In this week’s bulletin:
- There was no let up for Greece last week as the troubled country lurched ever deeper into crisis, desperate for eurozone finance ministers to agree to more emergency funding.
- Street riots and crumbling political resolve led to volatility in the financial markets and resulted in the cost of Greek borrowing soaring with worries about contagion as Spanish borrowing costs rose too.
- However, a softening of Germany’s demands that private investors should bear some of the cost meant a solution was put together over the weekend albeit subject to Greece’s parliament ratifying a further round of austerity cuts.
- Elsewhere, slowing growth in the US and BRIC developing economies also made investors wary although the IMF said it still expected the global economy to achieve substantial growth overall of around 4.3%. The UK should, according to OECD indicators, continue to enjoy stable growth in the months ahead.
- Global equity markets ended the week with small gains and losses across the board although investors favoured the havens of German and US government bonds.
- Bigger picture, despite a number of major events this year, global markets have mostly reacted stoically with the UK down some 2% whilst the US is up by a similar margin. Investors are being advised to focus on high-growth economies and defensive sectors in lower-growth economies as a strategy and making sure they are diversified by asset and geography.
On a Slippery Slope
A week on and nothing much seemed to have changed for investors – Greece’s woes still remained uppermost in people’s minds, exacerbated by nagging doubts over the strength of the global recovery. So it was no surprise that financial markets remained volatile as traders watched their screens avidly for news from Reuters or data from Bloomberg, indeed anything that would help them decide whether to sell or buy. But the week ended pretty much as it started, with the Greek sovereign debt crisis lurching onwards as the country’s politicians endeavoured to persuade its people that more pain was the only alternative. At the beginning of the week, billionaire investor George Soros criticised international authorities for “not providing a solution” for the eurozone debt crisis, adding that European finance ministers were basically buying time rather than tackling the problems. Whilst policymakers might have vacillated, the markets didn’t and traders very quickly marked down the price of benchmark ten-year Greek bonds, thus in turn pushing up yields to a record 18% as they priced in the likelihood of Greece defaulting on its commitments. Unsurprisingly, the cost of insuring Greek debt also exploded upwards.
The word ‘default’ is non-PC amongst eurozone policymakers – particularly in France and Germany – who prefer to talk about ‘re-profiling’. Should Greece renege on its debt then the biggest losers would be French and German banks who between them own some 75% or so – around €77bn – of the ailing country’s debt. UK banks rank third but, fortunately, are a long way behind in monetary terms, owning some €11bn. The Sunday Telegraph reported that UK banks have pulled billions of pounds of funding from the eurozone in recent months, reflecting increased concerns about a ‘Lehman-style’ event connected to a Greek default. As the week progressed, the pressure built; and at one point Greece’s Prime Minister, George Papandreou, offered to resign after he lost more political support for further austerity measures being demanded by the EU and IMF in return for the next tranche of bailout funds. In the streets of Athens there was anger and despair that finally turned to rioting but which did have the positive effect of galvanising Nicholas Sarkozy and Angela Merkel into agreeing to meet the next day to try to break the stand-off. Equity markets bore the brunt of short-term selling as investors scurried for the safety of US and German government bonds.
The pressure on European finance ministers to find a solution became an even greater imperative as fears of contagion from political and market turmoil in Greece sent Spanish borrowing costs to 11-year highs. Meanwhile, on the sidelines, Nout Wellink, the Dutch central bank governor, said Europe’s emergency bailout funds should be doubled (to €1,500bn) in size to convince financial markets of governments’ commitment to defending the euro. Such ‘shock and awe’ tactics were used twice by the US government during the banking crisis, which eventually brought stability to the markets. One of the major sticking points to a solution was Germany’s demand that existing private bondholders bear some of the cost of the second bailout; however, by Friday, Germany had backed down, throwing its weight behind a voluntary rollover of Greek debt, rather than a full scale debt exchange with extended maturities (which would mean losses for bondholders).
Kicking the Can
The news came in time to give investors a much-needed fillip, enabling equity markets to rally after several days of falls. Finance ministers and ECB officials met over the weekend and were expected to give the all-clear for Greece to receive €12bn of emergency loans that would see the crisis-hit country through to September and buy time for the authorities to agree the details of a second bailout. The Sunday Times was not so sure, though, saying the future of the eurozone was still in the balance with Greece asking for more time to implement the latest round of savage cuts demanded by the IMF/EU/ECB troika and as the battered country suffered from further waves of social unrest. However, the news today is that Eurozone finance ministers have postponed their decision on a €12bn loan to Greece until it introduces further austerity measures. According to the BBC, the ministers said they expected to pay the latest tranche of a €110bn EU and IMF aid package by mid-July, but that it will depend on the Greek parliament passing €28bn of new spending cuts and economic reforms.
The ministers also committed to put together a second bailout package to keep the country afloat. Jean-Claude Juncker, Luxembourg’s Prime Minister, who chairs the meetings of the 17 eurozone finance ministers, said that as long as the Greek parliament supported the new measures, he was certain Greece would get a second bailout. The Greek government expects a second rescue package to be similar in size to the first one (€110bn) but Athens has said it needs the €12bn from the existing package by July to avoid defaulting on its debt. Belgian Finance Minister Didier Reynders said the release of that would depend on the Greek Prime Minister George Papandreou surviving a confidence vote on Tuesday. “To move to the payment of the next tranche, we need to be sure that the Greek parliament will approve the confidence vote and support the programme, so the decision will be taken at the start of the month of July,” he said.
The other thorny issue that is causing investors to fret is the direction, or rather the strength, of the global economic recovery going forward. In recent weeks the flow of economic data has been mixed and somewhat inconclusive: on the one hand, the developing economies are still growing fast; but conversely, the developed world is for the most part (excluding Germany) struggling. One thing investors like is certainty but at this point in the economic cycle clarity is lacking, adding to volatility in the markets. Firstly, the US is clearly slowing – growing at a more sedentary pace than it was, with economists expecting it to grow at 1.3% in the second quarter, down from 2.2% in the first three months. Higher inflation because of rising commodity prices, particularly oil, is hurting the American consumer who in turn feels less confident; the Thomson Reuters/University of Michigan consumer sentiment index has fallen so far this month, compared with May. This drop in confidence is beginning to impact on consumer spending – shops in the US saw sales fall for the first time in eleven months in May, particularly for car dealers.
But whilst the US is the world’s largest economy, the 44 countries that make up the developing world account, in aggregate, for almost half of global growth and they, for the most part, are doing well. The four heavyweights are the BRIC economies, Brazil, Russia, India and China and they continue to expand. According to a report from the IMF, global growth will be 4.3% this year and 4.5% next year and, although China and India may be slowing, they will still see GDP rise by 8.2% and 9.6% respectively – both down from around 10% but still very respectable. This point was made by economist David Smith, writing in The Sunday Times, who said that, whilst the global economy is slowing, the fears are probably overdone. He pointed to temporary blips such as the effect of Japan’s earthquake on its own and the rest of the world’s supply chains. However, with the BRIC countries all having raised interest rates this year – mostly in response to inflation remaining stubbornly above targets – investors are worried that this may dampen demand too much. Surprisingly, one of the worst-performing stock markets this year, after Greece, is Hong Kong, where it seems that even there the rich are feeling less so, following the disappointing stock market flotation last week of luxury fashion house Prada. The company managed to raise only 80% of the expected $2.6bn.
Steady as She Goes
Whilst the US and BRIC economies may be flagging a little, the economic recovery in the UK is expected to remain on track over the coming months in the face of a deteriorating outlook for most of the eurozone. According to the closely watched leading indicators index compiled by the Organisation for Economic Co-operation and Development (OECD), Britain and Germany are on course for a stable pace of expansion, with the indicators for the UK steady at 101.6 in April (with anything over 100 indicating growth). Economist Howard Archer at IHS Global Insight said, “The OECD indicator for the UK suggests the UK is headed for modest economic expansion over the coming months,” with his own forecast being 1.4% for this year. Last week, figures from the Office for National Statistics showed that the number of unemployed fell by its largest margin in more than a decade, although the number of jobless rose to almost 1.5m, reflecting changes in the way those on benefits are calculated. Whilst a larger working population is welcome, one of the obstacles looking ahead is apparently a shortfall in skills which is leaving employers – 3 out of 4 – struggling to fill their vacancies.
Against the backdrop of concerns about the eurozone and the pace of global growth, stock markets have for the most part been remarkably resilient – even at the end of last week there were few major upsets. The UK slipped around fifty points yet Wall Street rose by the same, whilst Paris and Frankfurt were up but the Nikkei was down. Looking back at the last six months there has been no shortage of ‘events’ – the Arab Spring, the Japanese earthquake, inflation, slowing global growth and the eurozone sovereign debt crisis – which might have spooked investors. But, as Fidelity fund manager Tom Stevenson pointed out in The Sunday Telegraph, looking at a chart of the FTSE All-Share and allowing for the March blip, you would think that nothing of import had happened at all. Year to date the UK is down 2% but the S&P 500 has risen by the same margin as both markets trade sideways, reflecting investors’ assessment of events. Going forward he thought that probably one of the best strategies for investors is to focus on the high-growth parts of the world or the most defensive parts of the slower-growth countries and to be as diversified as possible by asset class and geography.