The Short View: Braced for very bad news

By Philip Coggan, Investment Editor

06/13/06 " Financial Times" -- -- Another day, another bout of jitters on global equity markets. This time round, it seemed to be a rash of hawkish statements from Federal Reserve governors that convinced investors more US rate rises were on the way.

The extent of the Fed’s anti-inflation rhetoric is such that some analysts are looking beyond this month’s meeting. “We now think that the Fed will raise the funds rate by 25 basis points at the June meeting, and possibly at the August meeting,” says Richard Berner, US economist at Morgan Stanley. “(This) will pose a continued challenge to risky asset markets.”
That investors were braced for very bad news from the economic data was shown by the release of the US producer price index numbers. Even though the core index rose 0.3 per cent in May, slightly more than expected, equity markets rebounded after the announcement, since even worse had been feared.

The recent swing in sentiment was shown by Merrill Lynch’s monthly poll of fund managers which found that 61 per cent expected the global economy to slow in the next 12 months, compared with 40 per cent in April. The proportion of managers who are overweight equities has fallen from 66 to 54 per cent in the same period.

The most dramatic change in sentiment has been in Japan where the Nikkei 225 index is down 17 per cent since May 9 and 11 per cent on the year. Many global investors were caught out by the strength of the Japanese market last year and were forced to chase it this year. It looks as if this “hot money” is being swiftly withdrawn. But the Japanese market’s decline may have a silver lining. It may mean the Bank of Japan will be slower to raise interest rates, which will reduce the potential monetary squeeze on the global economy. Hugh Hendry of the Eclectica hedge fund says the markets are a bit of a paradox just now. Many investors are worried about inflation – but they are too early. He believes the US economy is about to have a sharp slowdown that will cause the Fed to slash interest rates. That may cause inflation in the long run but will be hugely beneficial for Treasury bonds in the short term.

philip.coggan@ft.com

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