In stark contrast to the sentiment of central banks worldwide, in recent weeks, the major concern has been the marked slowdown in global growth, particularly in the United States and emerging economies.
Most economic indicators related to manufacturing, unemployment and inflation have indicated a growth pullback. In fact, the US Fed chairman, Ben Bernanke, reported that the pace of the US economy was "frustratingly slow." Later, the International Monetary Fund (IMF) indicated that softening growth being experienced by the US and other major economies should be temporary. They attributed the slowdown to transient factors relating to the global oil price shock, supply disruptions due to the Japanese earthquake and the ongoing European debt crisis saga.
These factors led to disruptions in the manufacturing sector, lower investor confidence and weaker economic data globally. These transient factors served to exacerbate the "soft patch" in global growth, rooted in the weaker-than-anticipated economic data arising from the United States and emerging nations of Brazil, India and China. In 1Q 2011, these countries' growth rates were significantly below the rates for the corresponding period in 2010, as indicated in Figure 1. This occurred as emerging nations attempted to slow their growth rates to more manageable levels, so as to reduce inflation and prevent overheating, while the US economy expanded at a slower than expected rate.
Signs of growth slowing United States
The latest string of economic data coming out from the US suggests the country's growth momentum is slowing. First quarter gross domestic product (GDP) growth rate fell to 1.8 per cent from 3.1 per cent experienced in the previous quarter (4Q 2010). In May 2011, the unemployment statistics deteriorated, as the US jobless rate rose to 9.1 per cent, the highest figure for the year. Statistics arising from the Labour Department showed payrolls grew at the slowest pace in eight months. Additionally, manufacturing slowed in May, as indicated by the 11.42 per cent decrease in the Purchasing Managers Index from April. Elevated unemployment levels and a subdued inflation rate of 3.16 per cent resulted in the Federal Reserve maintaining its accommodative monetary policy stance. The benchmark rate, the Fed Rate, remained at the historic low of 25 basis points and the second round of Quantitative Easing, dubbed 'QE2' finishes at the end of June.
India
India's growth effort has been cooling, as the economy experienced the lowest growth rate in five quarters, expanding by 7.8 per cent during the first quarter of 2011. Rapidly increasing inflation levels resulted in tighter monetary policies. In May 2011, the Reserve Bank of India raised the repo rate for the ninth time in the last year to 7.25 per cent, in an attempt to curb rising prices. Tighter monetary policy contributed to slowing growth, as reflected in the Purchasing Managers Index, which was down 4.9 per cent in May from April. However, in June 2011, the Reserve Bank of India indicated intentions to implement new policies aimed at containing inflation which would not sacrifice the country's growth efforts.
China
China's growth remained strong during the first quarter of 2011, with the economy growing by 9.7 per cent, falling slightly from the previously quarter's growth rate of 9.8 per cent. The Purchasing Managers Index fell for the second consecutive month, suggesting a tempering of manufacturing activity. The People's Bank of China has been increasing the reserve requirement ratio and interest rates in an attempt to reduce inflation and, yet again, there are concerns whether tighter monetary policy will restrict growth.
Brazil
The Brazilian government has also been attempting to moderate growth to manageable levels to prevent the economy from overheating. As such, the Brazilian economy has been showing some signs of slowing, with industrial production falling by 2.1 per cent in March as well as, falling consumer confidence. To curb inflation woes and bring the inflation rate to the 4.5 per cent target, the Central Bank of Brazil has tightened monetary policy, raising the benchmark rate (the Selic) to 12 per cent in April.
In addition to increasing borrowing costs, the Brazilian government has also been reducing spending and limiting credit growth to prevent the economy from overheating.
Implications of slowing on financial markets
Stock markets
Stock markets have been highly volatile in response to economic data suggesting a slowdown in growth, concerns over the European debt crisis and the impact of Japanese disaster on the manufacturing sector. Figure 2 depicts the fluctuations experienced year-to-date in the global stock markets, as investors reacted to new information. In June, stock markets fell globally in reaction to the weak economic data arising from the US and emerging markets, and heightened uncertainty regarding Greece defaulting on their sovereign debt. Year-to-date, the S&P 500 increased by 1.35 per cent while the MSCI Emerging Markets Index, the Brazilian Bovespa Index and India's Bombay Sensex Index, declined by 1.83 per cent, 10.58 per cent and 9.28 per cent, respectively. Much of the decline is attributable to the cyclical stocks on these indices, which are the most responsive to economic data and investor confidence levels.
Bond markets
After experiencing a decline in February, the credit market regained its momentum, earning positive returns in June. Normally, the most telling signs of investor confidence are reflected in the movement in the US Treasuries. In times of low investor confidence, risk appetite diminishes and there is an increased demand for safe assets (such as treasuries). Conversely, when investor confidence improves and risk appetite increases, investors lean toward riskier assets and consequently lower their demand for safe-haven assets, like treasuries. As Figure 3 illustrates, on a year-to-date basis, the JP Morgan Emerging Market Bond Index outperformed the US Treasuries Total Return Index and the JP Morgan US Aggregate Bond Index. Year-to-date, the Emerging Market Bond Index increased by 4.10 per cent, while the US Treasuries Total Return Index and the US Aggregate Bond Index increased by 3.04 per cent and 3.39 per cent, respectively.
Conclusion
In times of heightened uncertainty, fixed income instruments provide investors with better opportunities for predictable returns. While the corporate and sovereign bond markets may not be totally risk-free, they are an attractive alternative to the oscillating stock market and should be favoured by the investor seeking to minimise risk in a volatile environment. Weaker economic data arising from the main economies globally resulted in increased volatility in the financial markets as investors increased their risk aversion. However, many analysts expect that the effects of the Japanese earthquake on manufacturing output will abate and energy prices will be corrected. As such, they forecast this soft patch in growth would be temporary and economic growth will strengthen in the second half of 2011.
Bourse Securities Ltd
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