Financial Market Volatility and Global Growth

While I don’t intend for my Blog to focus only on market updates I think the current volatility we are seeing requires frequent communication. An important aspect of ensuring our financial lives are in order is to make sure we have money when we need it. We do this by managing our savings, investing and spending. We can control two of these but at the moment it is that part we can’t control that is causing the most concern. I’ll focus on the spending and savings aspects in coming updates but for now it is the investing.

The update below is reproduced with thanks to Ausbil Dexia Australia:

Over the past couple of months, the risks surrounding the global economy have increased significantly, manifest through significant moves in bond markets (yield falling aggressively), a spike in the gold price and global equity markets being aggressively sold off. Presently both bond and gold markets are overbought and equities oversold. However, whilst this may be the case, markets can stay at extreme levels for extended periods of time.

Another feature over recent months has been the extreme volatility in financial markets, the impact of which is however felt in the real economy, through:

• Undermining business and consumer confidence, and generating a delay in investment and and/or consumption.

• Risk aversion which can increase global funding costs for banks and/or economies that carry external funding requirements

• Rapid falls in global sharemarkets create negative wealth effects which can further erode consumer and business behaviour.

It takes quite a savage spike in volatility, and quite a large fall in global sharemarkets, to result in a significant shaving of global growth. The recent downward revisions to the last three years of US GDP growth estimates have certainly not helped matters. Despite the foregoing, the global economy is still likely to grow by around 3.8% this calendar year, albeit down from the IMF 2011 June forecast of 4.3%. It is worth noting, as seen in the following table, that the majority of global growth through the last decade was actually derived from Asia.

As a consequence of a strong Asia, global commodity prices and the AUD are likely to remain relatively elevated, as Asia remains the largest regional global consumer of commodities. Asia also remains Australia’s largest regional trading partner, with 75% of exports going directly to the region.

The risks to the global outlook remain tilted towards slower growth, with the largest being the prospect of the US economy reentering a recession. If it eventuates, it is highly likely Europe will follow and global growth will fall well below trend. In such an environment, commodity prices will move lower and the AUD will decline. Despite the growing risk of a US recession, this is not our central view.

We believe that, despite the weak August employment report, the US will grow moderately this year and pick up in 2012. We continue to believe the US Fed will take some decisive action (such as “Operation Twist” – buying long dated paper and funding it from short dated treasuries), in an attempt to revive the housing market and the US consumer, as consumers will be able to reset their borrowing costs at significantly lower rates. Furthermore, the Fed has committed to keeping rates between zero and 0.25% “at least until mid-2013”.

It should also be noted that it is not just the Fed making adjustments. The European Central Bank has entered the secondary market to buy Eurozone member government bonds as part of the Securities Market Programme, while at the same time re-commencing long-term refinancing operations as part of their euro-liquidity-providing operations. The Bank of Japan has further increased its Asset Purchase Programme by ¥15 trillion (US$195 billion) to ¥55 trillion (US$707 billion) and intervened in the foreign exchange market in an attempt to weaken the Yen. The Bank of England’s Monetary Policy Committee has tilted, by way of a vote, towards an easier policy bias. Finally, the Swiss National Bank has flooded the market with liquidity, helping to push two-year government bonds into negative rates of interest.

So whilst risks remain in financial markets, we believe that the negativity is more than priced in. Australian equities have been sold down – we believe excessively – and in many cases offer excellent value. Whilst the global macroeconomic picture remains troublesome, Australia is better positioned due to its leverage to ongoing strength in Asia. Moreover, in a wider sense, policy responses from major central banks are helping to stabilise and will eventually strengthen a weak global growth environment. As such, we believe it is wise to be cautious, but dangerous to be too pessimistic.

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