Global Markets

After two positive weeks, risk aversion reared its head and equities headed south. Equities in the U.S. were wildly volatile as first investors waited word from the FOMC on future monetary policy and then decided that it did not like the decision. While a quarter point cut in the fed funds rate to 4.25 percent was expected, some looked for an even larger cut in the discount rate — the interest rate that is charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility. And the FOMC post-meeting statement did not seem to address market concerns. But investors reacted negatively on Wednesday as well, after a concerted central bank action plan to combat the deepening credit squeeze was announced.

The Federal Reserve along with the European Central Bank, the Bank of England, the Bank of Canada and the Swiss National Bank announced measures aimed at easing pressures in the money markets. That response, after the Fed had disappointed investors on Tuesday, initially provided a welcome boost for stocks and other risky assets. But that did not last long. Financials led with sharp losses after investors digested the details of the plan.

The central banks will auction liquidity funding directly to a broad segment of commercial banks that will be able to pledge a wider variety of collateral. Some analysts were more skeptical about the plan, given underlying fears among banks about lending to each other, and they fear that this will take a long time to dissipate. U.S. financial stocks derived little support from the Fed's plan — and the volatile mood was not helped by oil prices, which surged nearly $4 a barrel on expectations of improved U.S. growth.

U.S. and European inflation indicators were higher than the ‘comfort zone’ for both the Federal Reserve and the European Central Bank. And what this portends for interest rates going forward depressed equity investors but cheered foreign exchange traders who look for higher interest rates to maximize spreads. And in the U.S., healthy November retail sales showed the consumer was alive and well going into the holiday season —  and further muddied the interest rate picture.

All equity indexes followed here were down for the first time since the week ending November 23. The declines last week ranged from 4.4 percent for the Hang Seng and 4.1 percent for the Bolsa to 0.6 percent for the DAX.

Global Stock Market Recap

Europe and the UK

The FTSE, CAC and DAX ended Friday on a positive note although the gains barely put a dent into the week’s losses. On Thursday, stocks dropped on concerns that the central bank plan to ease the credit crunch will not be sufficient to prevent an economic slowdown. Equities were hit when investors reacted negatively to the central banks’ plan to inject liquidity into the money markets. Traders said the money being offered is too small when compared with the overall size of the financial system and would not solve the funding problems faced by the banking sector. Central banks generally inject funds into the market to meet year-end financing needs. The plan addresses the current unusual circumstances.

After suffering its biggest one day percentage drop since August, the FTSE rebounded as investors took advantage of bargain prices especially for bank shares. The same thing was true in Europe as stocks rebounded from Thursday’s losses. Stocks in Europe gained even though the harmonized index of consumer prices was up 3.1 percent — more than a percentage point above the ECB’s inflation ceiling of 2 percent and the highest since 2001. While most of the jump was due to food prices, given the ECB’s inflation targeting mandate, it will be difficult for the ECB to maintain its current 4 percent interest rate without an increase going forward.

Asia/Pacific

Asian stocks continued to brood on Friday after a downgrade of a major U.S. bank and disappointing data from Japan. Shares fell across the Asia-Pacific region on skepticism about plans by major central banks to tackle tight credit conditions. The decline in the all important Tankan index of business confidence on Friday was larger than analysts expected, this combined with speculation that Chinese interest rates will increase weighed down investor sentiment. Both the Nikkei and Topix were down four of five days last week as Friday’s Tankan results proved that the economy is weak. Contributing to the weak performance in Japan and elsewhere were losses in the U.S. and European equities that negatively influenced investors here. Hopes for more vigorous action from the FOMC were also disappointed in this part of the world given the high level of uncertainty overhanging the financial markets.

Worried investors sent the Hang Seng index down 4.4 percent last week. The negative sentiment even affected property stocks in spite of local banks following the U.S. rate cut, which helps homebuyers. Investors seemed to be selling Asian stocks because they worried that the Fed’s quarter-point cut in interest rates and other measures might not be enough to avert a recession in the U.S., the region’s key export market. In Hong Kong, shares fell steadily during the day. Chinese stocks fell on comments by Hong Kong Monetary Authority Chief Executive Joseph Yam that China’s economic growth has been too fast and its inflation too high.

It should be noted that Asian central banks refrained from joining their North American and European counterparts in taking emergency action to boost market liquidity. The situation differs in Asia even though there are some funding strains in Australia, Korea and China. Even though the Bank of Japan took the lead among Asian central banks in expressing support for the emergency plan to ease liquidity concerns, it said it had no plans to take measures of its own. The BoJ has been supplying funds against pooled collateral since last year, allowing borrowers to access funds using a variety of collateral.

Asian Development Bank lowers growth forecasts

According to the Asian Development Bank (ADB), the economies of emerging east Asia are expected to grow 8 percent in 2008, down from an expected 8.5 percent in 2007. The report covers China, Taiwan, Hong Kong, South Korea and the 10 members of the Association of South East Asian Nations. ABD said that the outlook is subject to greater downside risks now and include the possibility of a hard landing for the U.S. economy, further global credit tightening, and an ‘abrupt’ adjustment in exchange rates and continued rising oil and commodity prices.

ADB noted that so far Asian banks have been relatively unscathed by the U.S. subprime mortgage market turmoil. Still the ADB warned that “despite limited spillover into emerging east Asia from the U.S. subprime turmoil, there are several signs of financial vulnerability related to sharp gains in equity and real estate prices.”

Chinese growth is likely to slow slightly next year to 10.5 percent from an estimated 11.4 percent this year. The Bank also noted that industrial production growth might have peaked in several countries including China, South Korea and Singapore. ADB expressed its concerns about the impact of the possible unwinding of carry trades given current heightened financial uncertainty. To execute a carry trade, investors borrow in low yielding countries such as Japan and invest in higher yielding countries such as Australia and New Zealand.

Currencies

The U.S. dollar gained new life and was up against most major currencies after increases in both producer and consumer prices prompted traders to cut back on their expectations for further Fed interest rate cuts. With inflation picking up it will be difficult for the Fed to aggressively cut rates. The dollar gained about 1.5 percent against the euro last week for its biggest weekly increase since August.

And against the yen, the dollar also gained about 1.5 percent after retail sales showed that the U.S. consumer is spending and industrial production showed that manufacturing is still growing. But the yen’s weakness on Friday was also attributable to the decline in the quarterly Tankan business survey to a two-year low which could stymie the Bank of Japan in its desire to normalize interest rates. Higher risk aversion has tended to help the yen in recent months as it encourages investors to trim back carry trades, in which the low-yielding Japanese currency is sold to fund the purchase of riskier, higher-yielding assets elsewhere. The dollar was helped this week by the unveiling of a coordinated plan among central banks to alleviate the liquidity crunch along with the Bank’s third interest rate cut this year to help the economy overcome the fallout from the housing crash.

Indicator scoreboard

While the Federal Reserve and other central banks dominated the news last week, several indicators managed to get investor’s attention — primarily because of their impact on central bank decisions going forward. Inflation indicators in the eurozone and the U.S. flashed warning signs that will not please the banks. All November readings were far above target or, in the case of the U.S. Federal Reserve, above their comfort zone. And in Japan, the highly regarded Tankan Survey showed a decline in business sentiment that is bound to delay any move by the Bank of Japan to normalized interest rates. Below are the highlights of the major international indicators that were released last week that can help to provide input to investment decisions moving ahead.

EMU — October industrial output was up 0.4 percent after sinking 0.8 percent in September. Output was up 3.8 percent when compared with last year. The latest gain was heavily dependent upon the intermediate (0.6 percent) and capital (1.0 percent) goods sectors since consumer goods (0.0 percent) were disappointingly weak and continues to lag behind the other major output categories. The national results comprise a very mixed bag with healthy increases in France (2.1 percent), Spain (1.0 percent) and Ireland (3.2 percent) contrasting sharply with drops in Germany (0.2 percent), Italy (0.3 percent) and the Netherlands (4.1 percent).

November harmonized index of consumer prices was up 0.5 percent and 3.1 percent when compared with last year. This is substantially higher than October’s 2.6 percent increase and the highest since May 2001. Core HICP, which excludes food, alcoholic beverages, energy and tobacco was up 1.9 percent on the year and unchanged from its October pace. Core was just below the ECB’s 2 percent ceiling. Excluding energy and unprocessed foods — one the preferred indicators — edged up to 2.3 percent on the year from 2.1 percent. Energy costs jumped 9.7 percent on the year from 5.5 percent in October and were in turn largely responsible for the acceleration in prices in both the transportation sector (5.8 percent from 4.1 percent) and housing (3.6 percent from 2.7 percent). Motor fuels were up more than 15 percent on the year and heating oil some 22.6 percent. However, annual price rises in clothing (1.2 percent), health (1.4 percent) and recreation (0.3 percent) are all still subdued.

Germany — October merchandise trade surplus was €18.2 billion and slightly larger than the €17.8 billion surplus in September. Exports were up 0.6 percent and more than 6 percent over the year. Imports meanwhile edged up just 0.2 percent on the month for annual growth of 5.2 percent. Within total exports, flows to non-EU countries were down 1.1 percent over the last twelve months despite climbing 10.8 percent to the EU states.

December ZEW economic expectations were down almost five points to minus 37.2 while current conditions declined almost seven points to 63.5. Uncertainly over the outlook for financial markets and worries about global growth, the strong exchange rate and the inflationary pressures caused by sharply higher commodity prices all helped to weaken sentiment this month.

France — October industrial output was up 2.1 percent and 4.0 percent when compared with last year. The increase reflected solid gains in most of the major production categories. In particular, the auto sector, which slumped 4 percent in September rebounded with a hefty rise of 6.9 percent. Food & agriculture was up 2.4 percent, energy 2.1 percent and semi-finished goods 1.9 percent. Output in the consumer sector rose a less remarkable 0.4 percent but capital goods advanced a solid 1.0 percent. The only decline was in construction where a 0.2 percent drop compounded the 0.4 percent decline posted in September. Manufacturing climbed 1.9 percent to stand 3.7 percent higher on the year.

Italy — October industrial output declined by 0.3 percent and was down 1.5 percent when compared with last year. The drop would have been worse but for a 1.3 percent bounce in energy production. Consumer sector output was down 0.1 percent (although this followed a 4.1 percent collapse in September) but intermediates were off 0.2 percent and capital goods slumped a full 1.0 percent.

United Kingdom — October producer output prices were up 0.5 percent and 4.5 percent when compared with last year. This is the highest annual gain since August 1991 (5.2 percent). The increase is primarily a function of spiralling energy and food prices. Core output prices edged up just 0.1 percent and are up 2.2 percent on the year. Gasoline prices were up 3.7 percent —its largest monthly gain in more than two years. Food products (0.7 percent) were also firm once more and alcohol prices rose an unusually large 0.5 percent. Most other areas however, were quite subdued with only paper registering a rise of 0.3 percent or more. Input prices jumped 1.7 percent and were up 10.3 percent on the year. Energy was once again largely to blame with a 9.8 percent leap in crude oil prices having a significant impact. Excluding food, drink, tobacco and petroleum, prices were down 0.2 percent and up 1.8 percent on the year. 

October global trade deficit narrowed to Stg 7.1 billion as exports posted an increase of 1.8 percent while imports dropped 1.9 percent. The underlying trade gap (excluding oil and erratics) declined to Stg6.6 billion from Stg7.2 billion. The bilateral trade deficit with the EU declined to Stg2.7 billion from Stg3.3 billion — its lowest level since November 2006. The deficit with non-EU countries was Stg4.4 billion, lower than September’s Stg4.6 billion deficit.

November claimant count unemployment dropped by 11,100 following a slightly steeper revised decline of 10,600 in October. The claimant unemployment rate was 2.5 percent, unchanged from October, and the lowest since April 1975. For the three months ending in October, the ILO measure of unemployment was down another 15,000 which reduced the jobless rate to 5.3 percent. 

October average earnings growth slipped to 4.0 percent from 4.1 percent the previous month. The decrease in overall rate (including bonuses) was due to weaker manufacturing growth and was only partially offset by stronger growth in the public sector. Average earnings excluding bonuses, were up by 3.6 percent in the year to October 2007, down from 3.7 percent in September. The driving force behind the slowdown was the private sector where actual earnings growth in October dropped to 3.8 percent from 4.4 percent to nudge down the headline rate to 4.2 percent from 4.3 percent.  However, this was concentrated in the manufacturing sector (2.5 percent from 3.1 percent) while services saw a slight pick-up (4.4 percent from 4.3 percent) due to higher pay in the public sector (3.2 percent from 3.0 percent). 

Asia/Pacific

Japan — November corporate goods price index was up 0.2 percent and 2.3 percent when compared with a year ago. Japan has not been immune to higher energy prices. Petroleum and coal product prices soared by 4.9 percent on the month and 19.9 percent on the year. Manufacturing industry product prices were up 0.3 percent and 2.4 percent on the year while minerals edged up 0.1 percent on the month and were up 4.6 percent on the year. With this release, the Bank of Japan has rebased the index to 2005 equals 100 from 2000 equals 100.

Fourth quarter Tankan business conditions for large manufacturers dropped to 19 from the third quarter reading of 23. The lower reading reflects large exporters’ concerns about the weakening U.S. economy as well as the firmer value of the yen. A higher value for the yen means that repatriated profits will be less and price competition for their exports will be greater. Small manufacturers sentiment, which largely reflects the domestic sector edged up to 2 from the third quarter reading of 1. Medium sized manufacturers’ reading was unchanged at 10. In the nonmanufacturing sector, the index readings for large (16 down from 20), medium (2 down from 4) and small (minus 12 down from minus 10) all declined on the quarter. Demand is expected to remain weak, both at home and increasingly overseas, helped by the stronger yen.

China — November consumer price index jumped 6.9 percent from a year earlier after climbing 6.5 percent in October. This was the quickest pace in 11 years. Inflation was up 4.6 percent in the first 11 months and significantly higher than the People’s Bank of China’s 3 percent target for the year. Overall, food climbed 18.2 percent. Non-food prices were up 1.4 percent after rising 1.1 percent in the previous month. Utility prices including water, electricity and gas were up 5.6 percent.

November industrial output was up 17.3 percent when compared with last year and slightly slower than October’s 17.9 percent increase. Raw steel production grew by 4.3 percent on the year and down from 13.5 in October. Steel products output growth also decelerated to 12.7 percent from 17 percent in October.

November merchandise trade surplus climbed 14.7 percent to $26.3 billion in November from a year earlier, the third-biggest monthly total. The $15.2 billion trade surplus with the U.S. pushed the 11-month total with that country to $149.2 billion.

Australia — November employment soared by 52,600 jobs while the unemployment rate climbed to 4.5 percent thanks to an increase in the participation rate to 65.3 percent. Full-time employment increased by 8,200 to 7,594,200 and part-time employment increased by 44,400 to 2,989,000. Unemployment increased by 19,800 to 499,500. People looking for full-time work increased by 15,200 while the number of persons looking for part-time work increased by 4,600.

Americas

Canada — October merchandise trade surplus widened to C$3.3 billion from C$2.8 billion the previous month. Exports were down 0.5 percent but imports dropped 2.0 percent. The trade surplus with the U.S. narrowed again to C$6.2B, its lowest level since October 2006 as the value of imports fell more steeply than exports.  The decline in global exports was the third in as many months and led by decreases in agriculture & fishing products (5.1 percent) and energy (1.8 percent). Other notable drops were in autos and industrial goods & materials (0.6 percent). The only significant advance was posted by machinery & equipment (1.9 percent) which climbed on the back of a sharp (24.0 percent) rebound in aircraft & other transportation equipment from its lowest level in September since January 2000. The drop in imports was broad-based outside of machinery & equipment (up 0.3 percent). Energy dropped as did industrial goods & materials and other consumer goods. 

October factory shipments edged up 0.1 percent after sinking 1.1 percent in September. Shipments were up 1.5 percent when compared with last year. On an industry-by-industry basis, 12 of 21 manufacturing industries were up during the month. Aerospace & parts jumped 8.4 percent and miscellaneous producers were up a healthy 6.1 percent. Petroleum & coal also rose 2.0 percent, helped by the return to normal output levels by several plants hit by longer than usual shutdowns in September. However, transportation dropped 2.3 percent as motor vehicle sales slumped 5.8 percent. Auto parts were off 1.4 percent. Unfilled orders dropped 1.7 percent after a similar-sized decline in September and new orders slipped 0.1 percent for the third drop in a row.

Bottom line

For the second week, central bank activities dominated. The FOMC announcement on Tuesday set off a torrent of selling in the U.S. — other main world markets were closed at the time. And on Wednesday, the Fed’s second announcement concerning a plan to ease liquidity problems — in concert with the ECB, Banks of England and Canada and the Swiss National Bank — set off volatile gyrations in the equity market. However, inflation data captured investor attention on Thursday and Friday when U.S. producer and consumer prices showed greater than expected increases. And in Europe, the inflation story was the same — prices were up faster than anticipated. These are key data for central banks with official inflation targets such as the ECB and the Banks of England and Canada and even those with no official target, such as the U.S. The U.S. dollar benefited and was up against most major currencies for the week.

The only central bank activity this week is the monthly Bank of Japan two day meeting. No change in policy is anticipated. The economy has been showing signs of weakening as evidenced by the recent downward revision to GDP and the declining business sentiment in the Tankan. And even though the Bank has resolutely repeated it wants to normalize interest rates, analysts anticipate it will be a while before they can act.

This week is the last full trading week of the year and most investors will be locking in their positions in most uncertain times. This will also be the last full week of economic releases until after the first of the year. Investors will monitor any and all price releases, especially those in the UK and Germany. And in the U.S., housing start data will be examined for signs of life in this beleaguered sector.

Looking Ahead: December 17 through December 21, 2007

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