Market comment: Premature market euphoria gives way to sober realism

There has been a genuine improvement in market sentiment, but it is difficult to justify US and European stock market gains of around 30% since early March. Further declines can be expected, even if the lowest point in the bear market is behind us.

The gap between Libor and overnight rates has fallen below levels last seen before the collapse of Lehman Brothers. This shows that the stimulus injected by the central banks is helping the money markets to function better. But recent increases in risk appetite are excessive and potentially dangerous, given the enormous scale of toxic assets in banks’ balance sheets.

Unemployment
US jobs fell “only” 539,000 in April, less than expected and the smallest monthly decline since October 2008. But, at 8.9%, the US jobless rate was the highest since September 1983.

Europe and Japan are sinking even more sharply than the US. In China, investment and retail sales are now rising, but exports are still falling sharply. Overall, talk of global recovery is premature.

Inventories were slashed worldwide, indicating recent improvements in real activity may be temporary. A sustained recovery requires stronger final demand, but spending by firms and individuals will be hampered for years by the need to reduce debt and repair weak balance sheets.

Inflation
Bond yields and commodity prices may signal fears over rising medium-term inflation, but in the near term, inflation is falling, with the US, Japan and China experiencing deflation.

Countering recession is still the policy priority. In the US, the Fed remains forceful, and the European Central Bank, after cutting rates to a record low 1%, pledged to buy e60bn in covered bonds issued by eurozone companies as part of a credit easing programme.

The Bank of England expanded its £75bn quantitative easing programme to £125bn, because of the fragility of the world’s banking system. There is now hope that we will avoid a 1930s-type slump. But risks of a Japanese “lost decade” remain very serious.

David Kern of Kern Consulting is economic adviser to the British Chambers of Commerce. He was formerly NatWest Group chief economist