Global Markets

Global growth prospects continued to be debated in financial markets and for the most part, risk-takers prevailed — most equity markets followed here were up on the week. At the beginning of the week, Asian investors had an opportunity to respond to the increase in bank reserve requirements by the People’s Bank of China. And on Friday they responded to the Federal Reserve’s increase in the discount rate. And during the week, they debated the fiscal crisis in the eurozone. Growing confidence in the global recovery and fading concerns about sovereign default mid-week helped markets gain momentum.

The Federal Reserve increased its discount rate by 25 basis points to 0.75 percent in a move that has no monetary policy significance. Rather, the move is part of the normalization process and widens the spread between the discount rate and the federal funds rate to 50 basis points. In more normal times, the spread is one percentage point. The move should be viewed in the same vein as the Fed's previous decision to let an array of emergency liquidity programs expire. The move was made at the request of the 12 Federal Reserve Banks.

The Board's decision to increase the rate at which it makes short-term loans to depository institutions should not have come as a surprise. It was practically pre-announced by Fed Chairman Ben Bernanke in his February 10 testimony to the House Financial Services Committee. At that time Bernanke said an increase in the discount rate was coming soon and he was careful at the time to emphasize the non-monetary policy character of the impending change.

On the week, all equity indexes were up with the exception of the Hang Seng, Topix and STI. Gains ranged from 0.3 percent for the Nikkei and SET to a healthy 4.7 percent for the DAX.

Global Stock Market Recap

Europe and the UK

The FTSE, DAX and CAC gained for the second consecutive week. The three indexes were up on each of the last five trading days. After opening lower Friday on traders’ initial reaction to the Fed’s announcement, Nestle’s forecast that sales growth will accelerate overshadowed the Fed’s move. The FTSE was up 4.2 percent while the DAX and CAC gained 4.0 percent and 4.7 percent respectively for the week.

Investors were wary amid concerns that efforts by Greece, Spain and Portugal to curb their budget deficits would harm the economic recovery and China’s moves to restrict lending to prevent its economy from overheating. The more important economic data released last week focused mainly on the UK. The data were disappointing with unemployment surprising on the upside while retail sales surprised on the downside. Equities were up at the end of the day anyhow as investors chose good earnings reports to more than offset the dour economic news. And the ZEW continued to level off showing some hesitation by financial experts about German growth.

Western European companies that have reported earnings since January 11 have beaten analysts’ forecasts for net income by an average of 15 percent, according to Bloomberg.

Bank of England minutes

The minutes from the February 4^th monetary policy committee meeting said that the Bank of England’s monetary policy committee voted unanimously to wait and see how effective their monetary stimulus program has been. The Bank has spent Stg200 billion through quantitative easing in addition to keeping its policy interest rate at a low 0.5 percent. The MPC was unanimous in its decision not to extend quantitative easing. The MPC said the economy faced “headwinds” as credit remained hard to get and spending was restrained by private sector debt repayment and government deficit reduction. However, offsetting this were exceptionally accommodative monetary policy and the weaker pound sterling.

Asia/Pacific

For once Asian/Pacific markets were the first to react to U.S. news, not last. And markets across the region (except Thailand of those followed here) declined Friday as traders reacted negatively to the Fed’s administrative move that raised the discount rate by 25 basis points to 0.75 percent. Trading on Friday made the difference for the weekly results, cutting weekly gains and in a few cases, turning results from positive to negative. The Hang Seng dropped 1.9 percent in the holiday shortened week while the Topix edged down 0.3 percent and the STI inched down 0.1 percent. Traders were apprehensive that the Fed’s move to begin to withdraw stimulus would adversely impact the nascent global recovery. Markets in China and Taiwan were closed for the week long Lunar New Year holiday.

The People’s Bank of China and the Federal Reserve bookended the trading week here. On Monday, investors where markets were open (regional markets in China, Hong Kong, Taiwan, South Korea, Singapore and Malaysia were shut for the holiday) got their first chance to respond to the previous Friday’s news that the People’s Bank of China for the second time this year had raised the reserve requirement ratio for banks. And on Friday, they were first responders to the Fed’s move increasing the discount rate.

Reserve Bank of Australia minutes

In the minutes for its February 2^nd meeting, the Reserve Bank of Australia said its decision to unexpectedly keep interest rates unchanged this month at 3.75 percent was “finely balanced” amid concern that European sovereign debt risks may weaken the global economic recovery. However, board members also said that if economic conditions continued to improve as expected, further increases in the cash rate were likely to be necessary. “But they did not regard that outlook as requiring an increase at every meeting.” The RBA under governor Glenn Stevens was the only central bank in the world to raise borrowing costs three times in 2009, taking its cash rate target to 3.75 percent in December from 3 percent in October.

Bank of Japan

As expected, the Bank of Japan left its policy interest rate at 0.1 percent where it has been since December 2008. The vote was unanimous. The monetary policy board kept its core economic assessment unchanged. It said that the economy was picking up mainly due to various policy measures taken at home and abroad although there is still not sufficient momentum to support a self-sustaining recovery in domestic private demand. The BoJ said that the decline in business fixed investment has been coming to a halt. The Bank noted that although the CPI continues to decline, the rate of decline is moderating mainly reflecting developments in petroleum prices.

Since the MPB met last, the government has heightened pressure on the BoJ to cooperate in defeating deflation. Finance Minister Naoto Kan has heated up the debate on whether the Bank should have a specific inflation target. He said that he wants to see price growth of 1 percent and that the government and the BoJ should work closely to achieve that end. For its part, the BoJ has been reluctant to adopt inflation targeting in part, out of fear it may lose flexibility in operating its monetary policy. At its December meeting, the monetary policy board defined price stability as the consumer price index stabilizing in a positive range of up to 2 percent with the midpoint around 1 percent.

At his post-meeting press conference BoJ governor Masaaki Shirakawa defended the Bank’s relatively flexible approach to maintaining price stability, shrugging off remarks by the finance minister. Mr Shirakawa said that the recent global financial crisis had shown the potential downside of neglecting other economic factors by focusing too closely on price changes. He also escalated pressure on Prime Minister Yukio Hatoyama to contain the world’s largest debt with a warning that investor “trust” won’t be assured in the aftermath of Greece’s budget woes. Hatoyama’s administration has yet to detail plans to repair its finances since S&P warned that it may cut the nation’s AA rating. Kan aims to develop a fiscal strategy by June, and this week he said the government will consider overhauling the sales tax.

Currencies

The dollar was up against the euro, yen, pound sterling and Swiss franc last week but was down against the commodity currencies of Australia and Canada. The dollar was boosted at week’s end by the Fed’s surprise (in timing only) discount rate increase on Thursday after U.S. markets were closed. The dollar soared on the move, but gradually retreated Friday from its Asian highs on profit taking. The dollar hit a high of $1.344 per euro before gradually backing off to about $1.36 towards the end of trading in the U.S. (ET). The euro has been under pressure thanks to Greece’s budget woes.

The dollar initially soared after the Fed increased its discount rate by 25 basis points to 0.75 percent at the request of the regional Federal Reserve banks. This fueled speculation that the Bank would soon begin to tighten monetary policy. While the Fed has been telegraphing the move for some time, the actual event shocked market players. The Fed tried to dispel the notion the move was a prelude to broader monetary tightening. It repeated its previous statement that “economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

The euro steadied against the dollar on Friday after suffering significant losses earlier in the week, crippled by debt concerns and speculation the U.S. economic recovery was leaving the euro area behind. The euro was punished again when the Fed raised its discount rate as another step in unwinding the measures taken to prop up the fiscal system and broader economy in the wake of the financial crisis.

The pound sterling swooned against the euro and the dollar. News that showed the UK government borrowed £4.3 billion in January, which is normally a surplus month, put downward pressure on sterling. A larger than expected drop in retail sales sent the currency even lower. The retail sales decline was attributed to a combination of cold weather and the restoration of the value added tax to 17.5 percent that dampened British household spending.

Selected currencies — weekly results

Indicator scoreboard

EMU

December seasonally adjusted merchandise trade surplus jumped to €7.0 billion from a larger revised €5.3 billion in November. The unadjusted data showed a €4.4 billion surplus, up from €1.8 billion shortfall in the year ago period. The improvement in the seasonally adjusted figures reflected a 3.1 percent monthly gain in exports that outpaced a 1.7 percent rise in imports. Exports were 1 percent lower than a year ago while imports were 6.0 percent lower. As usual, Germany dominated the headline data, providing €9.9 billion of the black ink. The other larger EMU states fared markedly less well however, with France (€0.6 billion) and Italy (€0.7 billion) posting small surpluses and Spain (minus €2.6B) once again in the red.

Germany

February ZEW expectations component slipped 2.1 points to 45.1 and its lowest level since July last year and its fifth consecutive monthly decline. The February drop may have been in part due to the financial problems surrounding Greece, but previous declines suggest that there are clear doubts about the outlook. By contrast, the current conditions measure rose 2.2 points to minus 54.8. This was its ninth straight monthly gain and the index now stands at its best level since November 2008. ZEW indicated that it still anticipates just a slow recovery in both Germany and the eurozone over the next six months and anticipates a difficult time for the retail sector.

January producer prices jumped 0.8 percent — its steepest monthly gain since July 2008 — but are down 3.4 percent when compared with last year. Excluding energy, the PPI was up 0.1 percent on the month and down 1.2 percent on the year. On the month, the only increase in prices of note was in the energy sector where charges were up 2.2 percent. By contrast, prices were unchanged in both the capital and consumer goods and were up a relatively modest 0.3 percent in basics.

United Kingdom

January consumer price index was down 0.2 percent but jumped 3.5 percent on the year thanks to last year’s tumbling oil and higher taxes. Core CPI actually fell a surprisingly steep 0.6 percent from December but was up 3.1 percent on the year. High street prices are seasonally soft in January but early sales had probably removed at least some of the potential downside from this source this year. Moreover, the data will have been biased firmer by the impact of the 2.5 percentage point hike in VAT introduced at the start of the month. Among the main sectors, annual inflation rates rose especially sharply in alcohol & tobacco (from 4.4 percent to 6.6 percent) and transport (8.7 percent to 11.0 percent). However, annual deflation in clothing & footwear became yet more entrenched with prices down 4.5 percent on the year after a 3.5 percent slide in December.

January claimant count unemployment jumped by 23,500 after declining a revised 6,600 in December. Although the jobless rate held steady at 5.0 percent, the renewed surge in the number out of work more than offset the back-to-back drops posted in the previous two months. ILO number of unemployment for the fourth quarter declined by 4,000 and left the jobless rate unchanged at 7.8 percent. Headline average earnings growth last quarter held steady at just 0.8 percent following a sharply weaker revised pace in the three months to November. Excluding bonuses, the headline rate was similarly stable at a record equaling low of 1.2 percent, again after a sizeable downward revision to the previous month's figures.

January retail sales plunged 1.8 percent but were up 0.9 percent on the year. The retail sales index now includes automotive fuel. On the old measure, sales fell 1.2 percent on the month, the steepest on record, but were up 2.6 percent on the year. However, the data need to be seen in the context of both the 2.5 percentage point increase in VAT and especially bad weather that almost certainly reduced foot traffic. Not all the sectors underperformed. Heavy monthly losses were seen in household goods (down 13.4 percent) and fuel (down 11.1 percent). Non-store retailing (down 3.2) and food (down 2.4 percent) also suffered badly. However, overall non-food volumes were steady and there were sizeable increases at non-specialized stores (5.1 percent) and in both clothing & footwear (4.7 percent) and the other stores category (2.5 percent).

Asia/Pacific

Japan

Fourth quarter gross domestic product was up 1.1 percent after the third quarter was downwardly revised for the third time. In the third quarter, GDP was revised from the original estimate of plus 1.2 percent to plus 0.3 percent and now to no growth at all. On an annualized basis, fourth quarter GDP was up 4.6 percent. When compared with the same quarter a year ago, GDP declined by 0.9 percent. Quarterly strength was centered in exports of goods & services, up a very solid 5.0 percent on the quarter and by private non-residential investment, up 1.0 percent with private consumption up 0.7 percent. Weakness was centered in private residential investment which fell 3.4 percent. Government consumption rose 0.8 percent in the quarter though public investment fell 1.6 percent.

December tertiary index dropped a more than expected 0.9 percent and was down 2.8 percent on the year. Analysts had expected the index to slip by 0.2 percent on the month. This was the second consecutive drop on the month and the 17th consecutive on the year. Seven industrial groups declined. Wholesale & retail trade was down 1.3 percent while scientific research, professional & technical services dropped 4.1 percent. Miscellaneous government services were down 3.1 percent while compound services dropped 2.4 percent. Real estate & goods rental & leasing was down 0.9 percent while finance & insurance slipped 0.2 percent and transport & postal activities edged down 0.2 percent. On the upside were accommodations, eating & drinking services which were up 2.3 percent while living-related & personal services and amusement services were up 1.2 percent.

Americas

Canada

December manufacturing sales were up 1.6 percent but inched down 0.1 percent on the year. The advance in nominal sales was more than accounted for by a solid 2.1 percent rise in volumes, although real shipments were still 1.8 percent weaker on the year. The nominal increase was led by a 28.1 percent monthly leap in aerospace products & parts. Motor vehicle sales were up 4.4 percent and purchases of coal & petroleum products climbed 2.4 percent. Gains here were easily sufficient to offset a 6.4 percent slump in metallic mineral products. New orders surged 6.5 percent from mid-quarter and, with inventory levels down 1.0 percent for their 10th monthly drop in 2009, the inventory/sales ratio fell to 1.37 months. At the same time, backlogs were up 2.3 percent, their first gain in six months.

January 2010 consumer price index was up 0.3 percent on the month and jumped by 1.9 percent on the year and the fastest pace since November 2008. Excluding food and energy, the CPI edged down 0.1 percent but was up 1.2 percent on the year. The BoC's preferred index which excludes eight volatile items edged up 0.1 percent, lifting its annual rate from 1.5 percent to 2.0 percent. The increase was mainly due to the transportation sector where charges climbed 1.5 percent. All of the other sectors except health & personal care (up 0.5 percent) posted gains either matching or coming in less than average. Recreation, education & reading rose 0.1 percent while alcohol & tobacco edged down 0.1 percent. On the year, prices rose most sharply in energy (8.2 percent) which in turn ensured a hefty increase in the transportation sector (7.7 percent). However, most of the other major sectors saw annual gains of less than 2 percent. Prices dropped in shelter (down 1.1 percent) and clothing & footwear (down 1.9 percent).

December retail sales were up 0.4 percent as they rebounded from November’s decline of 0.5 percent. On the year sales were up 6.7 percent. Volume sales were better, up 0.6 percent on the month, extending the trend that began in January 2009, and helped by a return to more normal weather during the month. The increase in nominal sales was spurred by the auto sector which saw sales rise 0.9 percent from November despite a 0.2 percent drop at new car dealers. Used car dealers saw demand up 1.7 percent and gasoline sales jumped 2.2 percent. Excluding autos, sales were up just 0.1 percent and 2.4 percent on the year. There were also solid monthly gains in clothing & accessories (2.1 percent) and at general merchandise stores (3.3 percent). More modest advances were registered by furniture & home furnishings (0.5 percent) and miscellaneous retailers (0.4 percent). However, sizeable declines were seen in pharmacies & personal care (1.3 percent), food & beverages (1.2 percent) and building & outdoor home supplies (1.2 percent).

Bottom line

Equities were up in Europe and North America but were mixed in Asia after investors reacted negatively there to the increase in the Federal Reserve’s discount rate. The administrative move which was carried out at the request of the regional banks had been telegraphed many times in advance. It was for the most part recognition of improving financial conditions and does not reflect a change in monetary policy or tightening anytime soon.

This week offers the usual threat of data overload that accompanies the last week of the month. But also on tap is Fed chairman’s semi-annual Congressional testimony. Fed watchers will be parsing every word in chairman Ben Bernanke’s written testimony and his responses to members of the House of Representatives and Senate on Wednesday and Thursday respectively.

Looking Ahead: February 22 through February 26, 2010

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