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29 May 2023

Economic review: Fragile, handle with care

By Gary Dugan

For just a day, we received the kind of information that would have given us all a boost. For just a day one of the US employment indicators suggested a sharp acceleration of employment growth.

However, 24 hours later the full-scale US employment report quashed any hope that things were getting  remarkably better.

In essence, the US economy is displaying modest solid progress. To our mind the pace of recovery should be sufficient generate reasonable returns from risk asset classes.

Our near-term hope for the equity markets is that good US economic data will maintain the positive momentum of markets. Last week we got a mixture of economic news although generally in the right direction.

On Wednesday, the ADP survey of private sector jobs growth showed a way over consensus increase in new jobs of 200,000.

However, by Friday the excitement had died down as the more important and typically more accurate reflection of current employment conditions the Non-farm payrolls report disappointed.

Non-farm payrolls rose just 100,000 for the month of December against forecasts of 150,000. The unemployment rate fell to 9.4% from 9.8%, although this was more a reflection of fewer people looking for jobs.

Ben Bernanke characterised current conditions as "we have seen evidence that a self-sustaining recovery in consumer and business spending may be taking hold," however, he also commented that the recovery was “still fragile”.

Last week’s other economic data was generally more upbeat with the surveys of confidence in the manufacturing and service sectors generally ahead of expectations. Encouragingly the indicator of new orders accelerated sharply.

The strong end to 2010 in the United States and Europe should be evident in the corporate results season that gets underway in the coming weeks. Unlike the start of the third quarter results season we do not believe that expectations are not set that high.

Analysts expect fourth quarter earnings for the US corporate sector to be flat on the third quarter results yet most of the macro data suggests that a good upswing was underway.


The problems of the Eurozone remain a stumbling block to the markets. The European Central Bank (ECB) was called upon to intervene in the markets to steady investor nerves. Portugal needs to refinance €9.5 billion of maturing debt in April and June. Portuguese 10-year bond yields rose above 7% as the Swiss National Bank confirmed that it had stopped accepting Portuguese government securities as collateral for repurchase agreements.

A Portuguese 10-year Government Bond yield of 7.14% represents the Eurozone era high for any bond market in the Eurozone and a 59 basis point rise in yields over the course of the week.

The financials

Ongoing problems in the financial sector is another issue that we have highlighted as a risk for 2011.

Last week saw more evidence of problems for the banks in the US and the Eurozone. US banks continue to be held back by legal opinions on the foreclosure issues in the US mortgage market.

Massachusetts’s highest court upheld a ruling against US Bancorp and Wells Fargo. The share prices of a number of the US banks came under selling pressure.

The financials in the Eurozone can fair no better as the problems of Portugal and other periphery continue to weigh on sentiment.

Some of the Portuguese and Spanish banking stock prices are hitting multi-year lows. Also the Credit Default Swaps spreads (the cost of insuring debt) of European financials were hitting new highs.

Inflation remains a greater risk for the emerging rather than the developed markets. As we set out before we are tactically indifferent between emerging and developed markets at this time.

We believe the performance of emerging market equities could be held back by high inflation forcing policy makers into trying to slow emerging market growth. In the current week we will see inflation reports from Europe and the United States.

Although inflation will we believe pick up we do not believe it will encourage the ECB or the US Federal Reserve to increase interest rates any sooner. US headline inflation is expected to rise to 1.4% year-on-year, quite a jump on last month’s 1.1%, however core inflation is expected to be subdued at just 0.7%.

In Europe Eurozone inflation is expected to hit 2.2% although again core inflation is expected to remain at the same level seen for some months of just 1.1%.

Whilst we have our tactical reservations about emerging market equities we are more sanguine about emerging market debt.

We saw a structural shift last week when the bond yield of a collection of emerging market credits fell below the bond yield of a collection of developed market European credits.

As we have argued before the much stronger balance sheets of emerging market companies and countries argues for much lower yields in the emerging markets of the new world relative to the debt burdened old world.

We expect the continued outperformance of emerging market debt markets.

Commodity prices

We continue to argue that investors should be more discerning in their commodity investments. With prices having risen so sharply in recent months, some commodity markets could succumb to profit taking unless the fundamentals generate further upward surprises.

This coming week grain prices could receive support from a further round of downward revisions to grain supply and upward revisions to demand from the United States.

While some metals are in better supply/demand balance (such as aluminium) strong demand and low inventories are likely to support prices in the medium term.

The better supported metal prices due to more fundamental supply shortage include copper, silver and gold.

The writer is Chief Investment Officer, Private Banking, Emirates NBD