By ROBERT HARLEY 01/07/2010
A busy month for markets, and on the economic front...
At home the Government announced their long awaited emergency budget - much in line with expectations. Whilst the new independent Office for Budget Responsibility (OBR) subsequently revised down UK growth expectations, many commentators were sceptical of the ability of the UK economy to achieve these new targets. We have some sympathy with this view, driven more by the precarious nature of the global recovery. Either way the outcome is highly uncertain, something the OBR also acknowledges.
The Toronto G20 summit ended with arguably mixed results. Some countries wanted to adopt deficit reductions immediately; others feared this action would slow or maybe halt the recovery. In the end both parties claimed victory by agreeing to "a growth friendly consolidation strategy" (with some country specific exclusions). What caught the headlines prior to Toronto was the announcement that China would relax its peg to the US dollar following political pressure from the US. We expect any revaluation is likely to be limited, given the renminbi is also grappling with a weakening euro.
In spite of the announcement of the Eurozone €750bn rescue package in May, spreads on Greek, Spanish and Portuguese debt continued to widen. Concerns over the solvency of European banks have also returned. The European Central Bank (ECB) has responded by announcing the implementation of stress tests in an effort to allay market concerns. Transparency and credibility of these tests results are likely to be a major condition for the return of confidence to markets.
In the markets, US Treasury and UK Gilt yields have been strengthening throughout the month suggesting inflationary pressures (and growth prospects) are likely to be more muted going forward. Equity markets have responded to this lower growth scenario by falling through what were perceived to be major support levels. On a more positive note, the historical yields of the major UK and European equity indices are now offering a clear premium over Bond and Gilt yields and appear cheap on all historical valuation metrics. Sell-offs in equities may well prove to be good buying opportunities, although markets are likely to remain volatile.
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