Market
volatility update 25 May 2012
What’s happening in Greece?
In the May elections,
anti-austerity parties did better than expected, but no party could form a
government. This has led to fears that Greece isn’t committed to the debt-cutting
measures it promised as a trade-off for bailout funds from European policy
makers.
Fresh elections will be held in
mid June, and it’s unclear what the outcome will be. If an antiausterity
government is formed, and the European Union doesn’t provide further funds, the
Greek government will soon be unable to pay its debts (a large chunk of which
are owed to banks in Europe and the European Central Bank).
If this happens, Greece may
choose to leave the eurozone or be forced out.
Why does it matter if Greece exits the
eurozone?
What’s worrying investors mostis
the possibility of a ripple effect from a Greek default and exit. Other
European countries – Spain, Italy, Portugal and Ireland – are also in a lot of
debt.
Spain and Italy are larger economies
than Greece, and their debts, which are much bigger, are held by banks and
investors worldwide. The Italian government bond market is one of the world’s
largest.
If these countries default on
their debts, the losses would be felt by banks internationally. They’d be less
willing to lend, further dampening global economic growth at a time when
several European countries are in recession and the US economy is still
recovering.
What’s caused the market volatility?
With the uncertainty in Europe,
investors have become very nervous. They’ve reacted to each piece of news about
new developments, causing swings in investment markets.
With all the focus on Europe, what about the
US?
While the media focus is on
Europe, it’s important not to forget the two largest economies in the world,
the US and China.
Growth in the US economy is solid
but not spectacular. Employment and consumer spending are looking better and
there are some positive signs in the housing market.
How is China performing?
After a period of very strong
growth, China’s economy is slowing. It’s unclear how far and fast the slowdown
will be. However, if growth starts to weaken seriously, policy makers in China
can act quickly to stimulate the economy.
How does all of this affect Australia?
We’re not immune to these global
concerns. Our sharemarket has recently seen similar levels of volatility to
international markets.
A slowdown in the rest of the
world, and particularly in China, could hurt our exports. If there’s an international
shortage of loan funds, our banks will face higher funding costs.
But there are good reasons to be
optimistic about Australia’s position. There’s still a strong pipeline of
investment, especially in the resources sector. The government’s finances are
much healthier than in most countries, and our banking system is strong. Policy
makers have room to cut interest rates further to keep the economy growing, if
necessary.
Why has the Australian dollar been volatile?
Our currency has long been an indicator
of the level of global confidence. When there are threats to the global
economy, investors move to “safe haven” currencies, such as the US dollar, and
our dollar falls.
How could interest rates be affected?
When the Reserve Bank of
Australia makes decisions on interest rates, it considers risks to global
growth as well as Australia’s inflation outlook. So if the global economy
continues to
weaken, the RBA is likely to cut
rates further.
Lower interest rates are good if
you have a variable interest rate mortgage or invest in bonds. However, if you
invest in cash or short-term deposits, your returns will fall.
So what’s the outlook?
The future remains uncertain, as
there are several paths the situation in Europe could take. The problems facing
Europe have been bubbling away for almost three years and it will be some time
before they’re resolved. You can expect sharemarkets to remain volatile until
the outcome is clearer.
However, the long-term outlook
for European countries certainly isn’t all bad. History shows that the
countries in similar situations eventually recover and grow again.
Despite the current market
volatility, we believe shares still offer reasonable potential returns over the
medium term – better than bonds, cash or property.
Indices:
The
All Ordinaries Index has moved down over the past week decreasing -16 points (or -0.4%) since closing last
Friday to end of trade Today.
The
rest of the world as measured by the MSCI index is up +13 points (or +1.1%) from closing last Friday to end
of trade Thursday.
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