What a difference a week makes. July was looking like another steady month of returns for risk takers until the final few days of the month, when investor sentiment turned sour.
As a result, investors missed some important economic data releases, particularly in Europe, where signs emerged of a potential turn in the credit cycle. Weak demand for credit from the corporate sector, as well as an unwillingness on the part of lenders to dole out money, has been a key factor holding back Europe’s recovery.
Encouragingly, the latest bank lending survey from the European Central Bank (ECB) suggested that credit conditions might be starting to change, with both a pick-up in supply and demand for new loans.
Investors’ minds were focused elsewhere, however, as markets digested the new santions against Russia, the Banco Esperito bailout and the deteriorating situation in Gaza/Israel, as well as several corporate profit warnings.
US markets also wobbled, as labour cost data appeared to suggest that inflation pressures were building, igniting fears of an earlier rate hike by the US Federal Reserve, although these were quickly reversed.
The result of all these worries was a spike in market volatility. Between 24 July and 6 August the MSCI Europe Index fell 4 per cent, and the VIX index, which is a commonly used measure of market volatility, jumped by 40 per cent to its highest level since April.
While markets focus on when the ‘big correction’ will come, some of the better economic data is slipping beneath the radar.
The release of the ECB bank lending survey is a case in point. After years of being starved of credit, companies are now starting to find that bank managers in the eurozone are slightly more willing to open their ledgers. For the first time since 2007, eurozone banks as a whole reported that they were making credit conditions easier, not tighter, for European companies.
This comes at a time when corporate demand for loans has moved into positive territory. After many years of balance sheet consolidation, companies are now looking to expand and demand for loans to increase capital expenditure is on the rise.
Despite the fragility of the eurozone economy, the situation has improved significantly over the past 12 months, with business and consumer confidence running very near all-time highs in many countries.
Meanwhile, the rate at which companies can borrow is getting cheaper. The cost of companies to borrow up to ¤1m (£792,000) had its biggest downward move since the middle of 2009. This might not seem like a big deal, but these loans are important for small businesses, which — as in most economies — constitute the bulk of employment and economic output. Any improvement in lending conditions is, therefore, a good signal for future economic expansion.
Borrowing rates declined by even more in the crisis economies of Italy, Spain and Portugal. However, the gap between the cost of borrowing for an Italian company compared to a German company is still very wide, which suggests that the European financial markets are still some way from full health.
Tentative signs that credit is becoming easier to come by will be welcome news to the ECB. However, with the results of the European bank stress tests still some months away, the expansion of credit in the eurozone is likely to remain lacklustre at best.
The ECB obviously hopes that with bank balance sheets on the mend, and with the provision of cheap long-term funding in the form of its targeted long-term refinancing operations, a credit revival will start later in the year.
While markets focus on when the ‘big correction’ will come, some of the better economic data is slipping beneath the radarBarring a severe shock to growth, stemming from the Ukrainian/Russia crisis, investors should not expect much more from the ECB this year. Yes, inflation is running at extremely low levels, but the recent weakness in the euro has given the bank a slight reprieve in terms of taking more immediate action.
The positive tone of the lending survey is another step down the long road back to recovery. However, in times of increased market tension, investors should remember to keep their eyes firmly on the road, especially if they want to avoid the potholes that may still lie ahead.
Kerry Craig is global market strategist of JP Morgan Asset Management
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