A second is that the global economy is also proving to be surprisingly resilient, a point discussed below, and a third is, or could be, that, if commodity prices come further off the boil - and oil prices especially drop swiftly - inflation expectations will moderate. This should push bond yields down, not up, but the lower inflation will also be reversing the present squeeze on real disposable incomes and profit margins from higher commodity prices and so boost growth without the need for more immediate cuts in interest rates.
On the resilience of the global economy, this is all the more surprising in view of the credit crunch, the weakening housing markets on both sides of the pond, the rise in oil prices to levels few dared to imagine and the steady downward lurch in consumer confidence.
Just looking at the US, where first quarter GDP growth was revised up, much of the economic news for the start of the second quarter has been better than expected. The April ISM surveys were better than expected (the manufacturing survey was below the water line but still better than expected), as were the April Non-Farm payrolls, retail sales - ex autos, housing starts and durable good orders.
Also, the chart shows that exports continue to grow strongly in contrast to the weakened state of the domestic economy and weak import growth. The dollar’s competitive position has, no doubt, helped net trade but the strength of US export growth also reflects the decoupling in the global economy - in particular, that by the developing economies, a number of which, including China and India, are still growing more strongly than expected.
For government bond markets the take-away is not that interest rates need to rise but that the case for more immediate cuts has suddenly become less pressing than it was a short while ago. The ECB has been unwavering in its message that monetary policy should focus on stabilizing inflation and not stabilizing output and, as both sets of minutes from the last FOMC and MPC meetings show, the BoE and the Fed are now keen to impress upon the markets that they share the sentiment. Bond markets have been adjusting to reflect the sentiment but look a little oversold now.
On equity markets, their rebound from the mid-March lows pushed several sectors, notably Oil and Mining, among others, into overbought conditions of varying degrees, and some profit-taking was due. But do equity markets deserve to be lower? I don’t think so. They were discounting a lot of bad news in mid-March and still are, as the chart below shows.
Some might argue there is more of an earnings’ wreckage to come but I’m not sure there has been an earnings’ wreckage. Against a quite difficult backdrop, US corporate earnings - ex financials - still managed to grow by 7 percent last quarter and consensus earnings estimates point to something similar for the current quarter.
Also, thanks to the Fed’s astute policy response, the destabilizing feature of the credit crisis is no longer present though one can’t help feeling the volatility has only been suppressed and could easily return with a vengeance. But isn’t that the wall of worry that equity markets climb? If commodity prices are coming off the boil and oil prices tumble, this could kick start equity markets into another rebound.
