Global Markets

Risk adversity surfaced again last week and drove most of the major equity indexes down, with some at three month lows in a new wave of selling. Investors are more pessimistic about equity markets than at any time in the past decade, according to a Merrill Lynch poll of global fund managers. Sentiment towards equities is even more negative than during the period between 2000 and 2003 when the sell-off in global stocks was much sharper. Investors have cut their exposure to both equities and bonds and are moving into cash as fears of stagflation mount.

These concerns were underlined last week as worries about the global banking sector helped undermine U.S. and European equity and credit markets. Morgan Stanley said quarterly earnings plunged 57 percent thanks to the investment banking slowdown. This in turn sparked fears about the company’s ability to generate profits. But perhaps even more worrying was news that a U.S. regional bank was slashing its dividend and would raise at least $2 billion of fresh capital to cope with mounting credit losses.

Not all stock indexes were plumbing new lows last week however. Canada’s S&P/TSX Composite set a new record high on Tuesday morning when the index rose 1 percent to 15,089.50 surpassing its record close of 15,047.34 on May 20. The index has been positively affected by all time high prices for oil, grain and metals. The Canadian stock market has been among the best performers in 2008 but suffered a correction on Thursday and Friday as it was swept along with the downward draft from south of the border. The TSX composite index fell 283 points to 14790 on Thursday for its worst day since March 19 and 209.5 points on Friday. However, of the indexes followed here, the S&P/TSX is the only one that is positive for 2008.

Only the three Asian indexes — the Hang Seng, STI and PSEi were up for the week. The Sensex was the biggest loser, down 4.1 percent while the Dow followed, down 3.8 percent.

China reduces fuel subsidies

China, the world's second biggest oil consumer, is increasing energy prices across the board. Effective immediately, the wholesale price for gasoline will increase 17 percent, diesel will rise 18 percent and jet fuel will climb 25 percent. Note that gasoline/diesel prices at the retail level can be up to 8 percent higher than the wholesale benchmark prices. In addition, electricity prices will be boosted by about 5 percent on July 1. In the announcement it was made clear that the eventual goal is to “normalize” gasoline and diesel prices — this means full liberalization down the road. The increases in gasoline and diesel prices are above the market's expectation of a 10 percent boost, and way ahead of the curve in terms of the timing. Most analysts had expected Beijing to hold off on an unpopular fuel price rise until after the Olympics in order to keep a leash on inflation.

Global Stock Market Recap

Europe and the UK

The FTSE, DAX and CAC were down four of five days last week. All three indexes are nearing lows set in March. The declines can be traced to the usual villains — energy and banking. In Europe, banking stocks slipped on growing speculation of further writedowns and heavily weighted energy stocks declined after crude oil prices dropped on Thursday although they recovered on Friday. The declines were extended after the Philadelphia Federal Reserve Bank manufacturing survey showed that the sector contracted at an accelerated pace in June, providing yet another dismal view of U.S. economic performance. The FTSE mounted what turned out to be a feeble rally Thursday after retail sales unexpectedly rose by the most since records began, but it petered out in later day trading. Analysts opined that European banks may continue to face negative value adjustments on U.S. real estate-related structured credit exposures in the second quarter.

The three indexes managed to rise on Tuesday as mining stocks gained on firm metal prices and banks stocks rose on an analyst upgrade. The markets also drew strength from a report that the U.S. Federal Reserve was unlikely to raise interest rates when it meets next week. The FTSE shrugged off news of a jump in monthly inflation on Tuesday after strong earnings news from leisure group Whitbread boosted morale. Sustained strength from miners and banks also boosted the index.

Bank of England

The Bank of England was very much in the news last week. On Tuesday, Bank governor Mervyn King was required to write a remit to the Chancellor of the Exchequer after the consumer price index rose above 3 percent. Minutes of the June monetary policy committee meeting were released on Wednesday and new members were appointed to the Monetary Policy Committee on Thursday.

On Tuesday, the consumer price index jumped 3.3 percent when compared with last year. This required the Bank governor to write a letter or remit to the Chancellor of the Exchequer Alistair Darling, explaining why inflation is more than 1 percent above the 2 percent inflation target and what can be done to bring prices back to the target. In the letter, governor King predicted that inflation would rise above 4 percent by the end of the year due to rising food and energy costs. However, he gave no signal that the Bank was preparing for a series of rate increases to combat inflation. Rather King envisaged a return to a 2 percent CPI in two years.

According to the MPC meeting minutes, the committee voted eight against one to hold interest rates at 5 percent even though some members were ready to consider an immediate interest rate increase to contain inflation. However, the MPC saw no evidence of inflationary pressures in wages and noted that demand was already weakening although the speed and depth remained difficult to judge. Most analysts concluded the Bank is in a ‘wait and see’ mode as it looks for evidence that could shift the balance of risks in the economy more clearly toward either slower growth or higher inflation.

Finally, after a rather public skirmish, Charlie Bean, the Bank of England’s chief economist, was appointed deputy governor, taking over from Rachel Lomax on July 1. Mr. Bean’s promotion opened a new vacancy for an internal member of the Bank’s Monetary Policy Committee, and Spencer Dale, a career economist at the Bank will take that position and become the new chief economist. However, yet another deputy governor vacancy will arise next spring when Sir John Gieve, the deputy governor for financial stability, steps down two years early. Analysts think the new composition of the MPC means that interest rates are more likely to rise.

Asia/Pacific

Most of the stock indexes followed here closed lower on Friday and for the week. Only the Hang Seng, STI and PSEi gained on the week. Friday’s declines were attributed to oil related stocks that were negatively affected after China cut energy subsidies and raised fuel prices. Banking stocks also slipped after Moody's Investor Service cut its ratings on U.S. bond insurers and Citigroup forecast additional writedowns.

During the week, renewed worries about slower U.S. demand sent shares tumbling across the Asia Pacific region. Asian markets followed U.S. stocks downward as they are wont to do. Shanghai led the region lower by plunging as much as 6.5 percent on Thursday as investors worried that Beijing would not support share prices as it has in the past. Asian markets followed the example of New York as the Dow dropped to a three-month low overnight, in part on the first quarterly loss in 11 years at FedEx, which many investors consider a barometer for the wider U.S. economy. Carmakers, electronics companies and banks bore the brunt of the drop across Asia.

Shanghai Composite

On Friday, the Shanghai Composite closed more than 3 percent higher led by refiners and power producers after the government announced its decision to raise prices of electricity, gasoline and diesel. However, this was not enough to offset losses that occurred earlier in the week. Shanghai had declined because investors feared the government would not step in with measures to support share prices as it did in April when it slashed share trading taxes. The index has fallen by 46.2 percent so far this year. It is now closing in on its 2007 low of 2,541 that marked the start of a last year’s eight-month long rally of 141 percent.

Nikkei

The Nikkei ended the week below the 14,000 mark as investors sold because of the grim outlook for the U.S. economy and concern over the credit health of major U.S. financial institutions. Major decliners included mining, glass and ceramics, and machinery issues. Electronic makers like Toshiba, which depend heavily on the United States, faltered on weak U.S. economic data. Credit woes resurfaced after Citigroup reportedly warned of additional subprime-linked losses in a conference call on Thursday. Moody's also downgraded the triple-A debt ratings of U.S. bond insurers Ambac Financial Group Inc. and MBIA Insurance Corp.

Japanese investors sold a net ¥175.9 billion in foreign bonds last week, after buying a revised ¥404.6 billion in the previous week according to the Ministry of Finance. Japanese investors also sold a net ¥7.3 billion in foreign stocks after purchasing a net ¥16.9 billion a week earlier. On the other hand, foreign investors bought a net ¥153.7 billion of Japanese stocks last week and also acquired a net ¥732.8 billion in Japanese bonds.

Currencies

The dollar was down last week against both the yen and the euro as crude prices rose and stocks dropped. Renewed worries about banking stocks also contributed to the dollar’s woes. With the re-emergence of financial concerns some analysts questioned the ability of the Fed to raise interest rates anytime soon. The U.S. dollar lost ground on speculation of an early rate increase by the Fed, while the euro advanced against the dollar on growing fears that inflation in the eurozone economy would push interest rates up. Speculation of an early rate increase in the United States has been rapidly receding following the release of recent dismal U.S. economic data and media reports earlier this week projecting that the Fed is not considering tightening its credit policy in the near future.

Selected currencies — weekly results

Indicator scoreboard

EMU

May harmonized index of consumer prices were up 0.6 percent while the year on year rate was revised to an increase of 3.7 percent from the flash of 3.6 percent. The latest bounce in HICP inflation was broad-based with national data from all member states above 3 percent on the year with the exception of the Netherlands, which was up 2.1 percent. Energy of course was the main culprit. This component was up 3.6 percent in May and 13.7 percent on the year. Core HICP excluding energy, food, alcohol and tobacco was under the ECB inflation target: it was up 0.3 percent and 1.7 percent on the year. Excluding only energy, the HICP was up 0.3 percent and 2.6 percent on the year. Of all components, only communications was down both on the month and on the year. Food prices were up 0.5 percent and 6.4 percent on the year while housing jumped 0.8 percent and 5.7 percent on the year.

April merchandise trade surplus rebounded into surplus after a deficit in the prior month. The unadjusted surplus was €2.3 billion compared with a deficit of €1.6 billion in March and a surplus of €2.0 billion a year earlier. On a seasonally adjusted basis, the surplus was €2.2 billion. Exports were up 6.2 percent after plunging 4 percent in March. Imports were up 3.6 percent after declining 1.4 percent. Among the major product groups in the first quarter (detail lag a month), the deficit on primary products grew to €81.3 billion from €60.0 billion a year ago, wholly attributable to a sharp widening in the energy shortfall (€74.5 billion from €52.7 billion). Over the same period, the surplus on manufactured goods increased to €67.7 billion from €55.1 billion, in large part reflecting an improvement in the machinery and vehicles account.

Germany

June ZEW survey from the Centre for European Economic Research suggests that analysts are exceedingly pessimistic about the outlook for Germany. Economic expectations plunged to a 15-year-low of minus 52.4 from minus 41.4. Analysts had expected a decline of minus 43. The current situation component of the ZEW survey also fell, to plus 37.6 from plus 38.6 recorded in May. Given the financially biased nature of the survey, the ongoing decline in expectations is testament to concerns among analysts that the central banks might not have done enough yet to tackle the credit crunch or to keep inflation under control.

Producer price inflation continued to rise in May when a monthly 1.0 percent increase in the PPI lifted the 12-month change to 6.0 percent, its highest level in 22 months. The leap in the headline rates was largely due to yet another spike in energy prices which jumped 2.9 percent from April and are now up 15 percent on the year. Excluding energy, the PPI was up a much more modest 0.5 percent and 4.7 percent on the year. Other than energy, there were few monthly gains of significance with port meat up 6.4 percent on the month and 11.3 percent on the yea. Overall basic goods prices rose 0.6 percent on the month while capital edged up 0.2 percent and consumer goods both edged down 0.1 percent. Within the consumer sector, durables were up 0.2 percent while nondurables were down 0.1 percent

Italy

The merchandise trade gap widened out to a much as expected €1.0 billion in April. Although world exports were up 2.7 percent on the month, imports were up even more at 3 percent. Over the year to April, total exports were up 8.7 percent with flows to the EU up 5.8 percent. Overall imports on the same basis were up 7.5 percent, including a 4.1 increase in purchases from the EU. March saw another comfortable surplus on manufactured goods (€5.3 billion) but there were sizeable shortfalls on net trade in minerals (€5.6 billion) where energy was deeply in the red (€5.4 billion) and in agriculture and fishery products (€0.5 billion). Slowing economic activity abroad combined with an uncompetitive exchange rate will ensure that exporters continue to struggle over coming quarters. However, weak domestic demand should similarly keep a lid on imports.

First quarter unemployment rate jumped to 6.5 percent from an upwardly revised 6.2 percent in the fourth quarter. This was the highest since the third quarter of 2006. The labor force was up 0.4 percent while the number of employed edged up a mere 0.1 percent. Job-seekers were up 4.5 percent.

United Kingdom

May monthly increase in consumer prices moderated from April’s record jump of 0.8 percent to 0.6 percent. This in turn boosted headline inflation to 3.3 percent. The culprits were food and energy. Core CPI excluding food, beverages and tobacco was up a moderate 0.3 percent and 1.5 percent on the year. The most significant positive impacts on the 12-month rate came from food & non-alcoholic beverages (up 7.8 percent from 6.6 percent) and housing, utilities & fuels (6.3 percent from 5.4 percent). Other sizeable increases were seen in furniture and household equipment (1.7 percent from 1.4 percent). Against this, inflation fell in clothing & footwear which was down 6.3 percent for the second month. Overall goods sector inflation accelerated to 3 percent from 2.3 percent while service sector prices jumped to 3.8 percent on the year from 3.7 percent. RPI inflation rose to 4.3 percent from 4.2 percent while the formerly targeted RPIX accelerated to 4.4 percent from 4 percent.

May retail sales volumes soared by 3.5 percent and 8.1 percent when compared with last year. The monthly gain is the highest since records began in 1986. Sales were up in all major categories but were especially boosted by clothing & footwear as warmer than normal weather stimulated consumers. Food store sales were up 3.3 percent and 4.7 percent on the year while nonfood stores were up an even more robust 3.9 percent for a gain of 9.9 percent on the year. Clothing & footwear sales outpaced all others rising 9.2 percent and 11.2 percent on the year. The implied retail sales deflator, a guide to retail inflation, stood at minus 0.3 percent in May.

Asia/Pacific

Japan

April tertiary index jumped by 1.8 percent and was up 0.3 percent when compared with last year. Analysts had expected the index to edge downward by 0.2 percent on the month. March was revised downward to no change from an originally estimated 0.3 percent increase on the month. Industries that contributed to the increase included information & communications, wholesale & retail trade and electricity, gas heat supply & water. Transport, real estate services and medical health care & welfare also were positive on the month. The industries that declined included compound services, eating & drinking places, accommodations, learning support and not surprisingly, finance & insurance. The 11 service industries tracked by the index account for roughly 60 percent of Japan's economic output. Among them are utilities, transport, telecommunications, wholesale and retail, finance and insurance, real estate, restaurants and hotels, as well as medical, health care and welfare.

April all industry index was up 0.8 percent on the month. However, the index was down 0.3 percent when compared with the same month a year ago. The strength came from those industries that make up the tertiary index, which was released earlier this week. That index jumped by 1.8 percent on the month. 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.

China

May industrial output was up 16 percent on the year after gaining 15.7 percent in April. Output accelerated on rising exports. The shortening of a weeklong May holiday to a three-day break also boosted production. Sichuan's small role in manufacturing limited the May 12 disaster's effect on production but quake reconstruction work is boosting output of some products. Raw coal production rose 18.5 percent from a year earlier after gaining 13.9 percent in April. Crude oil output climbed 1.8 percent after increasing 0.5 percent.

Hong Kong

Seasonally adjusted unemployment rate for the three months from March to May was 3.3 percent, unchanged from the previous three months (February through April). Total employment decreased by around 2,100 in the March through May period.

Americas

Canada

May consumer price index was up 1 percent and 2.2 percent when compared with last year. Core CPI excluding food and energy was up 0.4 percent and 1.2 percent on the year. Both are well within the Bank of Canada’s inflation target zone of 1 to 3 percent. The Bank of Canada’s core CPI that is used for operational purposes and excludes eight volatile items edged up 0.3 percent and was up 1.5 percent on the year. Energy prices vaulted 5.5 percent and were up 11.5 percent while food prices jumped 1 percent and 1.9 percent on the year. Of the major categories, only clothing & footwear and household operations & furnishings declined on the month by 1.4 percent and 0.1 percent respectively.

April retail sales jumped 0.6 and 4.2 percent when compared with the same month a year ago. However, without Quebec's 3.4 percent sales growth, the national figure would have been negative as every province west of Ontario posted declining sales. Excluding the auto sector, sales were up an even more robust 1.1 and 5.8 percent on the year. Sales increased in six of the eight key sectors. Clothing & accessories sales were up 2.8 percent, and general merchandise was up 1.8 percent. However, automotive sales fell 0.2 percent on weaker results in both the new and used and the recreational vehicle markets. Gasoline station sales helped prop up the automotive sector, rising 1.9 percent from March, but that increase was largely the result of higher fuel prices in April.

Bottom line

This past week saw retail sales in the UK pleasantly surprise. The 3.5 percent monthly increase was attributed to an abnormally warm May. Economic news from the U.S. however, disappointed as industrial production edged down and the Philadelphia Fed manufacturing survey dropped more than anticipated. And in the UK and EMU, price data continued to exhibit increasing inflationary pressures. Stocks dropped with many indexes reaching lows not seen since March and the dollar lost its upward momentum and declined against both the yen and euro.

The focus next week will be on the FOMC announcement on Wednesday afternoon (US ET). Analysts expect the Fed will leave its fed funds target rate at 2 percent despite the fragility of economic growth and as inflationary pressures continue to build. In Europe, a plethora of key reports will be released at week’s end including a preliminary reading of Germany’s consumer price index. The inflation reading here along with the French producer price report is expected to bring more evidence of inflationary pressures.

Looking Ahead: June 23 through June 27, 2008

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