Global Markets

The week’s news was dominated by the precipitous decline and then recovery in international stock indexes and the Federal Reserve’s surprise intra-meeting interest rate cut. The Fed slashed interest rates by 75 basis points — the first unscheduled rate cut since September 17, 2001 and its largest single cut since 1982 — in a bid to arrest recession fears in the U.S. economy and stem a sell-off in world stock markets. The move hinted clearly at more cuts to come. The graph below illustrates the vast disparity that exists between key interest rate levels of the major central banks.

After horrifying losses in Asia and Europe early in the week, virtually all indexes covered here recovered a substantial chunk — and several managed to gain on the week for the first time this year. On Monday, when U.S. markets were closed for a holiday, equities in Asia and Europe plummeted in an old fashioned case of risk aversion. Commodity prices were also down as slower growth will reduce demand. Investors flocked to government bonds as a safe haven as well as currencies such as the Swiss franc and Japanese yen.

On Tuesday morning and prior to U.S. markets opening for the week, the Federal Reserve, in a surprise move, announced a cut in the fed funds target rate to 3.5 percent from 4.25 percent. Analysts questioned the need of an emergency move — given the long lags before the stimulus kicks in and only a week the FOMC was scheduled to meet. Despite this move, U.S. markets retreated Tuesday, but rebounded strongly on Wednesday and again on Thursday as signs of a fiscal stimulus package appeared to be making its way through Washington’s pre-election political morass.

To some, the recent declines in equities represented a catch up with reality as some central banks (Federal Reserve, Banks of England and Canada) have cut interest rates and investment banks have announced big write-offs while various rescue packages have been suggested to bail out troubled firms. Investors had assumed that the Fed would rescue the economy and the financial markets as it has in the past (even as they questioned the timeliness of the Fed’s prior moves). Investors who are proponents of decoupling assumed that if the U.S. economy faltered, the rest of the world could make up the slack in global growth.

Despite the turmoil, the All Ordinaries, Topix and STI in Asia and the Dow, S&P 500, S&P/TSX Composite and the Bolsa in North America gained on the week. However, all indexes followed here are down substantially since the end of business in 2007.

Global Stock Market Recap

Europe and the UK

The FTSE, CAC and DAX veered from negative to positive and back to negative last week. Losses on Monday alone ranged from 5.5 percent for the FTSE, to 6.8 percent for the CAC to 7.2 percent for the DAX. It is worth noting that German equities have been amongst the hardest hit in Europe so far this year after gaining 22.3 percent in 2007. The losses reflect the importance of exporters to the German economy and the disproportionately large exposure of companies listed on the DAX to the global economy in general and to the U.S. economy in particular. After the Fed’s announcement Tuesday morning, the FTSE and CAC soared, shedding earlier losses. When the day ended the FTSE had gained 2.9 percent and the CAC, 2.1 percent. But after dancing in the streets on Tuesday, European and UK markets returned to business as usual and declined once again on Wednesday. However, all three reversed direction on Thursday to post heavy gains once again. On Friday, good gains dribbled away after a lack luster performance by U.S. indexes. Banking and insurance stocks were down as investors continued to mull over the implications of the fraudulent activities of a Société Générale trader who lost the French bank €4.9 billion. The French CAC was hit harder obviously while the matter is being sorted out.

Bank of England minutes

The Bank of England’s monetary policy committee voted eight to one to leave interest rates unchanged at their January 10 meeting according to minutes published Wednesday. The monetary policy committee felt that “the short-run inflation outlook had worsened markedly” as higher commodity prices and a sharp decline in sterling increased the risks of inflation rising further above target. Those risks offset the possibility that “there could be a much sharper fall in growth” than the Bank’s central projection in its November inflation report. But while the Bank accepts that inflation is likely to rise further above its 2 percent inflation target in the coming months, it considers it crucial for the credibility of monetary policy to keep medium-term expectations of inflation in check. Analysts, while still expecting a 25 basis point interest rate cut at the Bank’s February meeting, think the MPC signaled that they would not cut interest rates as aggressively as the Fed.

Asia/Pacific

Despite opinions elsewhere, it is clear that Asian investors liked the surprise interest rate cut along with the proposed stimulus plan for the U.S. economy. After sinking precipitously on Monday and Tuesday on fears that the U.S. would enter a recession and there would be slower growth elsewhere as well, stocks righted themselves after the Fed’s surprise move to help ward off what many see as an incipient recession in the U.S. On Wednesday, stock markets across the Asia-Pacific region rebounded from the biggest two-day drop in 18 years, after the U.S. Federal Reserve lowered borrowing costs to 3.5 percent. Of the indexes followed here, the Hang Seng surged 10.7 percent. Hong Kong’s currency is pegged to the U.S. dollar and therefore any interest rate cut in the U.S. translates to lower rates in Hong Kong.

In Tokyo, stocks closed Monday at their lowest level in more than two years with the Nikkei diving 535 points on Japan's sluggish economic data, drops in other Asian equities and renewed jitters over the global credit crunch. The Topix closed at its lowest level since September 9, 2005. Stocks fell across the board with mining, nonferrous metals and metal product issues incurring the heaviest declines. Brokers said stocks — especially exporters — lost heavily on skepticism that a U.S. stimulus package unveiled at the end of the previous week (in only very broad terms) was not sufficient to bolster growth. However, Friday was different. Asian stocks soared after South Korea's economy expanded faster than estimated and the U.S. stimulus package, which had taken shape over the week, moved closer to approval and included tax rebates to bolster consumer spending. The Nikkei added 4.1 percent — the biggest advance since March 2002.

Bank of Japan maintains policy

As expected, the Bank of Japan monetary policy board unanimously voted to leave its policy interest rate at 0.5 percent. In November the consumer price index excluding fresh food was up for the second month. (December’s data were released after the meeting.) Prior to that, the CPI had posted negative readings for eight straight months. Since the U.S. subprime mortgage crisis, global money has shifted out of U.S. financial markets and into crude oil and other commodities. In turn, this has lifted energy prices in Japan and by extension, the CPI. Because the rising prices are not a reflection of increased demand resulting from a strong economy, a further increase in prices could have a negative impact on economic conditions.

Currencies

After gaining ground earlier in the week on the unwinding of carry trades, the yen was down slightly at week’s end while the euro was marginally higher despite the week’s volatility in the financial markets. The dollar was up against the euro Friday after U.S. stocks declined, prompting investors to buy Treasuries. With interest rates in the U.S. lower than those of the eurozone and projected to still go lower, it would be logical for the euro to increase in value. But the dollar strengthened as futures odds showed a 66 percent chance the Fed would cut its 3.5 percent fed funds target rate by 50 basis points on January 30 compared with 76 percent odds yesterday. Earlier in the week, the euro came under pressure as a survey suggested the eurozone economy was set to weaken, strengthening the view that the European Central Bank might have to abandon its hawkish stance on interest rates.

The yen appreciated on speculation investors will sell high yielding assets and pay back low cost loans from Japan as they bail out of carry trade positions. The yen rallied sharply on Wednesday, hitting its strongest level for two-and-a-half years against the dollar as rising risk aversion gripped the currency markets.

Indicator scoreboard

Germany — December producer prices excluding construction were unchanged on the month but up 2.6 percent when compared with last year. Core PPI was also unchanged on the month but was up 2.2 percent on the year. Excluding just petroleum products, the PPI was similarly unchanged on the month and up 1.6 percent annually. Basic goods dipped 0.2 percent on the month (up 2.3 percent on the year), capital goods were unchanged (0.8 percent) and consumer goods rose 0.2 percent (3.4 percent).

January Ifo survey overall sentiment index edged up to 103.4 from 103.0 in December, suggesting that business conditions stabilized at the start of 2008. The latest uptick in the composite headline index reflected the first increase since May in the expectations component (99.0 from 98.2) that more than offset a small decline in current conditions (107.9 from 108.1). At a sectoral level, there were increases in business sentiment diffusion indices across the board with the exception of retail (minus 17.6 from minus 15.3). The largest improvement, albeit still in negative territory, occurred in construction (minus 16.8 from minus 20.5) and was followed by manufacturing (17.4 from 16.6). Wholesale was essentially flat (3.2 from 3.1) while total industry recovered less than half of the December drop (5.9 from 5.2).

France — December consumption of manufactured goods jumped by 2.0 percent and was up 3.9 percent when compared with last year. The rebound in December was broad-based with solid monthly gains in all of the major categories. Autos (5.8 percent) were especially robust, although in part this may have reflected the then impending introduction of new environment taxes that could depress sales at the start of this year. Other notable increases were posted by textiles (2.5 percent) and household goods (1.7 percent) while the increase in other goods (0.4 percent) was rather more modest. Less autos, parts and pharmaceuticals, sales rose 1.5 percent following a 0.2 percent drop in November.

Italy — November retail sales were down 0.3 percent and up 0.2 percent when compared with last year. Average sales during the first two months of the quarter were just 0.2 percent above their third quarter mean while demand in November stood a very disappointing 0.6 percent higher than at the start of the year. Both food (0.1 percent) and non-food (0.3 percent) sectors were down — the latter having declined in three of the last four months and five of the last eight. Non-food sales now stand 1.0 percent below their year ago level on the back of widespread weakness amongst the major product groups.

United Kingdom — Fourth quarter preliminary gross domestic product was up 0.6 percent and 2.9 percent when compared with the same quarter a year ago. The fourth quarter advance was led by services which grew 0.7 percent on the quarter and 3.4 percent on the year. The quarterly rise was buoyed by particularly strong gains in transport, storage & communications (1.9 percent) and distribution, hotels & catering (1.0 percent). The other major categories also posted respectable advances with business & financial services (0.4 percent) just behind government and other (0.5 percent). Production industries edged up 0.3 percent on the quarter and were up 0.8 percent on the year. Quarterly growth in the sector was dominated by electricity, gas & water (1.7 percent), followed by mining & quarrying (1.1 percent). Manufacturing was flat. Agriculture was up 1.3 percent while construction posted a 0.7 percent advance.

Asia/Pacific

Japan — November all industry index dropped 0.5 percent but was up 0.4 percent. The tertiary index (released last week) which is a component of the all industry index edged up 0.1 percent in November. The all industry index takes a reading of activity in the 11 industries that comprise the tertiary index, 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. Overall, weak job creation continues to hamper household incomes and thus consumer spending, while that in turn is dampening investment and production in the domestic economy.

December merchandise trade surplus was ¥ 877.9 billion, down 20.9 percent from December 2006. Exports were up 6.9 percent while imports were up a modest 3.3 percent on the year. Exports climbed on continued strong demand for cars, steel and telecommunications equipment while imports were up on higher energy prices. Exports to Asia were up 8.2 percent (and 8.4 percent with China) while imports climbed 3.3 percent on the year (3.3 percent with China). Exports to the United States declined 4.5 percent on the year while imports were up 3.4 percent. On a seasonally adjusted basis, the surplus declined for the third month, dropping to ¥642.5 billion from ¥827.2 billion in November (see graph).

December consumer price index was up 0.2 percent and 0.7 percent when compared with last year. Most if not all the increase resulted from higher energy prices. Core CPI which excludes fresh food only was up 0.3 percent and 0.8 percent on the year, somewhat higher than anticipated. Prices for furniture & household utensils, clothes & footwear and medical care were down on the month; all other components showed increases or were unchanged. On the year, prices for fuel, light & water jumped 3.6 percent while transportation & communication prices were up 2.6 percent. Food prices were up 0.3 percent and 0.9 percent on the year. An alternative core inflation measure which excludes food and energy was unchanged on the month and down 0.1 percent on the year. January CPI for Tokyo was down 0.4 percent and was up 0.2 percent on the year. The January Tokyo reading is often a precursor for the national CPI of that month.

China — Fourth quarter preliminary gross domestic product was up 11.2 percent when compared with last year. The economy grew 11.5 percent in the third quarter. Growth was powered by domestic investment and export growth. The economy grew 11.4 percent in 2007 from a year earlier and the fastest pace in 13 years. The slight slowdown in Q4 growth was attributed to a minor slowdown in investment growth.

December industrial output was up 17.4 percent when compared with last year and slightly higher than November’s 17.3 percent gain.

December consumer price index was up 4.8 percent when compared with December 2006. For the year of 2007, the CPI was up 4.8 percent. The sharp climb in consumer prices reflected large increases in domestic food prices and global energy prices.

Australia — Fourth quarter final stage producer prices were up 0.6 percent and up 2.8 percent when compared with the same quarter a year ago. Final stage prices were up mainly due to building construction prices, up 1.4 and of course petroleum refining prices which soared by 12.8 percent. These increases were partially offset by price declines in other agriculture of 19.4 percent and electronic equipment manufacturing of 7.2 percent. Intermediate stage products were up 1.1 percent and 4.3 percent on the year. Preliminary stage products were up even more than intermediate. They were up 1.5 percent and 4.7 percent on the year. As expected, most of the increase was due to soaring prices in oil and gas extraction (up 11 percent), petroleum refining (up 12.1 percent) and property operators and developers (up 3.1 percent). The increases here were partially offset by declines in basic non-ferrous metal manufacturing (down 10 percent) and iron and steel manufacturing (down 2.3 percent).

Fourth quarter consumer price index was up 0.9 percent and 3.0 percent when compared with last year and less than analysts expected. Even the rising value of the Australian dollar was not sufficient to offset the impact of rising energy prices. Transportation prices were up 2.4 percent. The most significant increases were due to the rise in the price of automotive fuel (up 7.3 percent). Most other categories in transportation were up, with motor vehicle repair (0.9 percent) and urban transport fares (1.5 percent) being the most significant. Domestic holiday travel & accommodation jumped 3.7 percent. Offsetting these increases were fruit prices, down 13.5 percent, and vegetables, down 6.9 percent. Prices for pharmaceuticals dropped 5.4 percent while audio, visual & computing equipment prices sank 4.3 percent.

Americas

Canada — November retail sales were up 0.7 percent and 6.1 percent when compared with last year. Five of eight retail sectors posted advances. Excluding the auto sector, sales were up 1.7 percent on the month and 8.3 percent on the year. General merchandise sales were up 2.3 percent, furniture, home furnishings & electronics gained 1.4 percent, clothing & accessories gained 1.2 percent and food & beverages were up 0.9 percent. Sales in the auto sector were up 0.6 percent thanks to sharply higher gasoline sales (7.7 percent). However, on the downside there were declines in building & outdoor home supplies (2.4 percent) and pharmacies & personal care products (0.2 percent). In addition, an important chunk of the overall nominal increase was attributable to higher prices (mainly energy) since in volume terms total sales were up a much more modest 0.2 percent.

December consumer price index was up 0.1 percent and 2.4 percent when compared with last year. The core CPI which excludes food and energy was down 0.2 percent and up 1.7 percent on the year. The Bank of Canada core CPI which excludes eight volatile items was down 0.3 percent on the month and up 1.5 percent on the year. Gasoline prices were up 1.7 percent which was a significantly smaller gain than November’s 4 percent jump. The other major boost came from a 6.2 percent jump in air fares, the largest increase since December 2003. There were increases in fresh vegetables (6.2 percent) and, particularly, in heating oil and fuels (9.9 percent) which climbed at their fastest pace since the Hurricane Katrina-affected leap seen in September 2005. Prices declined for women’s & men’s clothing (4.7 percent and 3.2 percent respectively), traveller accommodation (2.4 percent) and books (9.0 percent). There was also another drop in the cost of video equipment (3.8 percent).

Bottom line

Last week was dominated by high volatility in the financial markets and the Federal Reserve’s intra-meeting interest rate cut that surprised just about everyone. While the Fed said they took this preemptive action in view of a weakening economic outlook and increasing downside risks to growth, many analysts opined that it came as a direct result of the global equity sell off on Monday when U.S. markets were closed. The markets were also cognizant of the fiscal aid package for the U.S. economy being developed in the highly charged political atmosphere in election year Washington. There was little new economic data in the U.S. and abroad to distract investors from financial market maneuvering.

Even as the Fed surprised markets on Tuesday morning, the Bank of Canada did what was expected and cut its overnight interest rate target by 25 basis points at its regularly scheduled meeting. The move is the second quarter point cut in as many meetings, leaving the policy rate at 4 percent.

The FOMC is scheduled to hold a two-day meeting on Tuesday and Wednesday with many analysts expecting an additional 50 basis cut to 3 percent. This week will provide a vast array of new economic data from the U.S. and elsewhere. Data in the eurozone and UK will be analyzed closely with the ECB and Bank of England meeting the following week. While the Bank of England is expected to lower its key rate by 25 basis points to 5.25 percent, the ECB is expected to maintain its 4 percent rate.

Looking Ahead: January 28 through February 1, 2008

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