Windows cleaned, accounts dressed? Pardon me for being cynical at the rather obvious nature of this announcement from struggling engineering group Downer EDI this morning. A day after fluffing a denial of media reports of cash flow problems in its troubled works division and casting doubt on the rest of the company’s finances, the company announced the sale of the remaining 49% stake in MB Century Drilling to MB Holding, the 2007 buyer of 51%. Downer will get an $88 million  “cash inflow” for the stake, which will help repair any holes in cash flow, and book a $5 million profit (after an $10 million impairment charge was taken earlier). Is this what the cynics call end-of-financial-year window dressing? Should the Downer EDI management get a job at Myer or David Jones doing their shop windows? The company’s market value has fallen from $3 billion at the start of this year to less than $1.3 billion.

Cue the crunch, mark 2? So now for the interesting stuff. Tonight all those Greek sovereign bonds drop out of various market indices and the European Central Bank offers three months liquidity as well. Tomorrow €442 billion of ECB liquidity to 1121 European bank ends and the ECB will offer six days liquidity to those banks wanting it, while Spain sneaks in an auction of five-year bonds (the amount hasn’t been determined.) It won’t be just another quiet day on the market, normality is not the name of the game, it will be the most stressful time for the global financial system in more than a year. Investors in Spain are very worried, their share market dropped a nasty 5.5% overnight, London was down 3.1%, Wall Street, 2.6% to 3.8%. The Standard and Poor’s 500 is now at a new 2010 low and is falling like a stone towards 1000 points again.

Safe havens please: So that’s why investors and others worried about today and tomorrow have been bolting for safe havens such as the US dollar/US bonds, Swiss francs and Japanese yen, and why key bond rates in America and Japan have fallen to levels normally associated with a recession (well, they were about these levels in 2008 and early 2009 when we have the GFC and great slump). All this might sound a bit esoteric, but look at the ASX today and you will find it down sharply on the last day of the financial year as super funds finish with much smaller gains than they thought three months ago.

Who said Greece wouldn’t hurt us? In fact this quarter will wipe out much of the gains from the first nine months as worries about Greece became concerns about Europe and the euro, the US economy slowed, as did China and Japan. The impact of the resources tax brawl looks tiny. The 10% fall in global copper prices has done more damage to BHP and Rio share prices than the tax brawl has done, while the 23% drop in spot iron ore prices in the past two months is telling us that Chinese demand is slowing. Remember all those know-alls who said Greece was too small to hurt Europe, or Australia? It all adds up.

Price pressures? Not only is there no inflation to worry about, there are signs deflation is around the corner for the US and Europe. The Fed and the ECB can’t do any more to boost their economies, except the latter has to keep a huge pool of liquidity available for banks, buying government bonds and other securities, as well as for national governments such as Spain, Greece and Portugal. So we shouldn’t underestimate the impact of the very sharp fall (plunge?) in the US Conference Board’s Consumer Sentiment survey. It made a mockery of the rise in the other US survey from Reuters and the University of Michigan.

US consumers glum/gloomy: The Conference Board survey reversed three months of rises to drop to 52.9 from 62.7 in May. The Present Situation Index decreased to 25.5 from 29.8. The Expectations Index declined to 71.2 from 84.6 last month. In comments, Lynn Franco, director of The Conference Board Consumer Research Centre said: “Consumer confidence, which had posted three consecutive monthly gains and appeared to be gaining some traction, retreated sharply in June. Increasing uncertainty and apprehension about the future state of the economy and labor market, no doubt a result of the recent slowdown in job growth, are the primary reasons for the sharp reversal in confidence. Until the pace of job growth picks up, consumer confidence is not likely to pick up.” Sounds a bit like what the Fed said after its meeting last week.

Where’s the inflation? All those know-all inflationists tell us that high levels of government spending will cause inflation. Well, we are now approaching the start of the second year of recovery in some economies (the US and Japan) and yet inflation is at near-record lows at less than 1% in the US and Europe and Japan has to live with deflation. The US 10-year bond yield fell under 3% last night and closed at 2.96%, the 30-year long bond in the US dropped under the 4% level to end about 3.94% and the two-year bond yield hit an all-time record low of 0.594 and finished about 0.60%, which was also the lowest close on record. The three-month note finished at 0.13%. It was lower in the crunch and briefly went negative. Japanese government 10-year bonds fell to 1.11%, a seven-year low, the Swiss franc hit an all-time high against the euro.

Shanghai blues: China’s main share index dropped 4.3% to close at a 14-month low yesterday, led lower by financial stocks as investors fretted about the growth outlook for the second half, while also digesting the implications of Agricultural Bank of China setting a lower price range for the Shanghai portion of its IPO. That means foreigners such as Kerry Stokes will have to pay more for their stake in the Hong Kong part of the bank’s issue. Later today we will get a couple of surveys of Chinese business and manufacturing sentiment, one government, one private. Any signs of a softening in their numbers will spark another round of doubt about Chinese economic health. Shanghai is now down 25% from its high of late last year and 23% this year as investors there worry about property companies, bank bad debts and growth.

Japan cooling: And with China worries affecting markets, look at Japan where the rebound seems to be faltering. Retail sales growth slowed last month, industrial production fell and unemployment rose to 5.2%, the highest since last December. These reports were all worse than the market had expected. Exports rose in May, but the growth rate was down on April. Prices remain negative, but the deflation’s grip on the economy seems to be easing. Japan and China are our two major export markets, so if they are cooling, or even just steadying, a lot of the enthusiasm for iron ore and coal will vanish.

So what about Australia? Everywhere there are now worries that if the major economies aren’t lumbering towards a double-dip slump, they are headed for a quarter or three or four of low growth and low inflation verging on deflation. Australia faces the prospect that if the Consumer Price Index for the June quarter (released late next month), shows an expected rise in price pressures, then the RBA may push rates up at its August meeting. We know the central bank won’t move next week at its July meeting, but there’s still billions of dollars of income flowing into the economy from those huge iron ore and coal contract price rises.

Why are bonds falling? But ask yourself, if inflation is a worry in Australia, why have our 10-year bond yields fallen from 5.855% in mid- April (when markets peaked) to about 5.140% yesterday? That’s a fall of more than 0.7%, and it’s why a couple of lenders have started edging down long-dated fixed rate home mortgages. But you don’t see any of the guru commentators looking at that fall and wondering why. All too hard when it’s easier to write about politics. Australian 10-year bond yields are now around their lowest for more than 13 months. Our economic recovery has been more sustained than overseas, and price pressures here are higher as a result. But the bond market seems to be on a different page at the moment.

Peter Fray

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Peter Fray
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