Global Markets

Central bank activities were investors’ primary focus this past week — and that did not change even after Friday’s weak U.S. employment situation report stunned market players. Equity and currency traders pushed the sell button on stocks both in North America and Europe (Asian markets were closed) and the dollar sold off against virtually all currencies. Gold jumped over $700 an ounce. The report which showed a slight drop of 4,000 jobs was the antithesis of market expectations for a 100,000 job increase. It should be emphasized that these numbers are subject to revisions in the next several months just as those for June and July were in this report. Many analysts immediately called for a Federal Reserve interest rate cut claiming that the Fed was already behind in providing an antidote to the spreading subprime mess. One month’s number is not a trend and other data released this week showed an economy that was still functioning at a relatively brisk pace.

Equity markets were jittery all week though, in part in anticipation of the sundry meetings and the plate of important economic information at hand and day-to-day volatility underlined investor concerns. On the week 11 of 14 indexes followed here declined while three — in Asia — managed to gain.

A plethora of central bank meetings

Four major central banks held policy meetings while the Federal Reserve issued its pre-FOMC Beige Book prepared by the regional banks. Pretty much as universally expected, the Reserve Bank of Australia, Banks of Canada and England and the European Central Bank left their interest rates unchanged at 6.5 percent, 4.5 percent, 5.75 percent and 4 percent respectively. The RBA followed its usual policy of not issuing a statement unless there is a rate change while the Bank of England broke with precedent and issued one for the first time in many years. Central banks also took more action in money markets to ensure liquidity.

Global Stock Market Recap

Europe and the UK

Jumpy equity investors continued to look to U.S. markets for reassurance but did not always find it as investors treaded tremulously through the debris from the subprime crisis. With U.S. markets closed on Monday for Labor Day, there was little direction and the FTSE and DAX were up on the day while the CAC edged downward. However, on Wednesday, stocks were down as fears about bank credit worthiness, never far away, resurfaced. This was especially true as investors awaited the Federal Reserve’s Beige Book and its anecdotal appraisal of the U.S. regional economy and interest rate policy decisions from the Bank of England and the European Central Bank even though both were universally expected to maintain their current interest rate levels of 5.75 percent and 4 percent respectively. Equity investors responded favorably to both banks decisions and post-meeting statements — along with a string of favorable U.S. economic data. And after Wednesday’s losses, some stocks looked like good buys. However, on Friday, the U.S. employment report sent investors running to the exits and dumping equities along with the dollar on U.S. growth fears. On the week, the CAC, DAX and FTSE declined. Both the CAC and FTSE were down below their end of 2006 levels for the second time in six weeks.

Bank of England issues a post-meeting statement

As unanimously expected, the Bank of England left its policy interest rate at 5.75 percent. The impact of the five rate increases has yet to fully work its way through the economy. In addition, the market turmoil is increasing risks of slower growth. The Bank has an inflation target of 2 percent. The July CPI reading was 1.9 percent on the year after 15 months of increases above the 2 percent level. The subprime turmoil has clouded the economic outlook after the bank signaled that five rate increases in the past year may not be enough to contain inflation.

The monetary policy committee, in a break from its normal practice, issued a statement with its decision. In it they acknowledged that heightened concerns about a variety of asset-backed securities have led to disruptions in worldwide markets not only in those financial instruments but also in money markets more generally. It reiterated the MPC’s mandate which is to set interest rates to meet the government’s 2 percent target for CPI inflation and it discussed recent developments and other economic data in terms of their implications for the outlook on inflation. They also said that “it is too soon to tell how far the disruption in financial markets will impair the availability of credit to companies and households. As stated in its August Report, the MPC is monitoring closely the evolution of both credit spreads and the quantities of credit extended, alongside all other data relevant to the outlook for inflation.”

ECB separates monetary policy from market functionality

The ECB kept its key interest rate at 4 percent while at the same time indicating that it retains its tightening bias because of continued upside risks to price stability. But at the same time, the ECB acknowledged the seriousness of financial market turbulence and the great uncertainty this is causing. At his press conference following the governing council meeting, President Jean Claude Trichet confirmed that price stability is subject to upside risks and that strong fundamentals of the euro area economy support a favorable medium-term outlook for real GDP growth. He also repeated as he has in the past that monetary policy is on the accommodative side and that money and credit growth remain vigorous in the euro area. He also said that the ECB will continue to monitor financial market developments closely. Trichet stressed that while the ECB has the responsibility for ensuring that Europe's money market functions appropriately, as always it must focus primarily on ensuring price stability. "We have the two responsibilities and they have to be fully and totally accepted as our major responsibility, but they are not influencing one another, that's absolutely clear," Trichet said.

Asia/Pacific

Stocks were mixed during the week as investors cautiously awaited economic data from the United States. Japanese and South Korean stocks were down four of five days. The Nikkei and Topix lost ground on the week. But the Hang Seng ended virtually unchanged despite crossing the 24,000 level for the first time midweek, but it was not able to sustain it. On Friday, investors traded cautiously ahead of the U.S. employment report (they are closed at its release time). Most traders had been cheered by encouraging economic data, including strong second quarter productivity growth and a drop in the weekly jobless claims numbers. The STI was the best performing index, gaining 2.8 percent on the week while the All Ordinaries gained 0.8 percent and the Kospi gained 0.6 percent. The Australian market was encouraged by the strong second quarter GDP and employment data along with an unchanged monetary policy.

Japan's Nikkei 225 average languished in negative territory for four of five sessions, and was down 2.7 percent for the week. The weakness was blamed on recent economic reports, which point towards a setback to economic growth. In addition, analysts were forecasting that second quarter GDP growth would be revised downward to a negative reading. Companies that have exposure to domestic demand led the slide and were later joined by exporters. Investors continue to worry about U.S. growth as well as their own domestic economy. Japanese stocks are sensitive to the global economy, given that many firms are reliant on foreign demand. Both the Nikkei and Topix are below their 2006 year-end levels — down 6.4 percent and 7.4 percent respectively.

RBA on hold

As expected, the Reserve Bank of Australia kept its key interest rate unchanged at 6.5 percent, an 11-year high. The RBA, like its counterparts in England, EMU and Canada, kept rates unchanged as they evaluate whether the turmoil in world financial markets would impact growth. Australia's economy is in its 16th consecutive year of growth, the jobless rate is at its lowest since 1974 and the central bank forecasts inflation will accelerate to the top of its target band of 2 to 3 percent and stay there until mid-2008.

PBOC increases reserve requirements

The People’s Bank of China ordered banks to put aside more money as reserves for the seventh time this year to cool lending and investment after inflation accelerated to a 10-year high. Banks now must place 12.5 percent of deposits at the PBOC beginning on September 25. The previous level was 12 percent. The ratio is the highest in almost 10 years. China is trying to prevent cash from record trade surpluses from driving up consumer prices and fueling asset bubbles. July's inflation rate was 5.6 percent on the year.

Canada

As expected, the Bank of Canada left the key interest rate unchanged at 4.5 percent. Recent economic data continue to show a strong economy with second quarter GDP growing at a 3.4 percent annualized rate and unemployment at a multi-year low. Analysts had expected a rate increase until recently when fears of fallout from the U.S. subprime mortgage crisis altered their rate expectations. But inflation concerns that would have called for a rate increase have not gone away. Core CPI was up 2.4 percent on the year in July while the Bank’s core CPI which excludes 8 volatile items was up 2.3 percent. Employment is at three-decade record levels. The Bank’s inflation target range is 1 to 3 percent focusing on the mid-point of 2 percent.

Currencies

The U.S. dollar dropped against most major currencies after the employment report said that jobs were lost in August. The calls for the Fed to aggressively cut interest rates escalated on the data. The market, which has been on pause recently in anticipation of the employment report and the Fed's meeting on September 18, now have priced in an anticipated 25 basis point fed fund rate cut to 5 percent. And some analysts expect that 75 basis points will be cut by year’s end. The dollar dropped to the lowest level in a month against the euro and weakened against the yen after jobs were lost for the first time in four years. Analysts are concerned that losses from subprime mortgages that have weakened the credit markets will spill over into the broader economy. Traders have been negative towards the dollar for some time now and need little incentive to sell.

According to the Bank of International Settlements, the yen and the Swiss franc have been widely used to finance speculative bets on the world's currency markets. The BIS said in its quarterly review that its international banking statistics showed that global lending in both currencies has risen in recent years. Total yen-denominated lending reached $1,050 billion in the first quarter of 2007, while Swiss franc-denominated lending has climbed to $678 billion. The yen and Swiss franc have below-average interest rates and have been used to fund global carry trade, where low-yielding currencies are sold to finance the purchase of high-yielding currencies.

Indicator scoreboard

EMU — Second quarter gross domestic product was up 0.3 percent and 2.5 percent when compared with the same quarter a year ago. First quarter growth was much more robust — 0.7 percent on the quarter and 3.2 percent on the year. Private sector consumption posted a modest rise of 0.5 percent versus the first quarter, supported in limited fashion by a 0.1 percent advance in government spending and more meaningfully by a 1.1 percent increase in net exports. Fixed capital formation was down 0.2 percent but this was hardly surprising in the wake of a 2.0 percent surge at the start of the year and a 1.7 percent jump at the end of 2006.

July producer price index was up 0.3 percent and 1.8 percent when compared with last year. Core PPI was up 0.2 percent and 2.9 percent on the year. Energy goods were up 0.5 percent and easily the strongest sectoral gain ahead of consumer non-durable goods (0.3 percent). Intermediate goods were up 0.2 percent while capital and durable consumer goods each edged up 0.1 percent. Amongst the larger member states, annual PPI rates are unlikely to trouble the ECB with Germany very subdued (1.1 percent) and France not much faster (1.9 percent, albeit in June). Italy (2.1 percent) and Spain (2.3 percent) may be seen as a little firm but both rates are well below their respective 2007 peaks and both are trending gently lower. 

July retail sales edged up a meager 0.1 percent and were up 0.7 percent when compared with last year. June sales were revised upward to an increase of 0.6 percent on the month from 0.4 percent. After jumping 1 percent in June, non-food sales ebbed down 0.1 percent in July and leaving food, drinks and tobacco as the sole driving force behind what little increase there was. For the countries reporting, the largest monthly increases were posted by Denmark and the U.K (both 0.8 percent) while the largest declines were seen in Belgium (3.5 percent) and Austria (1.6 percent).

Germany — July manufacturing orders sank 7.1 percent after soaring 4.6 percent in June. Orders were up 6.1 percent when compared with last year. Having been the driving force behind the June advance, predictably it was overseas orders that bore the brunt of the decline sinking 11.7 percent. The domestic sector dipped 1.7 percent although even this was more than sufficient to offset the modest 0.4 percent increase posted in the previous month. All major categories saw declines with capital goods down 10.4 percent followed by basic goods (down 3.7 percent) and consumer goods (down 1.2 percent).

July merchandise trade surplus widened to €16.5 billion as a 2.4 percent drop in imports more than offset a minor 0.1 percent decline in exports. Export prices were essentially unchanged on the month while import costs, up 0.3 percent, slowed sharply from June. Over the first seven months of 2007 exports have expanded by 11.3 percent versus the year ago period, comfortably outpacing imports which have advanced a more modest 7.4 percent. Within these figures the largest boost to exports has come from non-EMU EU states (15.7 percent) and the same region has seen the greatest increase in German imports (11.8 percent). However the most significant divergence between imports and exports is to be found with the non-EU countries. Here exports have expanded a solid 8.7 percent while imports have edged up a meager 0.9 percent.

July industrial production edged up 0.1 percent and was up 5.1 percent when compared with last year. Above average holidays in the month helped to dampen the increase but the data remain consistent with other recent indicators all pointing to some loss of momentum in the goods producing sector. Manufacturing managed a modest 0.2 percent gain on the month and construction jumped a typically erratic 1.3 percent — but advances here were almost offset by declines in intermediate goods (0.2 percent), consumer goods (0.8 percent) and energy (0.3 percent).

Italy — June merchandise trade balance recorded a surplus for the first time since July 2006. The surplus was €377 million. Seasonal factors helped to bolster the international trade sector but the return to black ink from the €0.7B deficit registered in May still compares favorably with the €1.59B shortfall posted in June 2006. There was a modest improvement with overall exports increasing 2.0 percent against an increase in imports of 1.6 percent.

United Kingdom — July industrial production edged down 0.1 percent but was up 0.9 percent when compared with last year. Manufacturing output was down 0.3 percent but up 0.8 percent on the year. Mining and quarrying grew a strong but erratic 1.2 percent, oil and gas extraction 1.4 percent and electric, gas and water 0.3 percent. At a sectoral level, only capital goods registered a decline (1.2 percent) while durable goods were flat and non-durables (0.4 percent) and intermediate goods (0.2 percent) increased modestly. In manufacturing the decline was concentrated in the transport sector which was down 2.6 percent courtesy of a 4.9 percent drop in aircraft output and a 21.2 percent slump in shipbuilding production. Other sectors were little changed with the only significant increase being in paper, printing & publishing which was up 1.2 percent.

Asia/Pacific

Australia — Second quarter gross domestic product was up 0.9 percent and 4.3 percent when compared with the same quarter a year ago. This is slower than first quarter growth which was up 1.6 percent on the quarter. Growth was slowed as storms and drought disrupted exports, and consumer spending cooled. This is the 16^th year of the current expansion. Consumer spending was up 0.5 percent and 3.4 percent on the year while gross fixed capital formation was up 5.3 percent and 11.6 percent on the year. The GDP chain price index moderated and was up 0.8 percent and 3.8 percent on the year. In the first quarter it was up 1 percent and 4.3 percent on the year.

August employment increased by 31,900 jobs — over double the expected increase of 15,000 jobs. The unemployment rate remained at 4.3 percent for the fourth month. Full time employment increased by 29,100 jobs while part time employment was up by 2,700. A skills shortage has pushed the unemployment rate to its lowest since 1974. Miners are hiring workers as they expand to meet soaring Asian demand, and retailers are opening new stores as consumer spending picks up. Jobs growth has boosted consumer confidence and retail spending. The participation rate was 65.1 percent.

Americas

Canada — August employment jumped by a significantly stronger than expected 23,300 bringing the cumulative gain over the first eight months of the year to about 232,000. The unemployment rate, however, was unchanged at the 33-year low of 6.0 as more people entered the labor force. Full-time jobs rose by 6,500 while part-timers were up 16,800. Employment gains were biased towards the goods producing sector which added some 20,400 positions while gains in services were limited to 2,900. Within the goods sector, the increase was dominated by construction (15,500) with much smaller advances posted by agriculture (4,300) and utilities (3,900). There were declines in manufacturing (3,200) and natural resources (200). Services were very mixed with hefty drops in transportation & warehousing (31,000) and professional, scientific & technical services (14,400) contrasting with large gains in educational services (32,800) and business, building & other support services (14,700).

Bottom line

The Banks of Canada and England, Reserve Bank of Australia and the European Central Bank all left their key interest rates unchanged at 4.5 percent, 5.75 percent, 6.5 percent and 4 percent respectively. The Banks acknowledged that the turmoil in financial markets had clouded the outlook. Economic data released last week were mixed. The U.S. employment situation report shocked investors. Employment was down in August, albeit by only 4,000 jobs. Offsetting this were declines in jobless claims (a more up to date series), positive ISM surveys and good productivity data. Skittish investors dumped stocks and the dollar on the employment report though. While U.S. employment was down, both Australia and Canada added more than double the jobs anticipated by analysts thanks to strong growth in the minerals sector.

This week gets started with Japan’s revised second quarter gross domestic product. The initial estimate was barely positive — up 0.1 percent on the quarter. It is expected to be revised downward into negative territory thereby postponing any hopes that the Bank of Japan had in its quest to normalize interest rates. Also on the calendar are major data releases for the UK including employment, earnings and retail sales.

Looking Ahead: September 10 through September 14, 2007

The following indicators will be released this week...
Europe
September 10	France	Industrial Production (July)
	Italy	Gross Domestic Product (Q2.07)
	UK	Producer Input and Output Prices (August)
September 11	France	Merchandise Trade Balance (July)
	UK	Merchandise Trade Balance (August)
September 12	EMU	Industrial Production (July)
	UK	Average Earnings (July)
		Claimant Count Unemployment (August)
September 13	UK	Retail Sales (August)
September 14	EMU	Harmonized Index of Consumer Prices (August)
	Italy	Industrial Production (July)
Asia/Pacific
September 10	Japan	Gross Domestic Product (Q2.07)
September 11	China	Consumer Price Index (August)
September 12	Japan	Corporate Goods Price Index (August)
September 13	China	Industrial Production (August)
Americas
September 11	Canada	Merchandise Trade Balance (July)
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