SOURCE: BMO Private Bank

May 16, 2013 07:15 ET

BMO Private Bank June Financial Market Outlook: Global Fiscal Policies Continue to Impact Financial Markets

CHICAGO, IL--(Marketwired - May 16, 2013) -

  • U.S. grappling with fiscal cliff and sequestration repercussions while Eurozone deals with austerity fall-out
  • Stocks rise as U.S. Treasury yields sink to new lows
  • Emerging equity markets are outperforming the S&P 500
  • IMF recommends imposing capital controls

From U.S. sequestration spending cuts and European austerity measures, to manufacturing setbacks in China, the uphill global economic recovery has gotten steeper over the past few months. And, according to BMO Private Bank's June 2013 Outlook report, financial markets are reacting swiftly.

Highlights from the report include:

U.S. Continues to Feel Repercussions from Fiscal Cliff Debate

The United States continues to be plagued by the after-effects of the fiscal cliff payroll tax increases and sequestration spending cuts that went into effect in early 2013:

  • U.S. disposable income adjusted for inflation fell to a 5.3 percent annualized rate -- the largest quarterly decline in disposable income since the third quarter in 2009.
  • U.S. government expenditures, particularly on defence, declined at an 11.5 percent annualized rate -- the 10th quarterly pullback in 11 quarters.
  • U.S. exports to the European Union declined at the same time S&P 500 companies were trying to keep sales growth intact.

"On the bright side, U.S. jobs grew by 165,000 new workers and the Dow and S&P 500 indexes rose to record highs," said Jack Ablin, Chief Investment Officer, BMO Private Bank. "These trends show that for all the economic data being published, markets are focusing first and foremost on job creation."

International Woes Influence Income Markets

Income markets have been affected by events from around the world and the release of various troubling economic reports has put the International Monetary Fund (IMF) on alert. Key market influencers indentified in the report include:

  • U.S. Treasury yields sinking to new lows in 2013 and the yield on the benchmark 10-year note slipping to 1.62 percent in early May.
  • Manufacturing and services in Europe contracting for 15 consecutive months.
  • Investor confidence being shaken by Italian political turmoil and the Cyprus bailout.
  • Bank credit extending to China's private sector, representing 135 percent of the country's gross domestic product -- the highest among all emerging-market economies, according to Fitch credit rating agency.
  • Japan's new monetary policy measures plunging the yen more than 20 percent against most developed currencies since November 2012. This is causing Japanese investors to buy sovereign bonds elsewhere, pushing bond yields down around the world.

"The IMF has expressed concern that the recent liquidity surge could create asset bubbles," said Ablin. "It also recommends imposing capital controls such as minimal holding period on bonds, taxes on capital inflows, and measures to dampen spiralling home prices. As the world economy recovers, Southeast Asian governments would be well advised to prepare for an eventual capital withdrawal."

Equity Markets Prevail

Stocks became unglued to the economy this year as investors sought alternatives to the yields offered on bonds:

  • The S&P 500 is nearly 14 percent higher compared to this time last year.
  • While economically-sensitive sectors like materials and technology are trailing, healthcare led with a 19 percent gain and consumer staples following closely behind with an 18 percent gain this year.
  • Earnings grew by roughly two percent year-over-year, with more than two-thirds of reporting companies beating their earnings estimates.
  • Small cap stocks however stagnated this quarter, the Dow Jones UBS Commodity index shed 6.5 percent, and gold plunged nearly 20 percent in the past six months.
  • Emerging equity markets have been outperforming the S&P 500 since early May.

EU's Austerity Measures

The determination and resolve by the European Union's fiscal and monetary policymakers has bolstered confidence among lenders, however the measures continue to produce mixed results:

  • Eurozone bond yields have steadily declined as systemic worries abated, cutting in half the yield differential between Italian and Spanish debt.
  • The Euro strengthened by more than eight percent against the U.S. dollar.
  • However, the increased pressure to revitalize Europe has given way to a growing anti-austerity movement.

"The paradox of austerity occurs when an entire trading bloc imposes cost-cutting and wage deflation simultaneously, halting expert-led growth," said Mr. Ablin. "Eventually, pressure will build on European policymakers to enact similar steps as the Bank of Japan, sending the euro lower against the dollar. We will see how this plays out; however, we warn against an economic race to the bottom as policymakers could just find the global economy there."

To view a copy of the report please visit:

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