SCOREBOARD: Fragile markets

The debt ceiling euphoria doesn't seem to have lasted long. Concerns have now turned to global growth or, more specifically, whether there is any. I have to agree that this time it's not without good reason. First time though. So we found out on Friday night that US economic growth was much weaker in the first quarter than initially estimated, revisions taking growth from 1.9 per cent to 0.4 per cent. Growth in the second quarter wasn't much better, rising 1.3 per cent. Looking further afield, most of the global PMIs – for Europe (confirmed at 50.4 in July) and China etc have slipped to the 50 mark or just below and then last night we found out that the ISM index fell sharply from 55.3 to 50.9. Remember that a reading over 50 generally indicates expansion in the manufacturing sector, below 50 a contraction. Similarly a reading over 42.5 generally indicates an expansion in the overall economy.

On the face of it then, global manufacturing was barely expanding in July, which is obviously a bit of a worry. Why I'm not ready to jump on that bandwagon yet is because these indicators can give false signals, especially during times of heightened anxiety. I would put concerns about European and US debt into that category and so it is unclear to me whether these surveys are simply capturing these concerns. Higher tier data – industrial orders, trade and industrial production – still suggest global economic growth remains robust, but this is something to watch. Seeing these PMIs dip so sharply is not a cause for celebration obviously. But note the speed at which they have fallen. It seems unlikely to me that real demand has just dropped off a cliff without some catalyst. This suggests to me that these surveys could rebound over coming months.

That said, one of the key implications from all this negative dataflow is that there is a very strong possibility that the US engages QE3 and, to be honest, I suspect the Brits must be thinking very hard about it as well. Indeed, the IMF are egging them on, suggesting that the UK should cut taxes and print more money if growth looks like it will be sluggish. Remember that QE was initially sold on the idea of deflation and depression. Neither of which are a threat now. The bar has obviously been lowered somewhat.

For now though, there has been a flight to safety. US Treasuries were pushed higher and on decent volumes too, running about 40 per cent higher than average on Monday and on decent ranges – 5-14bps. So the yield on the 2-year Treasury note fell 2bps to 0.37 per cent, the 5-year was down 8bps to 1.32 per cent and the 10-year dropped 9bps to 2.75 per cent. Australian futures rallied 7-8 ticks to 95.58 and 95.19.

Needless to say, European (-0.7 per cent to -2.9 per cent) and US stock markets weakened, with the ISM data outweighing agreement on the debt ceiling. Up 1.2 per cent at the high, stocks were soon offered, down -1.4 per cent at the low on Wall Street. They recovered somewhat into the close but still managed to lose 0.4 per cent (1,286). By sector, healthcare, industrials and consumer stocks were the hardest hit – telecommunications and utilities managing modest gains. The Dow was then off 10 points (12,132), the Nasdaq fell 0.4 per cent (2,744) and the SPI was smashed, down 1.7 per cent (4,393) given yesterday's strong rally. Through it all the earnings season still looks solid. With around 62 per cent of companies on the S&P having reported, 78 per cent have delivered positive earnings surprises.

As for forex and commodities, we saw some big moves. The greenback found favour with the market; the US dollar index rising 0.8 per cent from 1630 AEST. The Australian dollar was off nearly a big figure to 1.0968, the European currencies were smashed, sterling and euro down 163 and 147 pips, respectively, to 1.4250 and 1.6295. The yen was otherwise down to 77.27. Gold then put on $5 (from 1630 AEST) to be at $1,620. WTI fell 0.6 per cent ($95.15), Brent was flat (at $116.8) and copper fell 1.7 per cent.

Looking at the day ahead and the RBA meets, with 4 out of 25 economists forecasting a hike, none forecasting a cut and most expecting rates on hold. The futures market is pricing in an 8 per cent chance of a hike, which rises to 24 per cent by September. While I think there is a very strong case to hike and indeed that is what I would do, I don't think the RBA board has the same opinion. Indeed, I suspect they will leave rates steady citing global uncertainties. We know the government won't be arguing for a hike, with Treasurer Wayne Swan suggesting that the board will overlook temporary factors in its decision, which I'm taking to mean inflation. Clearly Swan thinks the rise in inflation is temporary and we know that some industry representatives on the board feel the same way.

For mine this is a fairly critical meeting though. Should the RBA board fail to hike rates today, following two back-to-back increases of about 0.9 per cent on the cores, then I think we should take that as a fairly strong signal that the inflation target has been massaged. We know that global growth concerns or global debt concerns or other concerns are not going away. They will be a constant feature; they were a constant feature through strong growth outcomes last year. The word of the moment has to be 'concerns'. The key question for the market is whether never-ending 'concerns' now mean the board will tolerate higher inflation. I think we'll find out today.

Adam Carr is senior economist at ICAP Australia. See Business Spectator's glossary for definitions of technical terms used in SCOREBOARD articles. 

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