Global Markets

Global markets gave back some of their heady gains from 2013 and were down both for the week and month of January. A retreat from risk was a defining theme of the last week, and the Federal Reserve's decision to continue curtailing its bond buying programs appeared to amplify it. Although the Federal Reserve was expected to cut its bond buying by a further $10 billion, the decision came against a backdrop of turbulence in emergin­g markets. Emerging markets swooned last spring after the Federal Reserve began to talk about pulling back on its purchases of Treasury bonds and mortgage securities. There was fear that money would flow out of emerging markets as United States interest rates rose, but it eased when it became clear that the scaling back was not going to have a major immediate impact.

The worry about emerging markets can be traced in part to their remarkable performance during the credit crisis that began in 2008. Many emerging economies had hefty foreign currency reserves and their growth attracted foreign investment. That investment helped push up local asset prices, which intensified the boom and brought in more foreign capital. The currencies appreciated, and countries began to buy more things from abroad while at the same time their industries were losing competitiveness. Current account deficits began to soar, but that did not immediately matter simply because capital was still flowing in. However, when the cycle turned, investors suddenly demanded to leave. Investors are nervous about Brazil, India, Indonesia, Thailand, Taiwan and Malaysia, to name a few. During the week, several of the emerging country’s central banks including those in Turkey, South Africa and India raised their interest rates to boost their flailing currencies.

Reserve Bank of India

The Reserve Bank of India tightened its stance again by raising its key repo rate by an additional 25 basis points to 8.0 percent. In turn, the reverse repo and the marginal facility rates were increased also by 25 basis points to 7.0 percent and 9.0 percent respectively. There was no change in the cash reserve ratio which stayed at 4.0 percent. The interest rate move was not generally expected and many were surprised by proposals to switch to a CPI-based inflation target. The rate increase was the third in five months and indicates the RBI’s continued hawkish stance. The central bank also gave indications that it is hoping that this could be its last rate increase in this round of tightening as some prices are showing signs of cooling.

The new Monetary Policy Review acknowledged that economic growth in the quarter just ended was disappointing with declining manufacturing output, sluggish consumption and stalled investment. Moreover, the RBI expects fiscal tightening to exacerbate this weakness through the current quarter. However, the announcement underlines the RBI's determination to bring inflation under control. To this end, although both the CPI (9.87 percent) and WPI (6.16 percent) slowed more quickly than anticipated in December, excluding food and energy the rates were only flat and slightly higher respectively and not consistent with the Reserve Bank's planned introduction of a 4 percent inflation target in 2016.

The RBI does not expect to tighten again in the near-term but is clearly focused on hitting an 8 percent interim CPI inflation objective for the coming year. As such, further interest rate increases are to be expected — almost irrespective of real economy developments — should inflation not continue to slow over coming months. The Reserve Bank also signaled that future policy reviews will take place on a two month cycle, rather than the current three month cycle, with the next now scheduled for April 1st.

Reserve Bank of New Zealand

As expected, the Reserve Bank of New Zealand left its official cash rate (OCR) at 2.5 percent where it has been since March 2011. In his statement, Reserve Bank Governor Graeme Wheeler noted that New Zealand’s economic expansion continues to have considerable momentum. Export prices for commodities — especially dairy products — remain high.

Both consumer and business confidence are strong and net inward migration has added to demand. Construction continues to be lifted by the rebuilding of Canterbury and work in Auckland to address the housing shortage. Continued fiscal consolidation will partly offset the strength in demand. GDP grew by 3.5 percent in the year to September and is expected to continue around this rate over the coming year. Inflation in 2013 was 1.6 percent on the year. The high exchange rate continues to dampen inflation in the traded goods sector, but the RBNZ does not believe the current level of the exchange rate is sustainable in the long run.

The governor noted that the improvements in the major economies have required exceptional monetary accommodation and there remains uncertainty about the timing of withdrawal of this stimulus and its effects, especially on emerging market economies. Wheeler said that the RBNZ remained committed to increasing the OCR as needed to keep future average inflation near the 2 percent target mid-point. The scale and speed of the rise in the OCR will be data dependent.

Global Stock Market Recap

Europe and the UK

European equities were mixed last week with the CAC, MIB and IBEX gaining and the FTSE, DAX, OMX and SMI retreating. The CAC edged up 0.1 percent on the week but was down 3.0 percent in January — its worst drop since June. The FTSE finished down 2.3 percent for the week and its 3.5 percent decline in January is its worst monthly performance since June. The DAX retreated 0.9 percent on the week and lost 2.6 percent in January, also its worst decline since June.

Friday’s declines occurred when Eurozone inflation slowed unexpectedly in January, leading investors to worry about the possibility of deflation in the region. Inflation has stayed below the European Central Bank's target of below but close to 2 percent for the 12th consecutive month. An unexpected decline in German retail sales also contributed to the negative mood among investors. Eurostat also said unemployment declined for the third consecutive month in December. The number of unemployed decreased 129,000 from November to 19.01 million. The latest monthly fall was the sharpest since April 2007. At the same time, the jobless rate came in at 12 percent for the third straight month in December. The rate was expected to rise to 12.1 percent.

Asia Pacific

Most equity indexes declined last week with only the Kospi virtually unchanged. In January, only the Jakarta Composite and PSEi advanced 3.4 percent and 2.6 percent respectively. At week’s end, most markets here were closed for the Lunar New Year — the Year of the Horse. Losses for the week ranged from 3.1 percent (Nikkei and SET) to 0.4 percent (Jakarta Composite). Among the major indexes, the Nikkei was down 8.5 percent, the Hang Seng lost 5.5 percent, the STI declined 4.4 percent and the Shanghai Composite retreated 3.9 percent in January.

The Nikkei closed out its worst month since May 2012 as jittery investors shied away from risk with the advent of the Lunar New Year that idled most other Asian markets with the exception of Australia. The value of the yen continues to impact exporters’ equity prices. They rise when the yen falls and retreat when the yen increases against the U.S. dollar especially and its other major counterparts. At week’s end, equities struggled to find direction as emerging market worries lingered and most markets in the region, including China, Hong Kong, Indonesia, Malaysia, Singapore, South Korea and Taiwan remained closed for the Lunar New Year holidays. A slew of economic data were released Friday morning in Japan. The production, employment and construction reports all showed that Abenomics spending has boosted the economy. However, looking ahead, investors would like to know what happens when the spending ends in April and the consumption tax jumps from 5 percent to 8 percent. However, the CPI slowed in December as a one-time windfall from year ago yen devaluation lapses.

Currencies

The U.S. dollar was up against most of its major counterparts including the euro, pound, Swiss franc and Canadian dollar. It was virtually unchanged against the yen but down against the Australian dollar. The Canadian dollar dropped to a new four and a half year low. The euro was hit Friday after consumer prices were up only 0.7 percent from January 2012 and further below the ECB’s target of just under 2 percent.

The emerging market currency selloff continued as investors retreated from riskier assets. Emerging market woes began last week after the Chinese manufacturing flash PMI indicated contraction — that is a reading below the 50 breakeven point. Currencies slid again after the Federal Reserve confirmed that it would scale back its stimulus by another $10 billion in February. The currency declines were not limited to those in Asia, but currencies such as the Hungarian forint, the Turkish lira and South African rand were hit hard over the week. Unexpected central bank rate increases did little to prop up their currencies.

The concern is that the Fed is going to continue to reduce its stimulus, which will likely raise interest rates and make emerging market countries reliant on foreign capital inflows (current account deficit countries) particularly vulnerable.

Selected currencies — weekly results

Indicator scoreboard

EMU

December M3 money supply was up 1.0 percent on the year, down 0.5 percentage points from its annual November rate. This was the aggregate's weakest performance since September 2010 and saw the ECB's preferred 3-month moving average measure slipping 0.3 percentage points to just a 1.3 percent rate. Private sector lending fell 2.3 percent from December 2012, matching its November decline. Loans for households slipped 0.1 percent and within this borrowing for house purchase shed 0.2 percentage points to a 0.7 percent annual rate. Lending to non-financial corporations was a little firmer but was down at a 3.0 percent annual rate after a 3.8 percent drop in mid-quarter. The improvement was more cosmetic than anything else. Loans to non-monetary financial intermediaries (excluding pension funds and insurance companies) posted a 12.2 percent decline, 3 percentage points steeper than recorded in November.

January EU Commission economic sentiment indicator (ESI) climbed to a reading of 100.9 — 0.5 points higher from the upwardly revised December reading to secure its highest level since July 2011. The ESI has posted modest increases every month since May. January's improvement was partly due to a more confident consumer sector where, as indicated in the flash report, sentiment climbed nearly 2 points to minus 11.7. Services also fared well, gaining 1.9 points to 2.3 and retail was up 1.6 points at minus 3.4. However, morale in industry dipped 0.5 points to minus 3.9 and was off 3.7 points at minus 30.1 in construction. Regionally, national ESIs rose 0.7 points in Germany and 1.1 points in France but were broadly flat in Italy and Spain. Among the larger member states only Germany (106.7) and Spain (100.3) posted levels above the 100 long-run average while both France (97.1) and Italy (96.6) continued to fall short.

January flash harmonized index of consumer prices was up 0.7 percent on the year after increasing 0.8 percent in December. The decline in overall inflation was essentially attributable to the energy sector where prices were down 1.2 percent on the year having been unchanged in December. The core rate that excludes energy, as well as food, alcohol and tobacco posted a 0.8 percent annual rate, up 0.1 percentage points from last time. Elsewhere within the limited breakdown, food, alcohol and tobacco slowed to a 1.7 percent annual rate, a drop matched by non-energy industrial goods (0.2 percent). By contrast, services accelerated marginally from 1.0 percent to 1.1 percent.

December joblessness fell for the third month in a row. The number of people out of work stood at 19.010 million, a decline of 129,000 compared with November but not enough to lower the unemployment rate from the previous month's downwardly revised 12.0 percent. Particularly promising was a much needed drop in youth unemployment which fell 77,000 on the month. However at 23.8 percent, the jobless rate here remains unacceptably high and a major worry for many EMU member governments. Nationally overall unemployment rates rose in six of the fifteen reporting states, most notably in Cyprus which saw another 0.2 percentage point increase to a new high of 17.5 percent. Among the larger economies, France (10.8 percent) and Germany (5.1 percent) held steady but Italy posted a surprise 0.1 percentage dip (12.7 percent) while a 0.3 percentage point drop in Spain (25.8 percent) provided further evidence of its economic recovery gaining some traction. Austria (4.9 percent) continued to occupy the bottom rung of the ladder while Spain was once again easily at the top. Germany’s unemployment rate is calculated using Eurostat methodology.

Germany

January Ifo business climate index added 1.1 point to a reading of 110.6 that left the headline measure at its highest mark since July 2011. The current conditions index was 0.8 points firmer at 112.4 and, in more than reversing December's 0.7 point drop, secured its strongest reading since June 2012. At the same time, expectations climbed for the third consecutive month, this time by 1.5 points to 108.9 and reached their highest level since February 2011. Among the sectors, morale in manufacturing was up more than 2 points at 17.7 and gained 1.2 points to 2.5 in construction. Confidence in wholesale saw a sharp 5.9 point bounce to 15.3 and in services increased 2 points to 25.5. The only reversal was in retail, which posted a 0.5 point decline to 4.2.

January joblessness was down 28,000 to 2.927 million following a steeper revised 19,000 drop in December. The unemployment rate was 6.8 percent, unchanged from its downwardly revised level in December. The latest decline in the number of people out of work compares favorably with an average decline of just 5,000 during the fourth quarter and is consistent with an economy whose recovery is gradually picking up momentum. Vacancies were only up 1,000 on the month but maintained their rising trend.

December retail sales dropped 2.5 percent and declined 2.4 percent from December a year ago. The monthly decline was the steepest since March 2011. To make matters even worse, November's previously reported 1.5 percent gain was revised down to 0.9 percent. December's drop means that volume purchases over the fourth quarter as a whole were down 0.9 percent from the previous quarter when they declined 0.4 percent.

France

December total household spending slipped 0.1 percent and was up 1.4 percent from a year ago. Spending on manufactured goods however, was up 0.4 percent and was up 1.6 percent from a year ago. The monthly year-end gain was largely attributable to a 2.7 percent increase in auto purchases. Household goods also posted a solid 1.2 percent increase. However, elsewhere textiles dropped 3.2 percent, food products edged up 0.1 percent and the other products category slipped 0.1 percent.

United Kingdom

Fourth quarter provisional GDP was up 0.7 percent on the quarter and up 2.8 percent from the same quarter a year ago. The annual growth was its best performance since the first three months of 2008. The economy has now registered positive quarterly growth for four consecutive quarters. There are no details of the GDP expenditure components available in the preliminary report but purely on the basis of measured output, three of the four main industrial groupings recorded quarterly gains. Total industrial production was also up 0.7 percent (manufacturing 0.9 percent) while services increased 0.8 percent (business and finance 1.2 percent) and agriculture 0.5 percent. The only decline was in construction (0.3 percent) although early estimates here tend to be particularly subject to (often quite large) revision. However, last quarter's good news needs to be seen in the context of an economy whose output is still 1.3 percent below its pre-crisis level (although the service sector is now actually 1.3 percent above).

Asia/Pacific

Japan

December merchandise trade deficit was ¥1,302.1 billion yen. The data mark the 18^th consecutive monthly trade gap. Exports were up a less than forecast 15.3 percent — forecast was for an 18 percent increase from a year ago. Imports also jumped a less than forecast 24.7 percent from the same month a year ago. Analysts expected imports to increase 26.2 percent. The weakening yen is helping Japan record higher exports, but it also makes the cost of imports more expensive, particularly for fuel and other resources. Exports to the EU were up for the 7th consecutive month, climbing this time by 23.0 percent from a year ago. Exports to Asia were up 16.0 percent and those to China, 34.4 percent. Exports to the US jumped 13.0 percent. On a seasonally adjusted basis, the trade deficit was ¥1.148.6 trillion, down from ¥1.293.8 trillion in November. On the month, exports were up 1.7 percent while imports slipped 0.6 percent.

December retail sales were up for a fifth month, this time by 2.6 percent from December 2012 after increasing an annual 4.1 percent in November. That was below analysts’ expectations of a 3.7 percent jump. Auto sales were up 14.2 percent after rising 13.8 percent in November. Fuel sales edged 1.2 percent higher after jumping 6.1 percent the month before. Retail machinery sales were up only 0.9 percent after climbing a healthy 8.0 percent in November. Food and beverage sales were up 2.3 percent after 3.5 percent.

December unemployment rate dropped to 3.7 percent from 4.0 percent in November. The number of unemployed persons was 2.25 million, down 340,000 or 13.1 percent from the same month a year earlier. Analysts expected unemployment to slip to 3.9 percent in December. The number of employed persons was 63.19 million, an increase of 910,000 or 1.5 percent from the previous year. For the month of December, employment declined 40,000 from November.

December consumer price index was up 0.1 percent on the month and up 1.6 percent for a second month from a year ago. Excluding only fresh food, the CPI slipped 0.1 percent from November and was up 1.3 percent on the year. That was the highest annual increase in the core since October 2008. Excluding both food and energy, the CPI was unchanged on the month and up 0.7 percent on the year. It was the third straight month that the index excluding food and energy increased. A main driver in the increase in the overall CPI and the core excluding fresh food was energy prices which were up 6.8 percent on the year. TV costs were up 1.1 percent while electronic goods were up 2.6 percent from a year ago. Companies have been passing higher import costs of processed food and energy on to consumers amid the weaker yen. Solid domestic demand continued supporting CPI. Prices of consumer electronics durable goods (TVs, digital recorders, personal computers, etc.) were up 2.6 percent on year in December.

December household spending was up 0.7 percent on the year after increasing 0.2 percent in November. With the exception of education (down 5.4 percent on the year), culture & recreation (down 1.9 percent) and fuel, light & water charges (down 3.1 percent), all sub-categories of spending increased from a year ago as consumers continued to buy prior to the introduction of an increase in the consumption tax in April from 5 percent to 8 percent. Housing expenditures were up 7.8 percent, furniture & household utensils were 5.4 percent higher and transportation & communication spending was up 7.9 percent.

December industrial production was up 1.1 percent on the month after slipping 0.1 percent in November. On the year, output was up 5.9 percent from the same month a year ago and slightly less than November’s 6.1 percent annual increase. Higher output of general/production machinery, metal products and electronic parts & devices drove the increase. However, the December figure was below the METI's forecast of a 2.8 percent increase mainly due to weaker than expected output of information/communication electronics equipment, which was 0.6 percent lower rather than the gain of 6.4 percent that was projected. METI maintained its assessment that Japan's industrial production "continues to show an upward movement." The ministry forecast that industrial output will rise 6.1 percent on the month in January and gain a further 0.3 percent in February.

Australia

December quarter final demand (excluding exports) producer prices were up 0.2 percent and were up 1.9 percent on the year for a second quarter. Prices received for other agriculture were up 11.1 percent, other transport equipment manufacturing was up 3.2 percent and building construction prices were up 0.4 percent. These increases were partly offset by declines in the prices received for petroleum refining and petroleum fuel manufacturing (down 5.5 percent) and computer & electronic equipment manufacturing (down 2.5 percent). Intermediate prices were up 0.3 percent and 2.1 percent on the year. Preliminary demand prices were also up 0.3 percent on the quarter and up 2.2 percent on the year.

Americas

Canada

November monthly gross domestic product was up 0.2 percent from October and up 2.6 percent when compared with November a year ago. November's advance was led by the goods producing sector where output, for the third time in a row, climbed 0.4 percent on the month. However, within this manufacturing dropped 0.5 percent, albeit after a 1.2 percent increase last time, while construction slipped 0.1 percent and agriculture, forestry, fishing & hunting declined 0.7 percent. Nonetheless, weakness here was more than offset by a 1.7 percent advance in mining, quarrying & oil & gas extraction combined with a 2.1 percent bounce in utilities. Services posted a 0.2 percent monthly gain dominated by a 0.8 percent increase in retail trade and a 1.2 percent increase in arts, entertainment & recreation. Transportation & warehousing (0.3 percent), finance & insurance (0.5 percent) and real estate & rental & leasing (0.3 percent) all advanced. The main areas of weakness were wholesale trade (down 0.6 percent) and professional, scientific & technical services (down 0.2 percent).

Bottom line

Global markets were shaken by the selloff in emerging markets. Economic data were mixed in Europe, the U.S. and Japan. However, initial estimates of growth in the UK and U.S. met expectations. The Reserve Bank of India increased its policy interest rates again while the Reserve Bank of New Zealand held its fire. The Federal Reserve continued to cut back on its bond buying programs.

The Bank of England and the European Central Bank meet during this coming week. The Reserve Bank of Australia returns from its January vacation. Investors will monitor the upcoming slew of purchasing managers’ indexes globally. And both Canada and the U.S. will release their employment data for January.

Looking Ahead: February 3 through February 7, 2014

Anne D Picker is the author of International Economic Indicators and Central Banks.