - or exchange them for something else. The Chinese yuan is clearly coming into greater focus.

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