The majority of the major equity indices closed in positive territory last week and demand for government bonds saw yields relatively unchanged, with the main central bankers keeping the party going last week. Germany’s DAX equity index was one of the standout performers, up 2.71% for the week, but still remains down 2.22% YTD. In the US, the S&P 500 finished the week up 1.71%, which included a new closing high on Thursday. In Asia, Japan’s Nikkei 225 Index closed 1.44% higher; the index has now gained 11.47% since May 19th, helping to recoup a large portion of the early year losses. In the government bond markets, the German 10-Year bond yield closed at 0.98% while the Irish 10-Year bond yield fell further to 1.90%!
In the currency markets, the Euro fell to the lowest level in almost a year against the US Dollar. After rising above $1.39 in early May the Euro has been on a steady decline, hitting $1.32 last week. This will be welcomed by Mario Draghi who has previously made efforts to talk down the strength of the Euro. However, the most compelling reason for the Euro weakening has been the economic backdrop in Europe; the Eurozone economy is stagnating and inflation fell further in July to a low of 0.4%. As well, inflation expectations have been falling, increasing the likelihood that Mario Draghi will embark on some form of quantitative easing. Essentially, the market is adjusting to the reality that monetary policy in the US and Europe has been diverging; the Fed has been winding down their latest bond purchase program while in June Draghi announced a package of measures including interest rate cuts, and he is adamant they will remain on a divergent path “for a long period of time”.
The initial estimate of Q2 GDP growth showed that the US economy bounced back from the weakness in Q1, explained away by the inclement weather, growing at an annualised rate of 4%. However, while the headline number was received well by the markets the underlying picture may not be as strong with inventory investment accounting for over 40% of GDP growth, which has been the case over the last couple of years. For a quick and simple understanding of the current inventory rebuilding and GDP growth, read this blog posting from Paul Hodges, Chairman of International Echem: 40% of US GDP growth since 2012 due to inventory build. He argues that companies are building inventory ahead of an expected recovery that never comes, forcing them to eventually unload inventory at knockdown prices, resulting in the volatility of quarterly GDP rates and the overall weak recovery.
On the macro front this week there are a number of important reports for investors to focus on. Key reports from Germany include: IFO Business Climate survey, GSK consumer Confidence, Retail sales, Employment, and Inflation. This should add more colour to concerns that Europe’s largest economy is being hurt by the standoff with Russia and the lack of momentum in the wider Eurozone economy. In the US there is the Markit Flash Services and reports on durable goods, employment, housing, spending and the second estimate of Q2 GDP growth for the US economy.
There is a raft of economic data from Japan on Friday which should provide an update on the progress of Shinzo Abe’s reflation strategy, with reports on retail sales, unemployment, consumer price inflation, housing and industrial production. There is a sense that the ‘Abe effect’ is waning, with calls for faster structural reform and more aggressive monetary policy from the Bank of Japan (BOJ). However, the BOJ are maintaining a more optimistic view for the economy, expecting Japanese exports to pick up, and therefore see no reason to add to their already aggressive stimulus package.