Recently reported economic data has generally confirmed prior signals from leading indicators that the modest global economic recovery weakened further. After posting better-than-expected growth of 3.6% (seasonally adjusted annual rate) in the first quarter, partly as a result of temporary factors, momentum stalled in the second quarter with growth likely to have subsided to around a 2.5% pace, indicative of a "growth recession" and the slowest quarterly advance since the recovery began. Latest global PMI figures for July show continued deterioration in manufacturing being offset by some recovery in services. Even so, the global composite PMI index remains at depressed levels and at best suggests growth may be stabilising.
The loss of momentum is universal, with disappointing final demand resulting in inventory corrections weighing on global industrial activity. It is generally believed, however, that the downturn is bottoming out with consumption demand expected to pick up over the second half as lower inflation feeds through to higher household real incomes. G3 policy is also much more focussed on supporting growth (more rate cuts and QE), while policy action in China is showing some early signs of success. In addition to some stabilisation in PMIs, most countries' economic surprises indices--often a good lead indicator of economic turning points--have started to trend high, particularly in the US and Asia.
In general, GDP growth forecasts in July were only modestly changed from the previous month, with the exception of the UK, as shown in the table below:
At the time of writing, of the major economies, the US, UK, China and Japan have so far reported GDP figures for the second quarter. The US and Chinese reports were in line with expectations but the extent of the slowdown in the US is evident from the paltry 1.5% annual growth rate.
The Chinese economy grew at 6.8% (saar), a very modest pace by its own standards. The Japanese economy grew just 1.4% on an annualised based in the second quarter; much worse than the 2.0%-2.5% consensus expectation and even lower than the 1.5% recorded by the US. Both private consumption and exports were weaker than forecast in the world’s third largest economy.
UK GDP figures were also something of a shock and while a third consecutive quarterly contraction had been predicted the economy declined at a near 3.0% per annum rate--a far worse outcome. With temporary factors and distortions at work it is difficult to determine underlying trends in the UK economy, but GDP is stagnant at best. Furthermore, the latest data is even casting doubt on the scale of an Olympics Games-fuelled rebound, expected to come in the third quarter.
Upcoming GDP figures from the euro area will provide little comfort and are likely to show the degree to which the EU sovereign debt crisis is now impacting on growth in the core countries.
Yet again the financial markets were driven by developments in Europe. Early month enthusiasm for the EU support programme to recapitalise Spanish banks was soon displaced by growing fears that Spain would require a full-scale bailout. Spanish and Italian bond yields soared, especially shorter maturities, which is a key sign of financial distress, and financial markets reverted once again to "risk-off" mode. Safe-haven, main government bond market yields dropped to new record lows, while equity markets and the euro relapsed. Spanish bond yields surging above 7.5% across most maturities proved too much for the ECB, however, and President Draghi pledged the central bank would do "whatever it takes" to preserve the euro.
Such a forceful response galvanised risk assets and, while no immediate action was announced at the next ECB meeting, Mr. Draghi sketched out the means by which it would intervene in bond markets and lower shorter dated debt yields. This is another attempt to buy time and reassure the financial markets that measures will be forthcoming but, once again, clarity and detail were lacking and implementation will be key.
Even so, this was sufficient to cause two-year yields in Spain to fall back below 4.0% and the euro and equities to rally strongly. Main commodity indices also continued to rebound but this was principally led by the worsening US drought causing grain prices to soar while the oil price recovered as Iran sanction supply constraints and the return of speculative buyers caused a 20% rally from recent lows.
The search for yield remains a high priority for investors with even some nominal rates now negative. During July the key beneficiaries of this trend were corporate bonds, where risk spreads narrowed substantially (returns in the UK were an equity-like 4.0%) and higher yielding equities offering secure income.
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Holly Cook, managing editor of Morningstar.co.uk, contributed to this article.
