It’s not often you can legitimately say there’s a potential market-moving event on every continent of the planet, but this week there is. It is, by definition, extraordinary. Whether it’s the United States, China, the Middle East or Europe, somewhere, somehow, markets are being influenced by politics or conflict, or both.
It’s a particularly interesting time for me given the importance I place on the idea that global money flows are inspired by market-sensitive international macroeconomic developments. That’s precisely what we’re seeing now. Perhaps the most real example of this in the past few days has been the movement in the Australian dollar. It fell over 1 US cent before the end of last week. That may not seem like much but in this quiet market, it’s a considerable move.
Let’s take a look at some of the international developments to see how the global economy is taking shape.
First let’s go to the United States. If you haven’t heard the term ‘fiscal cliff’, consider yourself lucky! I don’t know who coined that term but it’s terrible. I imagine some sort of rocky cliff with America falling over the edge on the 1st of January - crashing onto the ground (falling back into recession). It’s been used to describe the very real chance that the United States could fall into recession as automatic spending cuts and tax increases come into effect. Incidentally it does actually look like a cliff when you see how it will affect the economy on a graph.
Now that the US presidential elections are out of the way, President Obama has been able to speak publicly about what he hopes to achieve in his negotiations with Republicans with regard to the budget. To be honest, it’s not looking good at this stage. Obama is sticking firmly to his line that important welfare payments should not be scrapped, and Republicans are insistent that the rich should not have to pay more tax. There was a hint of compromise late last week but there’s certainly nothing concrete yet. Markets have not reacted well either. It’s not like we’ve seen a huge wave of selling activity, it’s more just a general sense of malaise. Markets know what’s at stake, and they also know it’s likely to go down to the wire. There’s even a chance neither party will agree on how to tweak the budget and, instead, Congress will have to agree to set a new date for the automatic adjustments to the budget to kick in (that is, making changes to the 2011 Budget Control Act). The markets are likely to lose patients with the latter scenario.
The next cab off the rank is Europe. We recently learned the continent remains firmly entrenched in recession. It contracted by 0.1 per cent in the three months to September. In the previous quarter the economy shrank 0.2 per cent. The region has now been in economic contraction (or zero growth) for four consecutive quarters. It’s not for lack of policy action. The problem is that Europeans (especially the Greeks and Spaniards) aren’t so keen on the policies that are being developed at present. This week saw almost daily rallies and protests on the streets of Athens and Madrid. Around a quarter of the labour force is unemployed in both Greece and Spain. And even those who have a job are seeing their wages frozen and their pensions cut. It’s causing an enormous amount of social unrest.
Greece did pass its budget last week, and has made the necessary tax increases and spending cuts (as largely determined by the Troika), but it’s going to need more time to meet its debt reduction goals – two years in fact. There were also some pretty dire economic forecasts. An example is that its economy is expected to shrink by 4.5 per cent in 2013. The country is still sucking on the teat of its European finance partners and is showing few signs of being able to stand on its own two feet.
The reality is that if you take away the European Central Bank’s (ECB) commitment to “do whatever it takes” to keep bond yields down and support markets, the ‘bond vigilantes’ would have done away with Greek debt a long time ago. However those wanting to sell Greek debt (or Spanish debt for that matter) are now coming up against a wall of money from the ECB. In this situation politics is getting in the way of free-market forces. Just hold onto your hat though for when it’s no longer in the ECB’s interest to safe-guard the debt of any of the European periphery nations’ debt.
The changing of the guard in China last week was also of significance. The world’s second largest economy now has a new president – Xi Jinping. The reason I haven’t included this global development higher up is that – despite its political significance – the majority of commentary and analysis that I have read on this has been fairly benign. In other words, Xi has, so far, said all the right things and made all the right promises – including stamping out corruption at the top levels of government, and lifting the living standards of all Chinese people. But some analysts have tipped as far away as the second half of next year before the new regime will have any material influence on the country or the economy. It has to be said though that it’s a younger team that’s been ushered in and one that’s more likely to be open to the forces of the free market.
I noted with interest how much time the news channels devoted to both the US elections and the Chinese leadership handover over the past two weeks. There was no comparison – the time spent on the US election absolutely swamped the Chinese handover. Now the US political wrestling was far more dramatic and unpredictable than what was unfolding in China, so it makes sense. But it also seems plain to me that China is doing its best to be seen as stable and on track in delivering its very well publicised economic reform agenda. In short, China is still a significant risk for both Australian and world economic growth, but its time in the sun is not yet.
Finally, I have to mention the Middle East. It’s been a while since the term ‘geo-political tensions’ was used widely in economic commentary. I imagine it was used just about every day during both Gulf wars. Today it’s used in relation to the return to fighting between two very old rivals: Israel and Palestine. Rockets are currently being fired in both directions and the dispute seems to be escalating. It was sparked by the recent assassination of the leader of the military wing of the Palestinian Islamic political party, Hamas.
So from a markets point of view, what are we watching for? I’d argue there are two markets to watch.
One is the Australian dollar. It fell over 1 US cent on Friday last week. That was due to geopolitical concerns in the Middle East, and also a report from the International Monetary Fund saying that the Reserve Bank would be justified in lowering interest rates further following a negative international macro-economic shock. Clearly the most senior economic bodies in the world are not confident enough to say ‘everything’s going to be ok from here’ – because it’s clearly not. The second market to watch is gold. The price of gold hasn’t moved too much in the past 6 months but that doesn’t mean it’s not going to move again soon. It doesn’t really matter whether it moves up or down, but when you start seeing it trend one way or the other, take serious note of it because it will be reflective of a broader thematic – a thematic likely to be linked to perceived risk in the market and the value of the US dollar.
The past two weeks have highlighted all the potential global economic flashpoints. At this moment in time markets are focused most heavily on developments relating to the US fiscal cliff. Europe too is proving a monkey on the markets back that it just can’t shake, but the situation is not as acute as it is in the US. Both flashpoints are political in nature and therefore come with a sense of unpredictability and volatility.
Domestically, markets – especially equities – have been relatively quiet. They’ll basically grind down to a halt this week too in the US with Thanksgiving Day celebrations. The point of drawing attention to the quietness of domestic equities markets though is to highlight how outwardly focused traders and investors are at the moment. And risk taking is only being done by the brave. In 2006 just about everybody was a risk taker.
Now is the time to take a look at the world around us. On every corner of the globe there’s a market-sensitive event occurring.
David Taylor
