Three keys for financial markets

Earlier signs have been mixed. Growth in China is clearly slowing down, with the latest figures for economic growth (measured by gross domestic product, or GDP) in the second quarter coming in at 7.6 per cent, the lowest level in three years. 

However, there are also some signs that China’s slowdown is starting to stabilise. Policy-makers have started to implement monetary and fiscal policies to support growth, with plenty of room to do more. Inflation pressures are also declining significantly, which would further enable easing measures. Hence it still appears likely that China’s economic growth in the second half of the year would rise back to above the 8 per cent level. 

With the GDP release out of the way, markets will closely monitor further economic releases from China, such as the purchasing managers’ index surveys and consumer price inflation. 

The second issue is monetary policy in the United States. Markets have been considering the possibility of a third round of quantitative easing (popularly called QE3) for the past several months, as US economic figures have appeared to be weaker than expected (for example, unemployment remains stubbornly high at 8.2 per cent). 

QE3 would not be a panacea for the US economy, which seems likely to remain weak for some time. But it would impact financial markets by boosting liquidity and leading to a bias for a weaker US dollar. 

The Federal Reserve has appeared rather reluctant to implement QE3, and markets are not pricing in this measure at its next policy meeting in early August. However, if key economic figures (such as non-farm payrolls, or the Institute of Supply Management surveys) remain weak in the next few months, then a launch of QE3 after that becomes likely. 

The third issue is, of course, Europe. There remains a huge disparity within euro zone debt markets. Recently two-year bond yields at the stronger economies such as Germany, the Netherlands and Finland have actually turned negative – showing exceptionally strong demand for those notes. Meanwhile, bond yields at peripheral nations such as Italy and Spain remain high and worrying.  

Talks continue on numerous issues – recapitalising Spain’s banking sector, increasing the firepower of the euro zone rescue funds, moving towards greater fiscal integration, and creating a common banking regulator. 

The weaker Eurozone nations also continue to face a key dilemma – how to boost the economy out of recession in the short-term, while ensuring that public debt does not balloon unsustainably in the longer term. 

All these are challenges that cannot be solved anytime soon, and the European situation will continue to act as a damper on market risk appetite. Further negotiations on debt levels and austerity packages for countries such as Greece and Spain are likely. Like Peter Parker, the euro zone peripheral nations realise that the best promises are the ones you cannot keep. 

 

Parson Singha is chief markets strategist in the Global Markets Dept at HSBC Thailand.