Global Economy

United States
At present, all focus is on debt in the US as the world waits patiently for a resolution to the debt ceiling stalemate, which if reached by August 2nd, will see the US government avoid an unprecedented default. This follows disappointing data in May continued to cause question over the strength of the US economic recovery with unemployment ticking back up to 9.1% and the Institute for Supply Management Manufacturing index recording
its largest monthly decline since 1984.

Europe
Like the US sovereign debt continues to plague the European peripheral countries and significant concerns have again escalated. The concern has been that any Greek defaults might set off a global credit crisis much as Lehman’s failure did in 2008. However French and German banks only have Greek debt exposure of US$53 billion and US$34 billion respectively, which is manageable.

The real concern is French banks’ US$590 billion exposure and German banks’ US$499 billion exposure to Ireland, Portugal, Spain and Italian debt. An uncontrolled Greek default (which to date looks to have been averted) could lead to a sharp rise in funding costs for these problem debt countries, making it harder for them to reduce debts, possibly leading to a run on exposed banks. Banks may then stop lending to each other, as occurred in the global financial crisis. All of which could lead to another credit freeze and disruptions to global economic activity, as occurred after Lehman’s failure.

Asia
Economic growth in China and India continues, albeit at a slower pace as can be observed by the following chart. The People’s Bank of China [PBOC] lifted banks’ reserve requirements again in May aimed at draining excess liquidity out of the economy in its continued effort to bring inflation under control.
The challenge, for both economies, remains to ward off inflationary pressures whilst at the same time avoiding a very sharp slowing in the economy, which would not only be detrimental to their respective economies, but would also have potentially sharp negative consequences for global growth and financial and commodity markets.



Also not surprisingly Japan’s economy fell back into recession with a second consecutive quarter of negative growth recorded in the March quarter where GDP fell 0.9 per cent. The magnitude of the decline can be attributed mostly to the March 11 earthquake which caused declines in private consumption, capital spending and exports.

Domestic Economy
The Australian economy experienced an interesting March quarter with a 1.2 per cent fall in GDP, a 1.6 per cent jump in CPI and an unemployment rate remaining steady at 4.9 per cent. Although the direction of growth and inflation was expected it was the magnitude of the numbers that was a surprise.

The fall in growth has since been largely explained by the negative impact of global natural disasters on the demand for Australian exports, which fell by 8.7 per cent quarter-onquarter. It is argued that the GDP results seem encouraging if they consider domestic demand in isolation, which actually rose by a solid 1.3 per cent quarter-on-quarter. The increase in inflation puts the annualised CPI number at 3.3 per cent, outside the Reserve Bank’s 2 to 3 per cent management bracket

Investment Markets
Global equity markets have all fallen in recent months as investors fear all the issues discussed above. The Australian market is not immune to the threat of a global slowdown and when coupled with concerns over domestic inflation and growth has also been driven lower.



With US and euro-zone debt being the major theme, the uncertainty around the global recovery is likely to linger for some time and we are likely to see increased short term volatility in investments markets. This continued volatility in financial markets highlights the changed world we live in.
The global financial crisis has left the world with a hangover of excessive debt levels and extreme monetary policy settings in advanced countries, excessively easy monetary conditions in emerging countries and very skittish investors prone to jump at the slightest hint of any potential problem. This indicates volatility will remain high for some time, highlighting the increased importance of asset allocation decisions for investors.



Contact

Daniel Minihan
T  +61 3 8635 1800
dminihan@moorestephens.com.au

www.moorestephens.com.au