Global Markets

Financial markets calmed down last week after the Federal Reserve on the prior Friday lowered the discount rate by 50 basis points to 5.75 percent. The Fed and other central banks including the European Central Bank have continued to provide ample liquidity as well. The turnaround in market sentiment since the Fed's discount rate cut and additional injections of liquidity have helped most of the major indexes followed here to recoup all or most of the prior week’s losses. But investors are far from sanguine and an air of caution continues to pervade the markets as market participants begin to assess the likely impact of the recent turmoil on the real economy. Opinions of the Fed’s move run the gamut. Some say it will not save the day and a fed funds rate cut is needed immediately. Others say the move is prudent and no further cuts are needed. 

The early part of the week was marked by a dramatic surge in short-dated U.S. Treasury bills, which are regarded as extremely low-risk, liquid investments. The rate on 3-month bills plunged as much as 125 basis points to 2.5 percent Monday. This was the biggest one-day drop since the stock market crash of October 1987. But prices steadily retreated over subsequent days and by week’s end the yield was back above 4 percent.

All indexes followed here were up on the week. All except the DAX gained over 2 percent on the week. The Nikkei and Topix are negative for the year while the FTSE is almost even.

Global Stock Market Recap

Europe and the UK

Favorable U.S. economic data Friday pulled the FTSE, CAC and DAX out of their mid-August doldrums and turned what could have been a negative day into a positive one. The FTSE and DAX added to their previous week’s gains while the CAC obliterated the prior week’s loss with a gain about double in size. While the gains were not of the magnitude of those in Asian markets, the three indexes are hovering around their end-of-July levels. The FTSE, DAX and CAC were up 2.6 percent, 1.7 percent and 3.8 percent respectively. Friday marked the sixth day of positive gains for the FTSE and CAC.

Asia/Pacific

Asian/Pacific shares staged a rally last week and despite Friday’s losses, gained back virtually all or most of the previous week’s losses. However, none of those followed here with the exception of the All Ordinaries and Hang Seng were able to make a dent in the losses incurred in the previous three weeks.

• The All Ordinaries recouped two weeks losses and then some.
• The Hang Seng also more than recouped two weeks’ losses — but there were special circumstances and they will be discussed below.
• The STI regained slightly more than last week’s triple digit loss.
• Both the Nikkei and Topix regained only about two-thirds of the previous week’s losses.
• The Kospi managed to regain about 80 percent of the previous week’s losses.

After August 17’s robust rebound in U.S. stock indexes, the Asian/Pacific stocks followed here responded with a rally of their own on Monday. Worries about a credit squeeze were soothed and investor appetite for risk sharpened after the Federal Reserve on Friday cut the discount rate by half a percentage point to 5.75 percent. And it continued with few exceptions as investors regained their appetite for risk. That is until Friday, when investors paused for breath as they awaited two key U.S. data reports including one on the housing sector. On Thursday, Japanese equities were boosted when the Bank of Japan kept its key interest rate unchanged at 0.5 percent — a move expected by most analysts given recent global financial market turmoil.

According to the Tokyo Stock Exchange, for the week August 13 through 17, foreigners were net sellers of Japanese stocks by ¥751.9 billion. It serves to emphasize the roll of foreigners in that week’s sell off when the Nikkei sank by 8.9 percent and the Topix by 9.4 percent. This was the fourth straight week that foreigners were net sellers and brings the aggregate figure so far for August to more than ¥1 trillion. The figure includes trading on the first and second sections of the Tokyo, Osaka and Nagoya exchanges.

Hang Seng soars

China's currency regulator announced that it will let individuals buy Hong Kong stocks for the first time. Chinese citizens with a Bank of China Ltd. account in the northern city of Tianjin will be allowed to invest foreign currencies under a pilot program. This sent the Hang Seng to its biggest gain in almost nine years, up 5.9 percent. Mainland Chinese companies listed in Hong Kong, known as H shares, soared by 8.7 percent. Allowing Chinese investors to buy Hong Kong stocks may help cool the domestic stock market. The CSI 300 has surged 139 percent this year after more than doubling in 2006, drawing warnings of a possible bubble. Hong Kong Exchanges and Clearing, which runs the territory's exchange, was quick to welcome what has been described as an historic liberalization. The inflated valuations prevalent in China are thought to be a reflection of local investors' limited opportunities.

PBOC reacts to inflation data

The People’s Bank of China raised interest rates for the fourth time since March after inflation surged to a 10-year high. Its key 1-year lending rate was increased by 0.18 percentage point to 7.02 percent. At the same time, the 1-year deposit rate was increased by 0.27 percentage point to 3.6 percent. Consumer prices climbed 5.6 percent in July as the cost of food soared and the PBOC warned that inflationary pressures were broadening and cited higher energy and labor costs along with people’s expectations for inflation. In addition, second quarter growth soared by 11.9 percent — the fastest pace in more than 12 years thanks to investment and exports. It's the second time this year that deposit rates increased more than lending rates. The government is trying to make bank savings more attractive to stem the flow of money into property and stock speculation and curb asset bubbles.

Bank of Japan postpones a rate increase

The Bank of Japan deferred action that had been signaled after their previous meeting in July and kept its key interest rate unchanged at 0.5 percent. But at the same time, the BoJ laid the groundwork for a possible increase in coming months. The Bank indicated that it expects recent market gyrations to have limited impact on the Japanese economy. At his post-meeting press conference Governor Toshiyuki Fukui said the bank is determined to narrow gradually the gap between Japan's extremely low interest rates and those of the rest of the world. These low rates have facilitated borrowing in yen to invest in higher yielding securities elsewhere, a move known as carry trade. The timing of the BOJ's next rate increase depends on several factors including prices, whether financial markets calm down and, possibly, decisions by other central banks.

Currencies

The yen continues to gyrate as risk aversion and the unwinding of carry trade positions waxes and wanes. Japan’s abnormally low interest rates in comparison to others around the world enticed speculators to borrow in Japan and invest elsewhere in higher yielding assets otherwise known as carry trade. But as the recent credit crisis touched other financial markets, wary investors have unwound their carry trade positions. One effect has been to drive up the value of the yen, as carry trade investors have bought yen to pay off their loans. While the yen edged down last week, it is still considerably higher than the comfort zone of Japanese exporters. Sales and profits increase when the yen is low in value compared to currencies of Japan's major export clients.

The yen was down after the Bank of Japan kept its monetary stance unchanged and as continuing improvements in stock and credit markets encouraged investors back into carry trades. Some market pundits thought the Bank’s lack of action would only serve to heighten carry trade demand and drive the yen’s value lower. Whenever the yen has appreciated against the dollar or sterling in the past, Japanese retail currency traders have mitigated the movement by moving in to sell the currency. Some believe the strengthening of the yen this time will be temporary and that once stock markets stabilize, Japanese individual currency traders will come back to sell.

The dollar which for two weeks had resumed its historic role as a safe haven during the recent market turmoil resumed its fall after last Friday’s move by the Federal Reserve to cut the discount rate from 6.25 percent to 5.75 percent. On Tuesday following a meeting with Fed Chairman Ben Bernanke and Treasury Secretary Hank Paulson, Christopher Dodd, chairman of the Senate Banking Committee, announced that the Fed chairman had agreed to use “all the tools” at his disposal to restore stability to markets. And although on Friday new home sales data and durable goods orders were better than expected, analysts warned that the data reflect conditions from before the credit and subprime crises of August and do little to change expectations for a Fed funds rate cut in coming weeks.

The U.S. dollar depreciated against all but two of the 16 most actively traded currencies. The dollar is down against the euro by about 1.4 percent for the week after a 1.6 percent increase the previous week.

Indicator scoreboard

EMU — June seasonally adjusted merchandise trade surplus was €5.2 billion. Exports were up 1.7 percent while imports gained 0.6 percent. For the quarter as a whole, exports (up 1.4 percent) were still outpaced by imports (1.7 percent). On an unadjusted basis, the surplus was €7.8 billion with exports up 4.1 percent and imports declining by 0.8 percent. Detailed data are only available for the first five months of the year but these would seem to underpin the competitiveness concerns expressed by some members. For example, exports to the U.S. are down 2 percent on the year while imports are up 4 percent.

Germany — August ZEW survey reading nose dived to minus 6.9 from 10.4 in July - the lowest level since December 2006 and the largest drop since August a year ago. At the same time, the current conditions index fell to 80.2 from 88.2. It is important to note that the survey panel consists of predominately financial market analysts and so the results would be naturally skewed by current market turmoil. Two-hundred-ninety-one analysts and institutional investors participated in this month's ZEW Financial Markets Survey which is conducted on a monthly basis by the Centre for European Economic Research (ZEW), Mannheim. The participants were asked from July 30 to August 20, 2007 about their medium-term expectations concerning economic activity and capital markets.

Second quarter gross domestic product grew by an unrevised 0.3 percent and 2.5 percent when compared with the same quarter a year ago. The key to the increase was net exports which added 0.8 percentage points thanks to a 0.9 percent increase in exports and a 0.9 percent drop in imports. Domestic demand was up a tepid 0.6 percent and would have been weaker but for another solid 2.5 percent gain in equipment investment. Even then, total investment dropped 1.3 percent. However, private consumption was up 0.6 percent. Government consumption was also soft, down 0.2 percent. 

United Kingdom — Second quarter gross domestic product growth was unrevised at 0.8 percent on the quarter and 3.0 percent when compared with last year. In terms of output there was a much better balance to the economy with the goods producing sector expanding by a solid 0.6 percent after a 0.4 percent decline in the first quarter and services again rising strongly, up 0.8 percent following a 0.9 percent increase at the start of the year. Manufacturing grew 0.7 percent and construction 1.0 percent. Among the major expenditure components, household consumption rose 0.8 percent, a pace matched by government spending. The only decline was in gross fixed capital formation which dropped 1.1 percent but this followed hefty gains earlier and still left annual growth at some 5.3 percent. Worth noting too is the acceleration in the GDP deflator to a 1.2 percent quarterly pace (0.4 percent in the first quarter) and a 3.8 percent annual rate (3.1 percent). Although not targeted directly, the pick-up in the economy-wide measure of inflation does not bode well for the future trajectory of the key CPI.

Asia/Pacific

Japan — June all industry activity index was up 0.2 percent and 1.3 percent when compared with last year. The all industry index takes a reading of activity in the 11 industries that comprise the tertiary index (released earlier this week), along with activity in the construction, agricultural & fisheries industries, the public sector and industrial output. This index is considered a close approximation of gross domestic product growth as measured by industrial and service sector output.

July unadjusted merchandise trade surplus was ¥671.2 billion, down 21.1 percent from the same month a year ago. Imports were up 16.9 percent while exports were up 11.7 percent on the year. The balance with the U.S. was down 4.1 percent with exports up 1.3 percent while imports were up 7.6 percent. Japan posted a deficit of ¥185.7 billion with China, up 15.4 percent on the year. On a seasonally adjusted basis, the merchandise trade surplus was ¥822.6 billion, up slightly from the June surplus of ¥821.8 billion. Both exports and imports were up 0.5 percent on the month.

Americas

Canada — July consumer price index edged up 0.1 percent and was up 2.2 percent when compared with last year for the fourth month in a row. Excluding food and energy, the CPI rose 0.1 percent, nudging the annual rate up to 2.4 percent from 2.2 percent. However, the BoC core index which also edged up 0.1 percent on the month, decelerated to 2.3 percent from 2.5 percent. Energy prices declined 0.4 percent while food prices dropped 0.3 percent. Transportation prices were down 0.6 percent and prices for health & personal care dipped 0.4 percent.

June retail sales dropped 0.9 percent after surging 2.6 percent in May. When compared with last year, sales were up 7.5 percent. The quarterly gain stands at an impressive 3.0 percent, the largest rise in almost six years. Most of the decline in overall sales was attributable to autos which slumped 2.7 percent. Excluding the auto sector, sales were down 0.3 percent and up 6.6 percent on the year. Among the other major categories, general merchandise stores dropped 0.7 percent, clothing & accessories 0.4 percent and building & outdoor home supplies 0.3 percent. Furniture, home furnishings & electronics were off 0.5 percent. Partially offsetting these declines were increases in food & beverages (0.7 percent), miscellaneous retailers (0.4 percent) and pharmacy & personal care (0.1 percent).

Bottom line

Last week saw calm return to the financial markets as banks began to show a willingness to lend as well as to borrow at the Fed’s discount window. With little new economic information, market events held the focus of investors while analysts on TV battled out the legitimacy of the Fed’s move.

However, in this coming week, there will be an avalanche of new data for market participants to absorb with most of it being released on Thursday and Friday. With several central bank policy meetings scheduled for the following week, the data will be carefully dissected for possible policy implications. It is the last week of the summer, with the UK celebrating its annual Bank Holiday on Monday. Those of us in the U.S. will have to wait until September 3 to celebrate our end of summer holiday, Labor Day.

Looking Ahead: August 27 through August 31, 2007

The following indicators will be released this week...
Europe
August 28	EMU	M3 Money Supply (July)
	Germany	Ifo Business Survey (August)
August 30	Germany	Unemployment (July)
	France	Unemployment (July)
August 31	EMU	Unemployment (July)
		Harmonized Index of Consumer Prices (August, flash)
	EU	Business and Consumer Confidence Survey (August)
	Germany	Retail Sales (July)
	Italy	Producer Price Index (July)
Asia/Pacific
August 30	Japan	Retail Sales (July)
August 31	Japan	Consumer Price Index (July, August)
		Household Spending (July)
		Unemployment Rate (July)
		Industrial Production (July)
	Australia	Retail Sales (July)
		Merchandise Trade Balance (July)
Americas
August 30	Canada	Industrial Product Price Index (July)
		Raw Materials Price Index (July)
August 31	Canada	Gross Domestic Product (Q2.07)
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