The banking crisis in Cyprus comes as a sharp reminder of just how fragile the global economy remains. For the first three months of this year and in the later part of 2012, most of the market talk has been about the rally in equities and, as a corollary of this rally, how the bond market was on the cusp of imploding.
Well, it just took a banking crisis in the middle of last month in Cyprus, Europe’s third smallest economy, to send a sharp reminder that such talk is premature, to say the least. In the US the yields of 10-year bonds fell sharply from 2.05 per cent to around 1.80 per cent (resulting in significant price increases) and in Australia 10-year bonds fell from 3.7 per cent to 3.4 per cent.
No bond market implosion there. And interestingly, notwithstanding the rise in Aussie yields since the middle of last year, the Aussie bond index returns have been flat, with many active managers producing positive returns and respectable income yields.
Even before this latest crisis, PIMCO was firmly of the view that interest rates in the core markets of the US, UK, Germany and Japan will remain pinned at low levels for the next three to five years. In Australia, too, market talk suggests the next move by the Reserve Bank would be down, not up.
The simple fact remains that both here and in the major overseas economies there simply isn’t the continuous flow of strong economic data to indefinitely support the current share market rally – and commodity prices are one indicator of this.
Copper, often cited as a good barometer of economic activity, is trading at its lowest price since August last year. Other commodity prices are well off their highs. Reinforcing this trend was a recent number out of the US showing the Institute of Supply Managers index for the services sector falling to 54.4 points in March from 56.0 in February, below the market consensus estimate.
Like Cyprus, this number tempered some of the optimism surrounding the favourable economic news that has been coming out of the US in recent months.
PIMCO does not dispute there will be some good economic numbers coming out of the US, and possibly even some countries of Europe. But the news will be patchy, at best, and markets will remain volatile. And events such as Cyprus simply reinforce the economic fragility – and skittish investor mood.
Finally, it’s worth noting in Australia that the recent share market rally has been driven by investors looking for yield – not capital growth. The major recipients of investor favour have been the fully franked and gilt-edged stocks such as the banks and Telstra. No great investor optimism there about an economy about to take off – just a search for income in uncertain times.
Peter Dorrian is head of global wealth management at PIMCO Australia
