US MARKET DATA POINTS TO A SUMMER OF CHALLENGES

 
David Morris
TODAY we’ll hear more from Ben Bernanke, as the chairman of the US Federal Reserve delivers his semi-annual monetary policy report to the Senate Banking Committee. He’ll follow this up tomorrow by addressing the House Financial Services Committee. He is likely to remind policymakers that fiscal issues must be addressed, and that they cannot rely solely on monetary measures.

Last week brought the release of minutes from the Federal Market Committee’s (FOMC) meeting on 20 June. The minutes confirmed that the Committee was prepared to take further action if necessary, but suggested that there would need to be a significant deterioration in the US economy before the Fed is prepared to extend its balance sheet with unsterilised asset purchases. Consequently, there now seems very little chance that the FOMC will announce further stimulus measures at its next meeting on 31 July and 1 August. Of course, the June FOMC meeting took place before yet another dire non-farm payroll reading. But it still seems likely that attention will now focus on the following FOMC meeting on 12 and 13 September. Because of this, it could be reasonably argued that further quantitative easing looks increasingly unlikely this year. After all, by mid-September, we’re just two months away from the US Presidential Election. The Federal Reserve could be wary of getting caught up in a political argument by undertaking another controversial round of asset purchases so close to the election. While the Fed could be forced into action by a sudden failure of, say, a major international financial institution, or a rapid escalation in the Eurozone debt crisis, such events are currently viewed as low probability.

Recently, relatively little time and effort has been spent discussing the merits of quantitative easing. After all, the global economic outlook continues to deteriorate, despite unprecedented monetary easing and the implementation of all the unconventional measures taken so far. Instead, the main question being asked is how well risk assets will hold up without additional significant central bank intervention.

In addition, the European Stability Mechanism (ESM) is yet to be fully ratified by Germany. The ESM is the permanent bailout facility, which was due to be operational at the beginning of July. At last month’s EU summit, German Chancellor Angela Merkel agreed that the ESM could be used to bail out Spanish banks directly. Yet, even as she appeared to overcome her previous objections to this use of the bailout facility, Merkel would have been all-too aware that the German Constitutional Court was considering objections to the ESM. Last week, it was announced that the Court will decide if German President Joachim Gaulk can sign the law ratifying the ESM by the end of July. But it could take another three months to decide whether the ESM is constitutional. Investors are assigning a very low probability to non-ratification so, if the Court issues an injunction preventing the President from signing the law, we can expect risk assets to sell off sharply.

Meanwhile, the second quarter US earnings season steps up a couple of gears, with 90 S&P 500 companies set to announce their results this week. Among the big names due to report are Bank of America, Coca Cola, Goldman Sachs, Google, IBM, Intel, Microsoft and Morgan Stanley. It is worth noting that earnings expectations have been massaged down again this quarter, so the majority of companies should again hit analysts’ targets. Assuming that they do, this reporting season should be uneventful. However, global economic conditions have deteriorated significantly over the last three months, so revenues are likely to be weak. This also means that there will be growing concerns about corporate profitability in the second half of the year, as the rate of earnings growth has fallen rapidly over the last 12 months. If corporate forward guidance continues to be downbeat, this could end up being a challenging summer for investors.