Central banks hog the limelight

Last week, every major central bank had something to say.

As a result, macroeconomics and monetary policy drove markets.

First up was the Reserve Bank of Australia, which decided to cut interest rates by 25 basis points last Tuesday from 3.75% to 3.5%.

A few hours later, Mark Carney and the Bank of Canada announced the overnight lending rate in our country would remain unchanged. This wasn’t a surprise, as few economists, if any, expected a rate increase. However, in the statement that accompanied the decision, Carney said, “The outlook for global economic growth has weakened in recent weeks. Some of the risks around the European crisis are materializing and risks remain skewed to the downside. This is leading to a sharp deterioration in global financial conditions.”

We continue to believe interest rates will not rise in Canada until 2013.

Last Wednesday, the European Central Bank left interest rates unchanged, which disappointed some investors as the market had been looking for either a rate cut or a hint that one could materialize soon.

Finally, on Thursday we had a triple whammy of Central Bank news as the Bank of England decided to keep interest rates at 0.5%, the Chinese surprised some investors by cutting interest rates for the first time since 2008 by 25 basis points to 6.31%, and Fed Chairman Ben Bernanke testified before a Congressional Committee.

The market was expecting Bernanke to drop a hint that further quantitative easing was on its way, but he didn’t and gold prices fell as a result. What confused the market further was that comments from other members of the Federal Open Market Committee had been interpreted to suggest earlier in the week that more accommodative policy was a distinct possibility.

As noted, gold had a bumpy ride this week falling off the highs reached last Friday thanks to the comments from Bernanke, WTI crude oil prices didn’t move a great deal by the end of the week, and the Canadian dollar managed to gain about a cent, closing around the US$0.97 level.

QE or no QE?

So with Central Banks moving to the forefront over the past couple of weeks, it’s not surprising to see gold prices used as a proxy for potential moves in monetary policy.

To understand this, all we have to do is look at the price of gold over the past few days. Gold prices had recently been in a slump as investors thought the likelihood of a third round of quantitative easing, or QE3, from the Federal Reserve was unlikely after the first quarter of 2012.

However, after a relatively disappointing U.S. employment report last Friday, gold prices jumped almost US$85 per ounce intraday as the market increasingly believed that the Federal Reserve would have to step in soon to stimulate the U.S. economy by providing more liquidity.

Such action would result in the printing of more money, which would have weakened the U.S. dollar and strengthened gold prices. However, on Thursday, gold prices fell US$50 intraday after Ben Bernanke’s speech to a Congressional Committee did not suggest that new QE3 policies would materialize in the immediate future.

Click through below to read about the trading week ahead.

Trading week ahead

With few influential companies reporting earnings next week, the focus of the market will likely remain on macroeconomic factors and two countries in particular, as news flow out of Spain and Greece will only increase in the coming days.

The Greek election is a week away, and while we won’t see any more polls, the discussion over the possible results and their consequences will only intensify until the winning party is revealed on the 17^th. That’s when we’ll know whether or not a coalition government can be formed.

We also expect the market will continue to digest a lot of this week’s monetary policy news, especially as China is expected to announce a number of key economic statistics on Friday night. While Bernanke may not have indicated that QE3 is coming, we don’t believe this option has been removed from the table and likely won’t be until we get a better picture of what’s going on in the European periphery.

While the Federal Reserve can’t do a lot to help Europe directly, it may be called to action if the problems across the pond start to have indirect consequences in North America.

That said, gold prices will remain in focus amongst commodities while oil and base metals will be influenced by the Chinese data and U.S. retail sales. The Canadian dollar has held firm at current levels, but will be vulnerable to any currency trade flow that sees investors continuing to move away from the Euro and into the U.S. dollar.

Is the China story over?

China cut interest rates this week by 25 basis points for the first time since 2008.

While the China story isn’t over, we will concede that growth is slowing and that the best years of China’s explosive growth last decade have come to an end.

Read: Canada’s fortunes tied to China’s

But that is not to say that growth will not continue or that demand for resources will disappear overnight. We believe China is in the midst of transitioning from an economy that has relied predominantly on exports to one that will see increasing consumption and investment domestically.

Diversifying economic growth like this is a good idea; however, it is a process that is measured in years. Therefore, it is logical that we should see some “growing pains” in China as this transition occurs.

Of course, complicating matters has been the poor economic performance of Europe and the United States. These two regions do a material amount of trade with China, so naturally Chinese exports have been affected, resulting in lower demand for a number of commodities.

We have noted in the past that China has both monetary and fiscal policy tools at its disposal to help stimulate economic growth. Naturally it would be great if the Chinese government did not have to use these tools, but it is reassuring to know that politicians and policy makers do have options as they confront economic headwinds.

Read: Portfolio managers bullish on China

Eventually the economic cycle will lead us to a global expansion and when that does occur, we expect demand in countries such as China to rebound. Admittedly, when such a rebound will happen is subject for debate, but if the Chinese can get exports moving again and see internal wealth converted into domestic consumption, then GDP growth should have an easier time remaining in the 8% range, if not higher.

Considering the population of China alone, along with the large populations of other emerging countries, we believe resource demand will continue to climb over the long run. So, we don’t believe the China story is over, but China will need some time to diversify its economic expansion which will serve to put it in a position to grow over the next few decades.

Gareth Watson is the Vice President, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends. @Gareth_RGMP