Global Recovery is Gaining Traction

The mood on the equity markets remains buoyant. In March, global equitiesrose by no less than 7.2%. April has so far seen this trend continued. The riskier credit markets are in good shape, with risk premiums falling across the board.

One major reason behind the positive mood is the favourable economic indicators. These show that the economic recovery is spreading. In addition to the emerging markets, some of which have already shown signs of slight overheating, the economic recovery is strongest in the US. The news that, for the first time since 2007, the US saw a substantial number of new jobs in March was greeted with enthusiasm.

Greece continued to dominate the headlines over the past few weeks. Government leaders had already announced that they wanted to prevent thecountry going bankrupt. However, doubts persisted on the financial markets and the yield on 10-year Greek government bonds rose to over 7%. Euro country leaders recently reached a deal to lend Greece up to EUR30 billion (at a rate of about 5%). Financial markets still seem not convinced; yields on Greek government bonds remain elevated.

Over the past few weeks, economic indicators have painted a largely favourable picture. The US was a particular source of highly-encouraging news. The most noteworthy was thatthe US labour market has seen a rise in the number of jobs for the first time in a long while. In March 162,000 new jobs were created, while the figures for January and February were adjusted upwards. The unemployment rateheld steady at 9.7%.

The two ISM indices, which are a good indicator of corporate America’s confidence in the economy, both displayed a healthy increase. The ISM manufacturing index rose from 56.5 to 59.6 in March, its highest level since July 2004. The index for the service sector rose from 53.0 to55.4 in March, its highest level since May 2006. The latter confirms that the economic recovery has continued to spread from manufacturing to the service sector. This is encouraging as the service sector represents a much larger portion of the US economy than manufacturing. It may also indicate a boost to domestic demand, as the recovery in manufacturing is still largely due to corporate stock replenishment and the recovery in exports.

The improvement in the labour market is of course good news for US consumers. Consumer spending has beenreasonably healthy over the past few quarters, but this was to a considerable extent driven by income gains derived from government transfers. This is not a sustainable situation and any further growth in consumer spending will crucially depend on labour income developments.

Greece’s debt problems continued to be the focus of attention for the media and the financial markets over the past weeks. Nevertheless, the country’s problems do seem to have abated somewhat. During the weekend of 10 and 11 April, euro zone ministers of finance reached a deal on an emergency loan of EUR30 billion on a bilateral basis, at an interest rate of about 5%. On top of that, the IMF will offer EUR15 billion. Incidentally, several days after the deal had been reached Greece raised EUR1.2 billion via a bond issue with maturities of 6 and 12 months.

Although concerns about Greece’s debt financing havedecreased – in the short term – investors have not beenreassured about the impact of the enormous cost-cutting measures which Greece needs to take. These will plunge the country into recession. Other euro countries will also have to cut spending substantially, which will squeeze economic growth in the longer term.

For the time being this will have little effect on the economic recovery in the euro zone as a whole. The PMI euro zone indices, comparable to the US ISM indices, continued their upward march in March and even displayed their largest hike in over three years. The PMI indices inItaly, Spain and Ireland rose to their highest levels since mid-2007. The EC overall economic sentiment indicator continued to rise and hit its highest level in nearly two years. In the euro zone, too, domestic demand appears increasingly to be contributing to the economic recovery, which until now had been chiefly export-driven

Economic growth in emerging markets is also export-driven. Countries such as South Korea, Taiwan, Vietnam and Brazil displayed export growth of over 30% on anannual basis. Compared to a month earlier, growth figures of at least 10% have been reported. These are slightlydistorted, however, due to the ‘Chinese New Year effect’ which kept February manufacturing activity relatively low.

Nevertheless, it looks as if the momentum in global trade is recovering after faltering briefly in January and February. Surprisingly, Chinese export growth was ‘only’ 24% in March. The lower growth compared to Korea and Japan can be explained by China’s own strong import growth. Korea and Taiwan have increasingly concentrated their export activities on China. In March, China also reported its first trade deficit (USD7 billion) in six years. We think this is a one-off and that import growth will slow over the next few months. Export growth should continue at about thesame level.

It was also announced that the non-trade-related capital inflow into China was negative over the first quarter. This is probably due to investor concern about China’s measuresto combat potential overheating of its economy. Figuresfrom March show that the measures to curb lending growth have been effective. Nevertheless, initial estimates indicate that the Chinese economy grew by 11.9% in thefirst quarter compared to the first quarter of 2009. This is the strongest rise in almost three years and an acceleration compared to the 10.7% growth of the fourth quarter of last year. It was also announced that inflation fell in March compared to February. In March consumer prices rose by2.4% on an annual basis, compared to an increase of 2.7%in February. We expect China to continue reversing its financial stimuli, including a return to a gradual appreciation of the renminbi.