Global Markets

Amidst declining volumes and diminishing investor interest, financial markets were at least able to conclude the last full trading week before the Christmas break with some optimistic economic news. Surprisingly robust figures out of the U.S and core Europe have boosted hopes for a pick-up in global growth and equity markets look poised to end the year with renewed, albeit cautious, hope for 2011.  That said, there is plenty that can still go wrong.

Asian stock markets issued an almost audible sigh of relief on the news that last weekend’s anticipated monetary tightening in China would be restricted to an increase in the reserve requirement ratio.  However, few believe that the latest move will be sufficient to achieve a 4 percent inflation target next year and many still suspect that it is more a case of when, rather than if, interest rates are hiked again.  At the same time, geopolitical tensions surrounding the Korean Peninsula have far from abated and there was fresh sabre-rattling late this week over South Korea’s plans to hold a live-fire drill at some point over the next few days.  

In Europe, contagion risks have not gone away and but for the ECB’s announcement that it would be adding some €5 billion to its subscribed capital, peripheral markets would have been under significantly more pressure than was actually the case last week.  As it is, spreads widened on news that Belgium, Greece and Spain had all been put on notice for possible downgrades and stock markets in Italy and Spain both finished the week lower.  Significantly too, new figures from the ECB confirmed another sharp increase in its bond purchases in the week to December 10.  At the same time, policy rifts between monetary authorities and politicians remain dangerously visible and a constant threat.  The EU leaders’ summit agreed to set up in 2013 a permanent mechanism to bail out any member whose debt problems threaten Eurozone stability.  This will entail a revision to the Lisbon Treaty, a move that was viewed positively as a sign of the collective determination to secure the long-term future of the single currency.  However, with regards to addressing more immediate concerns, there was no progress on calls to increase the current €750 billion financial safety net nor was there any mention of joint borrowing by member states in the financial markets. Accordingly, the door remains open to a return to the high levels of volatility that have characterised European markets for much of 2010. 

Meantime U.S. financial markets were hardly surprised by the FOMCs announcement that the target for the Fed funds rate would be left at 0.0 percent to 0.25 percent or that there would be no change to the US$600 billion QE2 ceiling.  Even so, robust economic statistics ensured that there were additional rises in Treasury yields and the currency responded bullishly.  

Nonetheless, given the high degree of uncertainty still surrounding the global economic outlook, few central banks give the impression of being in any hurry to revert to a more normal monetary policy stance.  Nonetheless, not all are prepared to adhere to the wait-and-see approach and the Riksbank was happy to move unilaterally this week with a 25 basis point increase in its key repo rate to 1.25 percent. That said, the tightening did follow news that annual growth last quarter was only just shy of 7 percent.

Despite the strong economic data, the rally in commodity markets is finally showing signs of running out of steam.  Gold in particular has clearly lost some of its lustre.  U.S. dollar strength has been a factor recently but the metal has also been hit by U.S. regulators’ proposed new rules limiting a single entity’s spot-month position to 25 percent of deliverable supply.  With traders also looking to book profits on what has been a sparkling year for the metal, prices were fixed below US$1,375 at the London close. Copper, lead and zinc prices were also all in decline over the second half of the week although tin was still in demand.  Oil prices drifted higher following OPEC’s decision to leave current production quotas unchanged for 2010. 

Global Stock Market Recap

Europe and the UK

Regional markets faced conflicting signals last week.  Warnings of a possible downgrade to Belgian, Greek and Spanish debt and further evidence of political infighting between the ECB and EU governments vied with generally positive economic news at home and abroad.  Peripherals struggled amidst renewed volatility in bond spreads and in Spain the Ibex lost 2.4 percent while in Milan, the MIB shed 2.0 percent.  In fact, the falls would have been steeper but for ECB’s announcement about expanding its capital base.  This certainly helped to calm immediate contagion nerves.  The EU leaders’ agreement to establish a permanent rescue mechanism for financially challenged regional states was also received quite positively.  Ironically amongst the major markets it was in Germany, where the economic data were typically much stronger than expected, that shares underperformed.  With a December manufacturing PMI close to a record high and the Ifo business sentiment index in the same month achieving a new peak, the DAX disappointed by ending the week 0.3 percent lower.  By contrast, in France the CAC edged up 0.3 percent, and in London the FTSE closed 1.0 percent to the good. 

Swiss National Bank

As widely expected, the SNB followed the steady hand lead of the ECB and BoE and left its target corridor for 3-month SWF Libor unchanged at 0.0%-0.75% at Thursday’s Monetary Policy Assessment. The central bank also indicated that it would continue to aim to hold market rates at around the 0.25 percent mark.  The SNB reiterated its increasingly familiar line that the current loose stance of monetary policy cannot be retained over the longer term but also signaled a willingness to adopt additional measures should deflation threats emerge.  Indeed, with annual CPI inflation currently running at just 0.2 percent, such risks are very real.  Significantly, the central bank refrained from any mention of the exchange rate, the buoyancy of which has been a key factor in keeping a lid on prices.  A number of bouts of intervention earlier in the year failed to prevent the local currency from appreciating sharply and the SWF is still trading around record highs against the euro.  The monetary authorities also released their new economic forecasts.  These show little change from last time with inflation put at 0.4 percent in 2011, up just a tick from September, and 1.0 percent in 2012, down 0.2 percentage points from the previous projection.  Growth is estimated at 2.5 percent this year and 1.5 percent next.

Asia Pacific

Regional markets began the week with a clear sense of relief that the PBoC has not hiked key interest rates over the weekend and in Shanghai, shares gained almost 3% on Monday alone.  However, having digested the latest robust Chinese economic data, investors became increasingly concerned that another monetary tightening of some form, possibly including higher official borrowing costs, is probably just a matter of time.  Against this more sombre backdrop, many markets were subsequently subject to bouts of profit-taking and nearly all struggled over the latter half of the period.  In Hong Kong in particular, falling volumes contributed towards a sharp correction on Wednesday/Thursday when the Hang Seng lost more than 3 percent.  Nonetheless, in Seoul the Kospi closed up on four out of five days as leading shares benefitted from rising optimism about the global economic picture.  At 2,026.3, the index was up just over 2 percent on the week.  Similarly in Australia, the All Ordinaries made gradual headway until Friday as gains in the financial sector offset losses in mining shares.   Even so, the benchmark index gained just 0.5 percent over the period.  Meantime, following a strong opening on Monday, Japanese shares drifted sideways for much of the remainder of the period.  A mixed fourth quarter Bank of Japan Tankan survey did nothing to boost investor appetite and there was little new economic data to get excited about.  The Nikkei ended on Friday 0.9 percent higher on the week at 10,303.8. 

Currencies

Not surprisingly, currency traders lacked the appetite to take out major new positions last week and markets in general displayed no strong sense of direction.  Overall the U.S. dollar enjoyed a positive period, buoyed by the improvement in investor sentiment encouraged by good domestic economic data.  Hence, there was a modest net gain versus the euro and the greenback also made some headway against a becalmed yen as yield spreads continued to widen in the U.S. currency’s favour.  There were also solid advances versus both the UK pound and the NZ$, the latter hit by the softer tone to commodity prices.  However, one of the best performers over the week was the Swiss franc which saw new record highs against the euro.  Despite an unchanged monetary stance from the SNB, the Swiss unit once again benefitted from safe haven inflows, a further reflection of the high levels of uncertainty that continue to nag international financial markets. 

Selected currencies — weekly results

Indicator scoreboard

EMU

The goods producing sector rebounded at the start of the current quarter, albeit with industrial output (ex-construction) rising a smaller than expected 0.7 percent on the month.  The October pick-up followed a lesser revised 0.7 percent decline in September and boosted workday adjusted annual growth from 5.4 percent to 6.9 percent. Overall production was 0.5 percent above its third quarter average when production rose 0.8 percent versus the previous quarter.  Gains were quite broad-based with capital goods leading the way with a 1.8 percent monthly advance that more than compensated for a 1.0 percent drop last time.  Intermediates rose 0.2 percent, non-durable consumer goods 0.4 percent and intermediates 0.2 percent.  The only decline was recorded in durable consumer goods where output slipped just 0.1 percent.  Disappointingly however, October saw further major divergences between the various members.  Hence, while production was rising 3.0 percent on the month in Germany, it was falling 0.1 percent in Italy, 2.4 percent in Portugal and edging up just 0.1 percent in Spain.  In Greece, output climbed a healthy enough looking 3.6 percent from September but the nation's data are very volatile and more relevant was a 4.6 percent annual decline.  The headline figures are a little disappointing but at least they still point to a modest increase in regional real GDP this quarter.  Growth in the aggregate might not be as fast as most would like but the real worry is that the core countries are pulling away from the rest and that cannot be good for the stability of financial markets in the periphery.

Annual harmonised consumer price inflation was confirmed at 1.9 percent last month, equaling the October outcome and so matching the highest rate seen since November 2008.  On the month, the HICP rose 0.1 percent after a 0.4 percent increase in October.  Significantly, the unchanged annual headline rate was mirrored in the three main core measures, all of which held steady at a subdued 1.1 percent.  The HICP excluding just energy ticked a notch higher however, from 1.2 percent to 1.3 percent.  There were few notable changes in the 12-month rates amongst the major expenditure categories. The only real exceptions were transportation, where inflation fell quite sharply (3.8 percent from 4.3 percent) and clothing and footwear, where it accelerated relatively quickly (1.0 percent from 0.4 percent).  Amongst the larger member states, the annual rate rose in Germany (1.6 percent from 1.3 percent) but fell in both Italy (1.9 percent from 2.0 percent) and Spain (2.2 percent from 2.3 percent).  French inflation was unchanged at 1.8 percent.  There is nothing here to worry the ECB unduly as soft core prices should offer any reassurance needed on the underlying picture.  Still, as the December (flash) PMI made clear, pipeline pressures on prices are beginning to build so as and when the recovery in domestic demand really gets going, the central bank may need to act quite quickly.

The flash December manufacturing PMI suggests that economic activity picked up well at the end of the year.  At an 8-month high of 56.8, the headline index was 1.5 points above its final November level and comfortably ahead of market expectations.  The December gain reflected a further acceleration in both output and orders growth.  The former achieved its best performance in five months and the latter grew at its fastest pace since April.  Backlogs similarly expanded at a quicker rate and employment was up for the fourth month in a row and at its best pace since July 2007.  However, input costs and, more worryingly, factory gate prices both gathered extra steam.  The former hit a 7-month peak while the latter saw its highest level since August 2008.   The increases here warn of bad news on the Eurozone PPI to come and ultimately, increasing pressure on consumer prices. That said, the generally bullish picture painted by the manufacturing PMI needs to be seen in the context of another fall in its service sector counterpart.  Here the PMI dropped from 55.4 to 53.7.  In fact, combined, the manufacturing and service sector surveys imply that economic activity expanded this quarter at its slowest pace since the first quarter.  Moreover, the December data once again underscore the sharp differences in regional economic performance between the rapidly growing France and Germany  and the remainder's slowing to near-stagnating position.

The seasonally adjusted trade balance was in surplus to the tune of €3.6B in October, up from a smaller revised €2.0B in September.  The unadjusted balance was in the black by €5.2B compared with a €4.8B surplus in the year ago period.  However, the improvement in the seasonally adjusted bottom line masked a contraction in both sides of the balance sheet as exports dropped 0.1 percent on the month and imports declined 1.3 percent.  Nonetheless, over the year both series saw solid gains with exports up 20.0 percent, just behind a 21.0 percent increase in imports.  The widening in the surplus occurred despite a slight reduction in the German contribution (€8.1B from €8.8B) although, as usual, Germany still more than accounted for the entire surplus.  Amongst the other larger EMU members France (€2.2B) was also in the black but there were fresh deficits in both Italy (€1.6B) and Spain (€3.4B).  Indeed, the outperformance of the German external sector was underscored in the export figures.  These showed annual growth of some 32.4 percent in Germany, nearly three times the rate of the second fastest expanding state, France (12.4 percent).  Still, the surplus for the region as a whole was its best outcome since July 2009 and suggests that net exports could add more to this quarter’s real GDP growth than the 0.1 percentage point contribution they made in the period just ended.

Germany

The ZEW survey for December suggests that analysts see the German economy ending the year on a positive note.  The current conditions index rose a further 1.1 points to 82.6, its highest level since July 2007, while expectations were up 2.5 points at 4.3, their best reading since August.  Although the rise in current conditions was a little on the soft side, expectations were stronger than forecast and the overall tone of the survey was decidedly optimistic.  Indeed, the main worry in the survey was the prospective performance of Germany’s EMU neighbours as fiscal consolidation really begins to bite next year.  Still, growth at home is expected to be underpinned by a strengthening in both domestic and external demand and it is this welcome balance that makes for a potentially much more sustainable economic recovery in Germany than in most other EMU states.

The December Ifo survey provided further reason for supposing that the national economy finished 2010 in good shape.  Overall sentiment edged up another 0.6 points on the month to a new record high of 109.9 within which both the current conditions and expectations components also gained 0.6 points.  The all-round buoyancy of this report is consistent with the flash PMI and ZEW surveys and suggests that the self-sustainability of the German economic recovery is nicely on track.  The headline index has climbed fully 15.4 points from the end of 2009 during which period it has either risen or held steady every month apart from a minor dip in February.  Amongst the main market sectors, retail showed by far the best improvement with a 10.6 point surge in morale to 24.0.  This is particularly promising as it holds out promise of a stronger household sector.  At the same time, wholesale saw a 3.7 point gain to 26.2 and confidence in services was up 1.5 points at 24.9.  By contrast, sentiment slipped 1.5 points in manufacturing to 23.7 and was 0.9 points lower at minus 15.7 in construction. 

France

Consumer prices edged up just 0.1 percent last month to leave the annual inflation rate unchanged at 1.6 percent.  Harmonised prices also rose 0.1 percent and stood 1.8 percent firmer on the year, also in line with the October outcome.  Core prices remained very soft with a 0.1 percent monthly rise that saw their 12-month growth rate dip a notch to just 0.7 percent.  The overall CPI was boosted by a 1.6 percent monthly jump in oil prices and a 2.0 percent increase in the cost of fresh food.  Outside of tobacco (4.3 percent) other categories were rather better behaved and several registered declines.  As a result, private sector manufacturing prices fell 0.1 percent from October within which clothing and shoes were down 0.4 percent.  Private sector services also saw charges slip 0.1 percent on the month, largely due to a 1.9 percent drop in the cost of transport and communications.

Sentiment in manufacturing rose surprisingly sharply this month according to the new INSEE survey.  At 103 the headline index was up 3 points from November and a couple of points higher than market expectations.  The December improvement more than made up for a 2 point decline in November and reflected healthy advances in both past output (12 from 8) and orders and demand (minus 15 from minus 25).  Within the latter, overseas orders were only flat (minus 15) implying that the gain was attributable to stronger domestic demand.  Executives’ view of future production also turned more positive.  The personal outlook for manufacturing was up 2 points at 8 while the general industry outlook rose 2 points to 10.  The upturn in manufacturing sentiment was mirrored in retail trade, the building sector and services.  As a result, all-industry sentiment increased 1 point to 105, its highest level since April 2008.

Italy

PM Berlusconi survived a vote of confidence on Tuesday but by just three votes in the lower chamber.  The victory helped to remove some of the immediate political uncertainty but opposition to the PM is strong enough for many to anticipate an early general election sometime next year.

United Kingdom

Consumer prices rose a stronger than expected 0.4 percent on the month in November.  The increase boosted the annual inflation rate to 3.3 percent, its fastest pace in six months and some 1.3 percentage points above the BoE’s 2 percent target level.  Both the RPI and RPIX also climbed 0.4 percent from October and were 4.7 percent higher than in November 2009.   Fortunately the CPI details were a little less worrying than the headline figures.  Notably the core index was up a more modest 2.7 percent on the year, unchanged from its October pace.  Similarly the CPIY (CPI less indirect taxes) also held steady at just a 1.6 percent annual pace.  Even so, there was a surprisingly robust pick-up in prices in the clothing and footwear sector where a 2.0 percent monthly jump boosted annual inflation from just 0.7 percent last time to 2.1 percent.  This may well reflect some shops moving ahead of January’s increase in VAT.  Other sizeable gains in 12-month rates were recorded in food and non-alcoholic drinks (5.5 percent from 4.5 percent) and in furniture and household goods (3.5 percent from 2.7 percent).  However, it was not all bad news as annual inflation decelerated in transport (5.1 percent from 5.8 percent), recreation and culture (1.1 percent from 1.5 percent) and in miscellaneous goods and services (2.9 percent from 3.0 percent).  Still, the November report will be seen by the more hawkish members of the MPC as further proof that consumer prices are getting out of control.  The Central Bank’s own November Inflation Report showed that the official line was that inflation would hold around its October pace over the next few months before gradually easing over the course of 2011.  As such, the gentle uptick in the headline rate last month is hardly a disaster. Nonetheless, with the Bank’s credibility increasingly on the line, financial markets are likely to become notably more agitated about the possibility of a near-term hike in Bank Rate.

Manufacturers’ raw material and fuel costs rose a much as expected 0.9 percent on the month in mid-quarter.  The latest increase, the third in succession, saw annual growth in the headline index climb to 9.0 percent from a higher revised 8.2 percent in October.  November’s monthly gain was largely attributable to surging energy charges with a 4.3 percent spike in fuel costs and a 2.0 percent rise in oil prices together adding more than 0.8 percentage points to the overall increase.  Nonetheless, manufacturers also had to pay significantly more for imported food materials (1.1 percent), imported chemicals (0.7 percent) and imported metals (0.6 percent).  By contrast, prices fell for home food materials (1.0 percent), imported parts and equipment (0.3 percent) and other imported materials (0.1 percent).  The 0.9 percent monthly rise in input prices compares with just a 0.3 percent pick-up in their factory gate counterpart, implying a further squeeze from non-labour costs on manufacturers’ profit margins.  Indeed, the gap between the 12-month growth rates has now widened to some 5.7 percentage points.  That output prices are not rising more quickly says much about soft demand conditions but the BoE must be concerned that producers at some point will either have to hike factory gate prices or risk going out of business altogether.

The October/November labour market data painted a rather mixed but ultimately somewhat weaker than expected picture of the economy this quarter.   Claimant count unemployment contained few surprises, declining for the second month running in November.  Even so, a 1,200 fall was well down on a steeper revised 5,200 drop in October.  The jobless rate on this measure was steady at 4.5 percent.  However, the lagging ILO statistics posted an unexpectedly sharp 35,000 jump in its measure of unemployment in the three months to October, the largest gain since the first quarter of the year.  At the same time, the ILO unemployment rate jumped full 0.2 percentage points to 7.9 percent, its highest level since the February-April period.  The good news for the BoE is that the relative sluggishness of the labour market continues to have a dampening effect upon wages.  The stickiness of CPI inflation has raised concerns that inflationary expectations might pick-up and, in turn, lead to upward pressure on pay settlements.  However, headline (3-month) annual average earnings growth in October was just 2.2 percent, a mere tick higher than in the previous period.  Moreover, single month earnings actually decelerated from 2.3 percent to 2.1 percent.  Significantly too, the growth in the ex-bonus index was essentially steady at 2.3 percent.  This report contrasts quite markedly with other recent economic indicators which, with the exception of the housing market, have generally pointed to a respectable increase in both output and demand this quarter.  As such, the latest figures will add to the uncertainty surrounding the economic outlook and, notwithstanding the ongoing inflation overshoot, likely increase the probability of Bank Rate being held at 0.5 percent for some while yet.

Retail sales volumes rose a much as expected 0.3 percent on the month in November and were 1.1 percent up on the year.  Excluding fuel, purchases also increased 0.3 percent from October and were 1.8 percent above their level in November 2009.  The breakdown of the headline figures makes for very mixed reading.  Thus, while food stores (0.6 percent) and the other stores category (2.0 percent) saw demand grow strongly over the month, there were sizeable falls in household goods (1.1 percent) and non-store retailing (0.9 percent) as well as smaller declines in non-specialised goods (0.6 percent) and clothing and footwear (0.1 percent).  Non-food purchases were up just 0.2 percent.   Anecdotal evidence suggests that a number of categories were quite badly affected by particularly bad weather in some parts of the country so the underlying picture may be a little brighter.  The fact that sales over the internet accounted for a record 10.5 percent of the total last month lends support to this view.  Certainly the just released December CBI Distributive Trades Survey suggests consumers are out in force in the run-up to Christmas.  However, the results of this survey quite often differ significantly from official data.

Asia/Pacific

Japan

The new BoJ Tankan survey indicated a slight decline in business confidence in the current quarter.  Optimism among large manufacturers dropped 3 points to 5.0, its first decline since the first quarter of 2009.  However, for small manufacturers there was a 2 point rise to minus 12.  Capital spending plans were also revised down with major manufacturers now forecasting a 2.9 percent increase for the fiscal year ending in March 2011, down from 4.0% predicted in the last survey.  However, all larger firms including non-manufacturers adjusted their forecast up from 2.4 percent to 2.9 percent.  There was also some better news on financials with the position of borrowers and the lending attitude of lenders improving for the seventh consecutive month.

The service sector recovered part of September’s 0.8 percent loss with a 0.5 percent monthly gain in October.  The increase boosted annual growth to 1.4%, still short of recent 2.0 percent high seen in July.  The start of quarter gain reflected quite broad-based increases in activity amongst the main component industries although there were declines in utilities, real estate, compound services. 

China

The government announced a 2011 target for CPI inflation of around 4 percent and a growth objective of 8 percent.  Neither figure came as a surprise to financial markets but with inflation currently running at 5.1 percent, there remains considerable speculation that official interest rates may have to be hiked sooner rather than later.

Americas

Canada

Manufacturing sales rose a stronger than expected 1.7 percent on the month at the start of the current quarter.  Moreover, the increase was only partly due to higher prices as volumes were up a healthy 1.1 percent too.  Annual growth in nominal sales was 9.0 percent and in real terms, 7.1 percent.  Some 14 of the 21 reporting industries saw higher demand with petroleum and coal products (4.3 percent) and primary metals (5.8 percent) especially robust.   There was also a sizeable advance in autos (3.7 percent) as well as in aerospace products and parts (7.4 percent).  However, buoyancy here was to some extent offset by weakness elsewhere.  Hence, computers and electronics fell 4.4 percent on the month, beverages and tobacco was down 2.8 percent and chemicals dropped 0.4 percent.  The rest of the survey was mixed.  On the positive side, new orders were up 3.0 percent from last time and the inventory/sales ratio dropped from 1.35 months to 1.33 months.  However, backlogs were off 1.4 percent.  Overall the October report is consistent with a manufacturing sector that is still expanding, but not at the heady rates seen earlier in the year.  There is nothing here to make financial markets believe that the BoC will be making any change to official interest rates any time soon.

Bottom line

Over a holiday-shortened couple of weeks, falling volumes could make for some volatility in financial markets as few investors will be looking to take out new positions.  Recent positive economic news has made for a more constructive near-term backdrop but with the fiscal screw only just starting to turn, there is still considerable uncertainty about what lays ahead in 2011.  

Looking Ahead: December 20 through December 24, 2010

Looking Ahead: December 27 through December 31, 2010

Over the period to December 24 the BoE and RBA will both present minutes from their December meetings while the BoJ makes its announcement on policy Sunday.  In Europe economic data includes final third quarter GDP in the UK and producer prices in both France and Germany.  In Asia/Pacific Japan releases its all industry index for October and New Zealand its third quarter GDP accounts.  Canada sees retail sales, monthly GDP and November inflation. 

Over the following week revised third quarter GDP will be issued in France and the ECB will update M3 money supply.  Japan dominates the Asia/Pacific region, releasing new figures on inflation, unemployment and industrial production.