September’s economic data and survey reports failed to signal even the modest Q3 recovery most commentators had hoped for. While the economic figures point to a somewhat weaker than anticipated second half, it was the changes to growth estimates for next year that were perhaps of greater concern. Indeed, growth disappointments led to some sizeable downward revisions to GDP forecasts, as can be seen from the table below, and were sufficiently disturbing for the major central banks to further ease monetary policy.
A very modest improvement on Q2’s “growth recession” is anticipated for Q3 but, more importantly, hopes remain that easier financial conditions will contribute to a somewhat stronger Q4 and an acceleration next year. This view is supported by the most recent data, which suggest that, although growth remains depressed, the deceleration is bottoming out with signs that domestic sectors in the US, China and the euro area are rebuilding some momentum.
Asia witnessed the most significant downward revisions to growth forecasts last month. In Japan, most commentators now expect Q3 output to decline by in excess of 1% following significant downturns in exports and industrial production. Together with the ending of subsidies for purchases of eco-friendly cars that had boosted consumer spending, a tailing-off of reconstruction activity and potentially weaker capex, only a limited recovery appears in store for Q4.
Destocking, weak exports and the on-going slowdown in property investment have undermined Chinese growth and, allied to a cautious policy response, have resulted in sizeable cuts to forecasts for this year and next. Weakening global output has also contributed to weakness in many export-oriented Asian economies and led to another round of downward GDP revisions across the region.
Although there were few changes to US, euro area or UK forecasts, US and euro area central banks both announced significant monetary policy initiatives. The US Fed effectively linked its monetary policy to improvements in the labour market and announced an open-ended asset purchase programme (QE3), including an additional $40 billion per month of agency MBS (mortgage-backed securities) purchases. Meanwhile, the ECB re-affirmed its intention to ensure the effective transmission of monetary policy by lowering peripheral country short-term bond yields. This entails unlimited purchases of sovereign debt, to be known as Outright Monetary Transactions (OMT), in exchange for a request for official aid under EFSF/ESM programme conditionality.
Expectations of this boost to monetary policy stimulus had already rekindled a “risk on” phase in financial markets, which continued through the first half of September, before flagging as the economic newsflow deteriorated and euro risks re-emerged. In particular, European politics and brinkmanship were back to the fore with Spain reluctant to ask for a bailout and Germany backtracking on ESM-funding of bank recapitalisations. Additionally, the US “fiscal cliff” is looming ever closer with currently mandated laws potentially generating a 5% hit to US GDP. The highly partisan nature of the current political environment makes compromise difficult and is of considerable concern not just to investors but also to US corporates who have curtailed both capex and hiring.
Even so, it was another decent month for risk assets with gains recorded by equities, corporate bonds and commodities. After a long period out of the limelight, Asia Pacific and Emerging Market indices led stock markets higher, supported by a strong Chinese rally late in the month as rumours of further stimulus measures resurfaced. Equity sector performance was mixed with neither defensives nor cyclicals favoured, although financials continued their rehabilitation as “tail risks” eased. Overall, equity trading volume picked up but volatility remained at low levels with the VIX index averaging its lowest monthly level since June 2007.
Within bond markets, main market government issues sold off heavily in the first half of September (UK 10-year gilts by as much as 50 basis points) but growth concerns and ongoing quantitative easing provided late month support. Elsewhere, the riskier the better as strong gains were recorded by high yield bonds, emerging market debt and structured products. The “search for yield” has reached the deeper recesses of the risk spectrum with ABXs, CMBXs, and other credit derivative instruments all making comebacks in recent months.
Commodity markets were enlivened by a re-galvanised industrial metals sector, which rallied some 10%, driven to a large extent by the return of speculative investors and short covering as QE3 weakened the dollar. Precious metals were also spurred by these trends but both the agriculture and energy sectors faltered following recent strong gains.
As for currencies, unsurprisingly given the background developments, the euro rallied and the dollar weakened in September with all of the main Asian/Emerging Markets/commodity currencies outperforming the dollar. As has been the case for much of the year, sterling is still perceived as the best of a bad bunch.
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