Global Markets

The first half of the week was spent waiting for the FOMC while the second half was spent reacting to it. And at the same time, a slew of economic data from the U.S., Europe and China indicated that growth was slowing globally.

But the FOMC was not the only market moving event. On Monday, investors had an opportunity to react to the results of the second election in Greece and the formation of a new pro-austerity government that would like to alter some of the bailout terms to stem the deleterious impact on growth that the current set of agreements has had. Then there was the G-20 meeting and ongoing meetings in Europe to stave off escalating problems with Spanish banks. At week’s end, Moody’s cut ratings on 15 large banks including five from the U.S., nine in Europe and the UK and one in Canada.

Group of 20 summit

The Group of 20’s two day summit was held in Los Cabos, a beach resort at the tip of Mexico's Baja California. At the conclusion, Europe won support from world leaders for an ambitious but slow moving overhaul of the Eurozone, even as pressure built in financial markets for quicker solutions to its debt crisis. Europe told a Group of 20 summit it intends to work on concrete steps to integrate its banking sectors, a major step long pressed by the United States and other nations to break the cycle of debt laden countries bailing out their troubled banks which only pushes governments ever deeper into debt.

G-20 leaders now await a European Union summit on June 28^th and 29^th where European officials say they will launch the long process of deeper integration starting with a push for banking union and with an aim of finalizing a broad plan by December. Financial markets have yet to be convinced about the chances of agreement. Germany has resisted taking on euro-wide financial risks if its citizens have to foot too much of the bill, while others, such as France and Italy, want to move more quickly.

Although the danger of Greece crashing out of the Eurozone eased after the weekend elections, risks are mounting that Spain will need an international rescue as its longer term debt yields hover above 7 percent, a level that has forced other euro countries to seek bailouts.

The FOMC re-twists

The FOMC announced on Wednesday that it is keeping the fed funds interest rate range at zero to 0.25 percent. At the same time, they extended ‘operation twist’ whereby they will replace short term securities with longer term debt by $267 billion through the end of the year in a bid to reduce unemployment and protect the expansion. The vote was 11 to 1 in favor of the policy. The continuation of the program is expected to put downward pressure on longer term interest rates and help to make broader financial conditions more accommodative. The extension was expected, but there were many market participants who thought that the Fed should do more to bolster the economy.

Flash PMIs — manufacturing continues to weaken globally

Flash manufacturing PMI readings continued to contract in June in Europe and China. The U.S. was the only country to show growth — albeit at a slower pace. The US index slipped to a reading of 52.9 from 53.9 in May. The reading signals a continuation of meaningful monthly growth in overall activity. The pace of activity may be a bit slower compared to the year to date average of 54.5, but individual readings on output and on new orders showed very little monthly change while employment growth, though slowing slightly, is still a big positive. China’s flash manufacturing index contracted for an eighth consecutive month due to weak export orders. The Markit/HSBC flash manufacturing index slid to a seven month low of 48.1.

In the Eurozone, the manufacturing sector continued to contract. At 44.8, the flash reading for June was once again shy of market expectations, down a further 0.3 points from the final May reading and at a three year low. Weakness in the headline reflected a fourth successive monthly decline in output and at its fastest pace in more than three years as well as a 13th consecutive drop in new orders. The survey also found the steepest decline in backlogs since June 2009 while employment was down more than in any month since January 2010. Among the core countries the German PMI worryingly shed a further 0.5 points to 44.7, a  three year low, while the French index was up 0.6 points to 45.3, a two month high, but still well short of the key 50 mark.

Global Stock Market Recap

Europe and the UK

Equities advanced last week despite falling back on Thursday and Friday on disappointing economic data in Europe and the U.S. along with continuing concerns over sovereign debt woes. Earlier in the week, equities were buoyed by the Greek election results and the formation of a coalition government. Both key German surveys from ZEW and Ifo declined while the flash manufacturing PMI indexes indicated further contraction. On the week, the FTSE, CAC, DAX and SMI advanced 0.6 percent, 0.1 percent, 0.5 percent and 1.3 percent respectively.

Shares declined Friday despite an announcement by the ECB that it will start accepting a wider range of collateral in its lending operations and assets of a lower quality. This is the second such move in six months to neutralize growing funding pressures on struggling banks. "The Governing Council has reduced the rating threshold and amended the eligibility requirements for certain asset backed securities (ABS)," the ECB said in a statement after its mid-month meeting, usually reserved for non-monetary policy issues. The changes, which will be worth over €100 billion and will come into force in the coming weeks, cover a range of assets. The move is the latest in a string of changes to ECB lending rules since the start of the crisis and the second loosening of its standards in just over six months to combat intensifying funding pressures on struggling Eurozone banks. The Bundesbank voiced its objections again on Friday after the latest changes.

A summit of leaders from Germany, France, Italy and Spain was held in Rome Friday. After the talks, Italian Prime Minister Mario Monti said the European Union should adopt pro-growth measures worth about 1 percent of the region's gross domestic product at the June 28^th and 29^th summit. But Italy, France and Spain made no perceptible progress in pushing Germany towards mutualizing Europe's debts or using existing bailout resources more flexibly. German Chancellor Angela Merkel did agree with leaders of France, Italy and Spain on a €130 billion package to revive growth. The measures, already in the works in Brussels, include increasing the European Investment Bank's capital, redirecting unspent EU regional aid funds and launching project bonds to co-finance major public investment programs. No new steps were announced on Friday.

Bank of England monetary policy committee minutes

Minutes of this month's monetary policy committee meeting confirmed expectations that members were widely split over what to do with monetary policy. Although the discussions left both Bank Rate (0.5 percent) and the asset purchase program ceiling (£325 billion) unchanged, four members, including Governor Mervyn King, were in a sizeable minority in seeking an increase in quantitative easing. Last month David Miles was the lone voice calling for additional stimulus. King, together with arch doves David Miles and Adam Posen, wanted an additional £50 billion worth of QE, raising the target to £375 billion, while Paul Fisher opted for a smaller £25 billion increase. This was the first time since August 2009 that the Governor has not voted in line with the majority. The remaining MPC members took the view that it would be better to wait and see how Eurozone developments unfolded, although all seemed to expect that an extra monetary stimulus would be necessary at some point. The tone of the minutes seemingly assures that the QE bar will be raised, either next month or in August to coincide with the release of the next Inflation Report. Indeed, already since the June meeting the BoE has indicated that it is working on new plans with the Treasury to ease banking sector funding costs following recent rises caused by financial stresses in the EMU area.

Asia Pacific

Equities were mixed as investors responded to the slew of market moving news during the week. For example, markets here rallied Monday as investors greeted the news that the ‘pro-austerity’ party had won the Greek election. But the enthusiasm was short lived and equities here followed European and U.S. markets mostly lower in subsequent trading sessions. Concerns about global growth dragged down equities as well.

Fragile global macroeconomic fundamentals are weighing on the markets, as the debt crisis in Europe continues to rage and recent global economic data vouch for the softening of economic conditions in the U.S. and China. On the week, five indexes declined while seven advanced. Declines ranged from 0.3 percent (All Ordinaries) to 2.0 percent (Shanghai Composite). Gains ranged from 0.1 percent (Sensex) to 3.8 percent (PSEi) and 2.7 percent (Nikkei).

Reserve Bank of India

The Reserve Bank of India shocked investors and left interest rates and required bank reserves unchanged Monday, defying widespread expectations for a interest rate cut. The RBI warned that relaxing policy could worsen inflation. Bonds, stocks and the rupee all fell. The RBI kept its policy repo rate unchanged at 8 percent and left the cash reserve ratio for banks at 4.75 percent, putting the onus on the government to take measures to revive flagging economic growth. "Further reduction in the policy interest rate at this juncture, rather than supporting growth, could exacerbate inflationary pressures," the RBI wrote in its mid-quarter policy review.

After cutting its policy rate by 50 basis points in April, the RBI had been widely expected to leave rates unchanged in June. But global and domestic economic conditions have deteriorated sharply since then, driving expectations that India would cut both interest rates and the cash reserve ratio. India's March quarter economic growth of 5.3 percent was far worse than expected and the weakest annual pace in nine years. The data sparked calls from industry for immediate action to lift an economy that Standard & Poor's says could be the first BRIC nation to lose its investment level credit rating. However, RBI Governor Duvvuri Subbarao had little room to maneuver after May benchmark inflation rose to 7.55 percent, below the double digits from last year but still highest among industrialized countries and the BRIC group of Brazil, Russia, India and China.

Reserve Bank of Australia meeting minutes

The minutes of the Reserve Bank of Australia’s June 5^th meeting noted that the decision to lower its key interest rate by 25 basis points to 3.5 percent came even after a “finely balanced” discussion. They noted that the domestic economy was holding up as global prospects worsened. The minutes noted that there was clear evidence “suggesting a softening in global conditions and uncertainty about the future in Europe had increased significantly.” The RBA noted that “with inflation expected to remain in the lower part of the targeting range over the next year or so, members considered that there was scope for monetary policy to be a little more supportive of domestic activity.” The RBA has cut the overnight cash rate target four times in the past eight months — by 25 basis points at successive meetings in November and December, by 50 points on May 1 and by another 25 points this month. Policy rates are near zero in the U.S. and Japan, 0.5 percent in the UK, 1 percent in the euro area and in Canada and 2.5 percent in New Zealand.

Currencies

The U.S. dollar advanced against all of its major counterparts last week as investors ducked risk and fled to the safety of the U.S. currency. On Tuesday the euro rallied to almost the highest level in a month against the dollar after a European Union official said a politically acceptable path will be sought for renegotiating Greece’s bailout conditions. At the same time, the U.S. currency fell against most of its major counterparts as the Federal Reserve started its two day meeting. Most primary dealers expected some form of added stimulus. The euro is down from this year’s high of $1.3487 on February 24^th even as it stabilized after the European Central Bank eased terms for collateral, boosting speculation the Bank will announce a third set of long term loans at its July meeting.

Selected currencies — weekly results

Indicator scoreboard

Germany

June ZEW survey’s expectations component showed the steepest decline, down nearly 28 points to a reading of minus 16.9, and its first negative reading and also its weakest level since January. The index has now shed more than 40 points since its recent April peak and, to make matters worse, the June decline was the sharpest since October 1998. At the same time, the current conditions measure lost almost 11 points to 33.2 also its lowest level since the start of the year. Uncertainty over the outcome of the Greek elections together with concerns about the ailing Spanish banking sector and, more generally, the outlook for German exports were cited as the main reasons for the notably more pessimistic assessment.

June Ifo business sentiment was down 1.6 points to 105.3 and its lowest level since March 2010. The current conditions edged up 0.7 points to 113.9 and came nowhere close to reversing May's 4.3 point decline, while expectations shed a further 3.5 points to 97.3, their lowest reading since October last year. Across the various sectors it was a mixed picture with some areas a little more confident and others notably less so. On the bright side, morale in retail gained 4 points to 0.3 and was also up 0.6 points to minus 4.6 in construction. However, manufacturing logged a fall in excess of 5 points to 5.0, services were off 3.5 points at 21.3 and wholesale lost 2.9 points to 5.0.

United Kingdom

May consumer prices edged down 0.1 percent on the month and were up 2.8 percent on the year. The annual rate was the first sub-3 percent reading and its lowest level since November 2009. The softness of the overall CPI was largely attributable to weakness in food, drink & petrol prices. Core CPI was up 0.1 percent from April and up 2.2 percent on the year. Elsewhere, annual inflation rates for most categories were little changed, the main exception being miscellaneous goods & services which posted a 0.6 percentage point drop to 2.1 percent. Inflation in the household sector was up 0.2 percentage points to a firm 3.9 percent but in recreation & culture, prices were down 0.7 percent on the year.

May claimant count unemployment jumped by 8,100 — the first increase since February and coming after a slightly shallower revised 12,800 decline in April. However, the jobless rate remained steady at 4.9 percent. By contrast the lagging ILO figures painted a stronger picture with unemployment on this measure down 51,000 over the three months to April. Employment was solid, up 166,000 while the jobless rate was unchanged at 8.2 percent.

May retail sales rebounded by 1.4 percent following a steeper revised and weather related plunge of 2.4 percent in April. Annual growth of volumes was 2.4 percent, up from down 1.1 percent last time. The headline data were flattered to a degree by a 6.2 percent monthly increase in auto fuel purchases without which sales would have advanced a more modest 0.9 percent. However, all areas made some progress and within a 1.3 percent increase in the non-food, ex-fuel sector, there were strong gains in non-store retailing (1.5 percent) and, in particular, clothing & footwear (3.4 percent). Household goods were up 0.7 percent from April, non-specialized stores 0.8 percent and food 0.2 percent. The ONS reported no evidence of any impact from the Jubilee celebrations which fell outside of the data's survey period.

Asia/Pacific

Japan

May unadjusted merchandise trade deficit ballooned to ¥907.3 billion. Both exports and imports were up on the year. Exports were up 10.0 percent on the year while imports were 9.3 percent higher. Exports to the U.S. soared 37.9 percent on the year. Exports sagged 0.9 percent to the EU, underlining fading European growth. Among Eurozone countries, exports declined to Germany, France and Italy. Exports to Asia were up 4.5 percent. They were up a modest 3.0 percent to China. On a seasonally adjusted basis, the merchandise trade deficit was ¥657.2 billion after recording a deficit of ¥512.0 in April. The May deficit was the 15th consecutive monthly deficit. Exports slipped 0.5 percent on the month while imports climbed 1.9 percent.

Americas

Canada

April retail sales declined 0.5 percent following a warm weather assisted 0.4 percent gain in March. The second decline in the last three months left purchases 3.4 percent above their year ago level. The drop in headline nominal sales was more than matched in the volume figures which showed a sizeable 0.8 percent monthly slide. Within total cash sales, eight of 11 subsectors posted monthly losses. Leading the way was motor vehicles & parts which registered a 1.2 percent decline and without which purchases would have fallen a shallower 0.3 percent from March and risen 2.5 percent from April 2011. The other main areas of weakness were clothing & accessory stores where sales were off 2.8 percent alongside sporting goods & hobbies (down 2.6 percent), electronics (down 1.6 percent) and building materials & garden equipment supplies (down 0.9 percent). Furniture and home furnishings dropped 0.8 percent and general merchandise 0.6 percent while food was down 0.3 percent. The best performing categories on the month were health & personal care (1.9 percent), gasoline (1.9 percent) and miscellaneous stores (0.7 percent).

May consumer prices edged down 0.1 percent and was 1.2 percent above a year ago — its lowest rate since the middle of 2010. Excluding food and energy, the CPI was up 0.1 percent from April and 1.5 percent on the year. The Bank of Canada’s preferred core CPI which excludes eight volatile items was up 0.2 percent and 1.8 percent. Seasonal factors had a small positive impact upon the monthly changes and adjusted for these the overall index was down 0.2 percent while the excluding food and energy CPI and BoC gauge were both unchanged at their respective April levels. Within the seasonally adjusted basket, the steepest increase was posted by food which saw a 0.4 percent monthly gain in prices while household operations, furnishings & equipment were 0.3 percent higher. Elsewhere prices were weak and there were monthly declines in clothing & footwear (0.8 percent) and, courtesy of lower energy costs, transportation (1.6 percent). Energy prices recorded their first annual decline (1.6 percent) since October 2009 while gasoline charges were down 2.3 percent from May 2011.

Bottom line

Market focus remained for the most part on the European debt situation and the series of meetings that were held to find a solution agreeable to all Eurozone members. At the same time, new economic data showed the impact that the crisis was having on global growth. The Federal Reserve did what traders expected — except it turns out that they wanted still more.

The EU holds a summit at week’s end to examine various alternatives that have been in process to resolve its pressing sovereign debt issues. New economic data releases in Europe and the Asia Pacific will be relatively light.

Looking Ahead: June 25 through June 29, 2012

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