A tad weaker on growth, Greek debt in focus: NBK

In the second quarter of the year, attention shifted back to the some old lingering problems and risks: the sovereign debt woes in the EU (Greece in particular), the budgetary/debt process in the US, and the questions surrounding the end of quantitative easing (QE2) in the US. Also in recent months, data from the globe over pointed to softer growth worldwide, but particularly in the US, the world’s largest economy. Equity, fixed-income, and commodity prices reacted accordingly by coming off their post crisis highs. Markets and policy makers are now in the process of assessing the second half of the year: how severe some of the issues are and how temporary (or not).

The US economy grew 1.8% in 1Q2011, after 3.1% growth in the prior quarter; the slowdown was also evident in retail sales and employment data among others for 2Q2011. Retail sales fell 0.2% in May, while the nonfarm employment gains were a very meek 54k in May as well and unemployment inched up again to 9.1%. The Fed Chairman Ben Bernanke believes that the witnessed slowdown is temporary and that the economy would perform better in H2, though not spectacularly. The hope is that the impact of weather, higher oil prices, the Japanese earthquake and the like would fade in time. Similarly, on the inflation front the Fed Chairman believes that higher CPI inflation rates, 3.4% y/y in May, are neither indicative of underlying pressure nor worrisome (as the “core” CPI stayed at 1.5% y/y).

The above assessment by the Fed Chairman pointed the markets in the direction of “no Fed policy change” in the medium-term future, and it further suggested that QE2, lapsing in June, would not give way to any imminent QE3. These prospects and the more cautious outlook, combined with renewed news/rumors about a potential “restructuring/rescheduling” by Greece prompted a retrenchment from the riskier asset classes. Things could calm down somewhat, as Greece is poised to pass new austerity measures and thus to get the second tranche (12 bn Euros) of its current rescue package as well as a needed new financing/rescue package.

In that light, the Dow Jones Industrials index came off 12800 in late May, towards the 12000 level, while US 10-year Treasurys went from yields over 3.50% in February to under 3.00% currently. Commodities similarly, appeared to stall from their latest bull run.

The Fed is now likely to just replace maturing assets on its balance sheet, keeping it at current levels as opposed to increasing its size. Official rates, fed funds at 0-0.25% are in place for the medium term, while reducing the balance sheet or increasing it (QE3) would require a drastic change from the current environment. The European Central Bank is also proceeding cautiously given the economic and debt problems of peripheral Europe. The market does expect however a second 25 bps hike in the official rate (to 1.50%), perhaps as early as July, primarily on the back of rising inflation rates in Europe, above the ECB’s comfort zone.

The major rating agencies raised concerns over the US debt situation, in particular the need to raise the US government debt limit that is expected to constrain the US Treasury by early August. The IMF is, of course, also urging everyone to put their fiscal houses in order, in particular the two huge economies of the US and Japan.

Emerging markets are also exhibiting signs of (expected) slower but still healthy growth for the second half of the year. Survey of purchasing managers indicate as much. In the GCC, oil prices remain well supported at $115-120 pb (Brent basis). These prices are well above budgeted prices and break-even oil prices for the GCC and thus continue to support vast government spending programs. Those programs are expected to support real GDP growth of 7.0% in the region led by stronger double digit growth in Qatar.