Global Markets

A plethora of better than expected earnings (but fewer better than anticipated revenues) clashed with worries about world economic growth leaving equity indexes mixed for the week. The Peoples Bank of China grabbed attention away from earnings with a surprise interest rate increase. The buildup to the weekend meeting of the Group of 20 in South Korea and the value of the yen, renminbi and of course the U.S. dollar could not be ignored either. Aside from China, there were little new economic data to divert investors’ attention. The anecdotal evidence presented in the Federal Reserve Beige Book did not provide a road map to QE2 — nor did the voluminous Fed speak during the week. Investors were quixotic — quick to punish companies that did not surpass expectations completely but at the same time, they ignored problems elsewhere.

There continues to be a close relationship between the value of the U.S. dollar and equities. When the dollar increases, investors become more risk averse and when the currency declines, it is a sign for a return to risk and investors gobble up shares. For example, a poorly received batch of U.S. technology earnings and the surprise Peoples Bank of China’s 25 basis point interest rate increase to 5.56 percent led to a flight from riskier assets on Tuesday. The move elevated fears that China’s attempt to slow the pace of domestic economic growth would crimp the global expansion. On Wednesday, however, a relapse in the dollar and a cool response by Asia to China’s monetary policy tightening enticed investors back into stocks.

On the week, shares were mixed in the Asian Pacific region but they gained in Europe and the UK as well as in the U.S. and Mexico. Canadian equities edged downward.  

Bank of Canada leaves rates unchanged

As anticipated, the Bank of Canada left its key interest rate unchanged at 1 percent after three previous increases because of slowing domestic growth and as the Federal Reserve considers further stimulation to the U.S. economy. By pausing, the BoC joins central bankers in Brazil, Malaysia and Australia in keeping borrowing costs unchanged in part to gauge the strength of the recovery. Canada has been benefiting from rising global commodity demand.

The BoC said that the global recovery was entering a new phase now that temporary factors including the inventory cycle and pent-up demand have run their course. Fiscal stimulus was shifting to fiscal consolidation over the projection horizon. The statement said that the outlook for Canada has changed and growth would slow further. The Bank also said that world currency tensions would cause a longer and harder recovery given that exports are sensitive to currency valuations and foreign demand.

Global Stock Market Recap

Europe and the UK

Equities in the UK and Europe hovered around the no change mark Friday before ending the week slightly negative as investors continued their currency/G-20 vigil. On the week however, the FTSE, DAX and CAC were up 0.7 percent, 1.7 percent and 1.1 percent respectively. While the FTSE and DAX are up 6.1 percent and 10.9 percent so far this year, the CAC still lags — it is down 1.7 percent in 2010.

There was little new economic information but in Europe at least it was favorable. The flash PMI indexes were stronger than expected in Germany and the eurozone and hold out hope that the goods producing sector may not be slowing quite as quickly as feared. And in Germany, the Ifo survey painted a surprisingly healthy picture of German business activity.

In London, Chancellor of the Exchequer George Osborn unveiled the coalition government’s new austerity plan which cut across virtually all facets of the economy. He wants to eliminate the £109 billion structural deficit during the lifetime of this parliament by, in part, removing almost 500,000 from the public payroll and slashing another £7 billion off welfare. The hope is that restored public finances will stimulate growth.

The Bank of England’s minutes of its October 7^th meeting showed a three way split between monetary policy committee members. One member voted to increase rates while another favored an increase in the quantitative ceiling. In the end, policy was unchanged pending the November quarterly Inflation Report.

Asia Pacific

Equities were mixed Friday and for the week. Friday’s trading was colored by trader caution ahead of the weekend G-20 finance ministers meetings and currency tensions. Despite speculation that some sort of currency agreement might emerge, analysts dismissed the likelihood of any real accord. On the week, eight of the 13 indexes declined anywhere from 1 percent (Hang Seng and STI) to 0.3 percent (Kospi). Other than the PSEi (up 1.7 percent) gains were in the 0.1 percent to 0.2 percent range with the Jakarta Composite virtually unchanged on the week.

The big regional news of course came from China where the People’s Bank of China shocked markets by increasing its key interest rates for the first time in three years. Investors also closely watched the spate of new monthly and quarterly data that were released as they came to terms with the interest rate increase. Third quarter growth eased to 9.6 percent from 10.3 percent in the second quarter (all Chinese data are annual comparisons) but inflationary pressures remain, perhaps explaining the interest rate increase. Investors are concerned that there could be a slowdown in global growth, but the interest rate increase seems to be internally directed — designed to keep prices under control.

Peoples Bank of China

The Peoples Bank of China, in a surprise move, raised both its benchmark deposit and lending rates by 0.25 percentage points. This was the first increase since December 2007. The PBoC said in a statement it will raise the one year yuan lending rate to 5.56 percent from 5.31 percent and the one year yuan deposit rate to 2.5 percent from 2.25 percent. The latest move represents China’s strongest effort so far to withdraw the monetary policy stimulus introduced during the global financial crisis and comes amid rising inflationary pressures. Between September and December 2008, the Bank had cut interest rates several times as part of the country’s effects to prevent a sharp economic downturn during the global crisis.

The move is the latest indication that China is struggling to fight stubborn inflation, soaring housing prices and an overly buoyant economy that is pumping out exports and resulting in the accumulation of huge amounts of foreign exchange reserves. The action reverberated throughout world markets, sending stocks lower in Europe and the United States (Asia Pacific markets were closed for the day when the announcement was made) as investors weighed the effect on China’s continued economic growth and its ability to serve as an engine for a global recovery.

A powerful economic stimulus package and aggressive lending by state-run banks had helped China recover from the global financial crisis that hit in late 2008. But heady economic growth and large infrastructure and building programs seemed to put too much fire in the economy. And so since early this year the government has been trying to moderate growth and restrain inflation, which has pushed up food prices and created social anxieties.

Bank of Thailand

The Bank of Thailand retained its key interest rate of 1.75 percent after increasing rates in July and August. The Bank expects a slowdown in global economic recovery and increased uncertainty about the world economy and financial markets. The Thai economy is expected to grow primarily due to domestic demand, according to the Bank’s statement. But it fears that slower global economic growth may adversely impact Thai exports, the growth engine. The bank estimates 6.5 percent to 7.5 percent growth this year. In the second quarter, Thai GDP climbed 9.1 percent following the 12 percent growth in the first quarter.

Reserve Bank of Australia

The RBA released minutes of its October 5^th meeting. At that time, the board left the policy interest rate at 4.5 percent. The minutes said that arguments for the decision were finely balanced. The board saw flexibility to wait but acknowledged that higher rates were possible going forward if the economy grew as expected. Underlying inflation was seen within the Bank’s 2 percent to 3 percent target range. It said that the recent increase in the Australian dollar would help contain inflation.

The board noted that the global outlook remained around trend but with significant differences across regions and was broadly unchanged since the September meeting. Equity markets had also strengthened over the past month, even though financial markets were still characterized by a degree of uncertainty, most notably emanating from the strains on public finances and banking systems in some of the smaller European economies. Domestically, the economy appeared to be evolving broadly in line with the Bank’s expectations. The outlook remained for public spending to slow but for private demand to pick up noticeably, particularly in the case of business investment. For the moment, however, indicators of current growth in demand remained moderate, both for households and businesses, and credit growth had been subdued, especially for businesses.

Currencies

Foreign exchange traders remained on high alert as the week ended. They awaited word from the two day G-20 meeting of finance ministers and central bankers in Gyeongju, South Korea. On the week, the U.S. dollar was up against its major counterparts.

The dollar’s fluctuations have been the primary determinant of risk appetite. On Thursday, positive German and Chinese economic reports combined with a batch of generally well received corporate earnings helped the market mood during the European day on Thursday. But in New York afternoon trading, a strengthening dollar prompted a quick dip in equities, before they managed to close slightly higher. And the prospect of QE2 has pushed down U.S. bond yields and therefore hurt the dollar. The currency’s decline has become synonymous with central bank assistance, helping risk appetite.

The PBoC interest rate increase saw risk appetite wane, fuelling safe haven demand for the dollar as equity and commodity prices swooned. However, the next day saw the dollar reverse direction and decline once again. The dollar hit a 15-year low against the yen in intraday trade and lost ground across the board on Wednesday as the prospect of further monetary policy loosening from the Federal Reserve weighed on the US currency.

Sterling lost ground elsewhere, however, after the minutes of the Bank of England‘s October monetary policy committee meeting heightened market speculation that the BoE was moving towards further quantitative easing. The minutes also showed that some members thought the need for more stimulus had increased, implying that more members of the MPC than just member Adam Posen believed there was a case for a further loosening of monetary policy.

Selected currencies — weekly results

Indicator scoreboard

Germany

October ZEW survey suggests that the recovery in the German manufacturing sector continued at a robust clip but confidence in the outlook has deteriorated further. The current conditions index jumped nearly 13 points to 72.6 — the measure now stands at its highest level since September 2004. By contrast, expectations slipped further, down almost 3 points to minus 7.2, its weakest reading since January last year. Even so, the decline in the forward looking index was still rather less sharp than the market anticipated.

September producer prices jumped 0.9 percent and were up 3.2 percent in August to 3.9 percent. The monthly gain was mainly due to a 0.6 percent spike in the cost of basics although both capital goods (0.1 percent) and energy (0.2 percent) saw modest increases. Consumer prices were unchanged from mid-quarter despite a 0.1 percent rise in durables. Excluding energy, the PPI was 0.3 percent higher on the month and 2.8 percent firmer on the year.

October Ifo business sentiment reading was 107.6, up almost a point from September. The gain was a reflection of increases in both the current and expectations components. The former advanced a modest 0.4 points to 110.2, its best level since the recovery began, while expectations were up 1.2 points at 105.1 and essentially reversed their September decline. The sectoral diffusion indexes showed positive developments across the board with the exception of retail. Morale here slipped 2.4 points to 9.1 but this was still well ahead of the levels seen as recently as July (minus 9.7). The strongest increase in sentiment was registered in wholesale (up 6.1 points to 19.4) but there were increases as well in manufacturing (1.6 points to 21.6), construction (1.7 points to 19.4) and services (0.9 to 21.4).

United Kingdom

September retail sales volumes were down 0.2 percent and followed a steeper revised 0.7 percent drop in August. As a result, annual sales growth was 0.5 percent, down from 0.8 percent last time. Excluding autos the sector performed a little better with purchases unchanged from mid-quarter and 1.8 percent higher on the year. Weakness was most apparent in clothing & footwear (down 0.8 percent on the month) and non-store retailing (down 0.5 percent). However, other categories held up rather better, notably other stores (0.7 percent). Household goods and non-specialized stores (both up 0.2 percent) also managed minor gains. At the same time, food sales edged up just 0.1 percent.

Asia/Pacific

Japan

August tertiary index slumped 0.2 percent but was up a seasonally adjusted 1.8 percent on the year. Miscellaneous services (except government services etc.) dropped 1.6 percent, scientific research, professional & technical services were down 0.6 percent and information & communications declined 0.3 percent as did transport and postal activities. Also declining were real estate & goods rental & leasing, accommodations, eating & drinking services and compound services. Not all industry subgroups were down. Living-related & personal services & amusement services advanced 2.4 percent while electricity, gas, heat supply & water were up 2.3 percent. Finance & insurance were up 0.5 percent. Wholesale & retail trade, medical, health care & welfare and learning support also gained on the month.

China

September consumer prices were up 0.6 percent, the same as in August. On the year, the CPI was up 3.6 percent after increasing 3.5 percent in August. For the nine months in 2010, the CPI was up 2.9 percent when compared with the same months a year ago after rising 2.8 percent in the eight months through August. All price categories were up with the exception of clothing which declined 1.5 percent and transportation & communication which was down 0.7 percent on the year. September food prices soared 8 percent on the year after increasing by 7.5 percent in August. Nonfood CPI was up 1.4 percent on the year after climbing 1.5 percent in August.

September producer prices were up 0.6 percent and 4.3 percent on the year, about as expected. For the nine months through September the PPI was up 5.5 percent when compared with the same nine months a year earlier. Prices for consumer goods were up 2.5 percent while production materials were up 4.9 percent on the year.

September retail sales were up 18.8 percent on the year after jumping 18.4 percent in August. For the nine months through September, retail sales were up 18.8 percent when compared with the same months a year earlier. For the eight months through August, retail sales were up 18.4 percent on the year.

September industrial output eased to an increase of 13.3 percent when compared with the same month a year ago after climbing 13.9 percent in August. For the first nine months of the year, output was up 16.3 percent on the year, slightly weaker than the 16.6 percent in August when compared with the same months a year ago. On the year, output was up 13.5 percent in the third quarter after increasing 15.9 percent in the second quarter.

Third quarter gross domestic product slowed to an increase of 9.6 percent from a year earlier after growing 10.3 percent in the second quarter, as the government withdrew stimulus and took measures to cool sectors such as the property market. For the nine months through September, real GDP was up 10.6 percent after growing 11.1 percent for the first half of the year when compared with the previous year. The moderation in economic growth was in line with expectations. Given the People Bank of China’s surprise decision to raise interest rates earlier this week, the data appear to indicate that the authorities are comfortable with the current slowdown and are more concerned about rising inflation and property prices.

Americas

Canada

September consumer prices were up 0.2 percent and 1.9 percent on the year. The Bank of Canada preferred core measure which excludes eight volatile items was up 0.2 and 1.5 percent on the year. Excluding food and energy, the core advanced 0.4 percent and 1.4 percent on the year. Food prices climbed 0.2 percent from August and recreation charges 0.1 percent but there were declines in health & personal care (0.3 percent) and household operations, furnishings & equipment (0.2 percent). Annual CPI inflation was lifted by higher food prices which were up 2.1 percent on the year after a 1.6 percent rise last time. Inflation on this basis was highest in transportation (3.1 percent) followed by shelter (2.5 percent). Among the main groups only in clothing & footwear (minus 2.5 percent) were prices below their year ago level.

August retail sales were up 0.5 percent and 3.5 percent on the year. Volumes were up 0.3 percent on the month. Nominal demand was most robust at furniture & home furnishing stores where sales climbed a very solid 2.1 percent from July. There were also respectable gains at motor vehicle & parts suppliers (0.7 percent) and in electronics (0.6 percent), food & drink (0.8 percent) and gasoline (2.1 percent). However, excluding the auto & gasoline sector, purchases were up only 0.1 percent on the month and 2.2 percent on the year. The main areas of weakness were clothing & accessories (down 0.8 percent), sporting books & hobbies (down 1.8 percent), general merchandise (down 0.5 percent) and miscellaneous retailers (down 1.0 percent).

Bottom line

Last week was dominated by a slew of third quarter earnings reports and the increase in China’s interest rates. Traders also warily eyed the G-20 finance ministers meeting which is in progress as I write. The Bank of Canada halted its series of interest rate increases and preferred to maintain the status quo at 1 percent.

As is usually the case, the last week of the month brings a slew of new economic data especially in Europe and Japan. The Bank of Japan meets to give its semi-annual outlook at week’s end. Both the U.S. and UK release third quarter gross domestic product results.

Looking Ahead: October 25 through October 29, 2010

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